DECISION UNDER RISK AND UNCERTAINTY

1. “Everything you gain in life will rock
and fall apart, and all that will be left of
you is what was in your heart.”

2. Decisions Under Risk and
Uncertainty
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3. Decision-making may be defined as the
process of selecting the suitable action from
among several alternative courses of action.
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The decision making process is constituted from
eight steps:
1. Identification of problem
2. Identification of criteria for decision making
3. Distribution of importance / weight of criteria
4. Development of alternatives
5. Analyse of alternatives
6. Selection of alternative
7. Execution of decision
8. Evaluation of effectiveness of decision

4. Risk and Uncertainty
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Risk refers to a situation in which possible
future events can be defined and probabilities
assigned.
Uncertainty refers to situations in which there
is no viable method of assigning probabilities to
future random events.

5. Decision-making under Risk
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Decision-making under Uncertainty
When a manager lacks perfect information or whenever an
information asymmetry exists, risk arises.
Risk is where you are unsure of what can happen, but you
know the likelihood of a particular outcome.
The decision-maker is not aware of all available alternatives,
the risks associated with each, and the consequences of
each alternative or their probabilities.

6. 2
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• Deductive and it goes by the name a
priori measurement
• Based on statistical analysis of data
and is called a posteriori
Concept of Decision-Making Environment

7. 2
Priori method-the decision-maker is able to
derive probability estimates without carrying
out any real world experiment or analysis.
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Posteriori measurement of probability is
based on the assumption that past is a true
representative of the future.

8. Modern Approaches to Decision-making under
Uncertainty:
• Risk analysis-involves quantitative and qualitative risk assessment,
risk management and risk communication
• Decision trees-involves a graphic representation of alternative
courses of action and the possible outcomes and risks associated
with each action.
• Preference theory-is based on the notion that individual attitudes
towards risk vary
-Risk averters
-Gamblers
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9. Managerial Economics

10. Characteristics of a Decision Problem
1. A decision-maker
2. Alternative courses of action (strategies)
3. Events or outcomes
4. Consequences or payoffs.
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11. Managerial Economics
The Payoff Matrix
A payoff matrix is an essential tool of
decision-making. It is a nice way of
summarizing the interactions of various
alternative action and events.

12. Managerial Economics
Alternatives=Decision Alternatives
Economic Conditions=State of Nature
Profits=Payoffs

13. Managerial Economics
The best of the bests: 45,70,53
Decision : Invest in Stocks

14. Managerial Economics
Maximizes the minimum Payoffs (Best of Worst)
Best of worst: 5,-13, -5
Decision: Invest in Bonds

15. Managerial Economics
Minimizes the Maximum Regret
Regret is the diffrence between best payoff and actual payoff received
Growing economy: best payoff is 70-40= 30(Regret)

16. Managerial Economics
Maximum
30
18
17
The minimum regret is 17
Decision: Invest in Mutual Funds

17. THANK YOU!
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