Decision-making conditions:

Decision is made under three conditions: certainty, risk and uncertainty.

Certainty:
When we have a feeling of complete belief or complete confidence in a single answer to
the question is called certainty e.g. Decisions such as deciding on a new carpet for the
office or installing a new piece of equipment or promoting an employee to a supervisory
position are made with a high level of certainty.
While there is always some degree of uncertainty about the eventual outcome of such
decisions but there is enough clarity about the problem, the situation and the alternatives
to consider the conditions to be certain.

Risk:
A state of uncertainty where some possible outcomes have an undesired effect or
significant loss.

Measurement of risk:
A set of measured uncertainties where some possible outcomes are losses, and the
magnitudes of those losses - this also includes loss functions over continuous variables.

Uncertainty:
The lack of certainty, A state of having limited knowledge where it is impossible to
exactly describe existing state or future outcome, more than one possible outcome.

Measurement of uncertainty:
A set of possible states or outcomes where probabilities are assigned to each possible
state or outcome - this also includes the application of a probability density function to
continuous variables.
Example:
Political Systems Inc. (PSI), a newly formed computer service firm specializing in
information services such as surveys and data analysis for individuals running for
political office. PSI is in the final stage of selecting a computer system for its Midwest
branch located in Chicago .While the firm has decided on a computer manufacturer, it is
currently attempting to determine the size of the computer system that would be the most
economical to lease.

Solution by using Payoff Tables:

The first step is to identify the alternatives. For PSI, the final decision will be lease one
of the three computer systems which differ in size and capacity. The three different
alternatives denoted by d1, d2 and d3.
D1=lease the large computer systems
D2= lease the medium sized computer systems
D3= lease the small computer systems
Thus the PSI states of nature denoted S1 and S2, are as follows:
S1= high customer acceptance of PSI services.
S2= low customer acceptance of PSI services.
For example, what profit would PSI experience if the firm has decided to lease the large
computer system D1 and market acceptance was high S1? What profit would PSI
experience if the firm has decided to lease the large computer system D1 and market
acceptance was low S2? And so on.
Payoff Table for the PSI Computer Leasing Problem

States of Nature
Decision
High Acceptance Low Acceptance
Alternatives S1 S2
Large System d1 200000 -20000
Medium System d2 150000 20000
Small System d3 100000 60000
Criteria for Decision Making under Uncertainty without using Probabilities:
Three of the most popular criteria available for this case is maximin, maximax, minimax
(regret).

Maximin:
The Maximin decision criterion is a pessimistic or conservative approach to arriving at a
decision. In this approach the decision maker attempts to maximize the minimum
possible profits; hence the term maximin.
PSI minimum payoff ($) for each decision alternatives

Minimum Payoff
Large System d1 -20000
Medium System d2 20000
Small System d3 60000

Maximax:
Maximax provides an optimistic approach. Using this approach for maximization
problems the decision maker selects the decision that maximizes the maximum payoff;
hence the name maximax.
PSI maximum payoff ($) for each decision alternative

Maximum Payoff
Large System d1 200000
Medium System d2 150000
Small System d3 100000
Minimax Regret:
The difference between the optimal payoff ($200,000) and the payoff experience
($100,000) is referred to as the opportunity loss or regret associated with our decision d3
when state s1 occurs i.e. 200,000-100,000=$100,000 and so on.
Regret or opportunity loss for the PSI problem

States of Nature

High Acceptance Low Acceptance

Decision
Alternatives S1 S2

Large System d1 0 80000

Medium System d2 50000 40000

Small System d3 100000 0

The next step in applying the minimax regret criterion requires the decision analysis to
identify the maximum regret for each decision alternative. The final decision is made by
selecting the alternative corresponding to the minimum of the maximum regret values;
hence the name minimax regret. For the PSI problem the decision to lease a medium size
computer system with a corresponding regret of $50,000, is the recommended minimax
regret decision.
PSI maximum regret for each decision alternative

Decision Alternatives Maximum Regret or Opportunity Loss

Large System d1 80000

Medium System d2 50000

Small System d3 100000

Example 2:
Allison Tate runs a small company that manufacturers low-cost ergonomic chairs, sold
via the Internet. Her firm has several popular models, each with annual sales of $200,000
to $450,000. She has an opportunity to invest in a new technology of manufacturing
chairs. Tate knows that a new facility will cost $300,000 and is unsure whether there will
be sufficient demand for the chair to cover this large investment. If the market is good,
she thinks sell 8,000 chairs at a profit of $100 each, generating a cash flow with present
value of $800,000. On the other hand, if the market is poor, she thinks she might sell only
1,000 chairs, generating a cash flow with present value of $100,000.How should she
make decision?

Solution of E
Decisi

3
Mkt.

320,000