Problems (Decision Making Under Uncertainty)

(1) The given matrix shows the payoff (Profit in Rs.) of differ-
ent strategies (alternatives). A
1
, A
2
& A
3
against states of
nature (conditions) E
1
, E
2
, E
3
and E
4
.
Indicate the decision taken under the following approach:
(i) Laplace Criterion (ii) Maximin Criterion
(iii) Maximax Criterion (iv) Regret Criterion and
(v) Hurvicz Criterion, the degree of optimism being 0.7.
Solution-
(i) Laplace Criterion: Since the probabilities of the states of nature are not known, we assume that they are
equal. In this case we assume that each of the four states of nature has probability 1/4 of occurrence. Thus
the expected pay off (profits) corresponding to each of the three strategies is as follows
Strategy A1 : D(4000 - 100 + 6000 + 18000) = 6975
Strategy A2 : D(20000 + 5000 + 400 + 0) = 6350
Strategy A3 : D(20000 + 15000 - 2000 + 1000) = 8500
(ii) Maximin Criterion: For the given pay off matrix the minimum assured payoff for each alternative are
A
1
: -100, A
2
: 400, A
3
: -2000
Since the maximum of these minimum payoffs is 400, the
alternative A
2
is selected according to the Maximin Criterion.
(ii) Maximax Criterion: For the given pay off matrix the Maximum
assured payoff for each alternative are
A
1
: 18000, A
2
: 20000, A
3
: 20000
Since the maximum of these maximum payoffs is 20000, any
one of the alternatives A
2
& A
3
can be selected according to the Maximax Criterion.
(ii) Regret Criterion: When event E
1
Occurs, the regret
payoffs for A
1
, A
2
& A
3
are obtained by subtracting
the each payoff from the maximum payoff i.e. 20000;
When event E
2
Occurs, the regret payoffs for A
1
,
A
2
& A
3
are obtained by subtracting the each payoff
from the maximum payoff i.e. 15000; When event
E
3
Occurs, the regret payoffs for A
1
, A
2
& A
3
are
obtained by subtracting the each payoff from the
maximum payoff i.e. 6000 & When event E
4
Occurs, the regret payoffs for A
1
, A
2
& A
3
are obtained by
subtracting the each payoff from the maximum payoff i.e. 18000.
Since the alternative A
1
corresponds to the minimum of the maximum regrets, the decision maker would
choose A
1
.
(ii) Hurvicz Criterion: As shown in the table given, we calculate the payoff values corresponding to each of the
alternatives.
Since the payoff corresponding to the alternative A
2
is maximum, the decision maker would choose A
2
.

(Strategies) Alternative
States of Nature

A
1
A
2
A
3

E
1
4000 20000 20000
E
2
-100 5000 15000
E
3
6000 400 -2000
E
n
18000 0 1000

(Strategies) Alternatives
States of Nature

A
1
A
2
A
3

E
1
4000 20000 20000
E
2
-100 5000 15000
E
3
6000 400 -2000
E
n
18000 0 1000
Column Minimum -100 400 -2000
Column Maximum 18000 20000 20000

(Strategies) Alternatives Regret Payoffs States of
Nature

A1 A2 A3

A1 A2 A3
E1 4000 20000 20000*

16000 0 0
E2 -100 5000 15000*

15100 10000 0
E3 6000* 400 -2000

0 5600 8000
En 18000* 0 1000

0 18000 17000
Maximum Regret 16000 18000 17000


(St rat egies) Alt ernat ives
St at es of Nat ure

A
1
A
2
A
3

E
1
4000 20000 20000
E
2
-100 5000 15000
E
3
6000 400 -2000
E
n
18000 0 1000
(i) Maximum Payof f 18000 20000 20000
(ii) M inimum Payof f -100 400 -2000
H = 0.7 X (i) + 0.3 X (ii) 12570 14000 13400
Decision Making Under Risk
When a decision maker chooses from among several possible options whose probabilities of occurrence can be
stated, he is said to take decision under risk.The probaboilities of various outcomes may be determined
objectively from the past data. If past records are not available to arrive at the objective probabilities than the
decision maker may, on the basis of his /her experience and judgement, be able to assign subjective
probabilities to the various outcomes.
the most popular decision criterion for evakluating the alternatives is the expected monatary value / expected
opportunity loss of the expected pay-off.These criterion are discussed below:
(i) Expected Monetary Value (EMV) Criterion: The expected monatery value for a given course of action is
the weighted average payoff, which is the sum of the payoffs for each course of action multiplied by the
probabilities associated with each state of nature. Mathematically EMV is stated as follows:
EMV (S
j
) = a
ij
p
i
Where m = number of possible states of nature
p
i
= probability of occurrence of states of nature i
a
ij
= probability of associated with the state of nature E
i
and course of action A
j
.
The EMV criterion may be summarized as follows:
Step 1 - List all possible courses of action and the states of naturte. Enter the conditional payoff values
associated with each possible course of action and state of nature along with the probabilities of the
occurrence of each state of nature.
Step 2 - Calculate the EMV for each Course of action by multiplying the conditional payoffs by the associated
probabilities and these weighted values for each course of action.
Step 3 - Select the Course of action which corresponds to the optimal EMV.
(ii) Expected Opportunity Loss (EOL) Criterion: An alternative approach to maximizing EMV is to minimize
the expected opportunity loss (EOL) also called expected value of regret.
Since EOL is an alternative decision criterion for decision-making under risk, therefore the results will
always be the same as those obtained by EMV criterion earlier. Thus only one of the two methods should be
applied to reach a decision.
The EOL criterion may be summarized as follows:
Step 1 - List all possible courses of action and the states of naturte. Enter the conditional payoff values
associated with each possible course of action and state of nature along with the probabilities of the
occurrence of each state of nature.
Step 2 - Calculate the Conditional Opportunity Loss (COL) value for each State of Nature by subtracting
each payoff from the maximum payoff for that event.
Step 3 - For each course of action, determine the expected COL values by multiplying the probability of
each state of nature with the COL value and then adding the values.
Step 4 - Select a course of action for which the EOL value is minimum.
(iii) Expected Value of Perfect Information (EVPI): The expected profit with perfect information (EPPI) is the
expected return, in the long run, if we have the perfect information before a decision is made. The Expected
Value of Perfect Information (EVPI) may be defined as the maximum amount one would be willing to pay to
acquire perfect infoemation as to which event (state of nature) would occur. EPPI represents the maximum
obtainable EMV with perfect information as to which event will actually occur. If EMV* represents the
maximum obtainable EMV without perfect information, perfect information would increase the expected profit
from EMV* upto the value of EPPI. This inclrease is equal to EVPI i.e.
EVPI = EPPI - EMV*