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Taylor III
Chapter Topics
Components of Decision Making Decision Making without Probabilities Decision Making with Probabilities Decision Analysis with Additional Information
Decision-Making Criteria: maximax, maximin, minimax, minimax regret, Hurwicz, and equal likelihood
Chapter 12 - Decision Analysis 4
In the maximax criterion the decision maker selects the decision that will result in the maximum of maximum payoffs; an optimistic criterion.
Decision
Apartment building Office building
Values
$ 50,000(0.4) + 30,000(0.6) = 38,000 $ 100,000(0.4) - 40,000(0.6) = 16,000
Warehouse
Chapter 12 - Decision Analysis
Decision (Purchase) Office building Apartment building Apartment building Apartment building Apartment building
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EV(Apartment) = EV(Warehouse) =
Chapter 12 - Decision Analysis
Table 12.8 Regret (Opportunity Loss) Table with Probabilities for States of Nature
EVPI equals the expected value given perfect information minus the expected value without perfect information.
EVPI equals the expected opportunity loss (EOL) for the best decision.
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Figure 12.2 Decision Tree with Expected Value at Probability Nodes Chapter 12 - Decision Analysis 19
Table 12.11 Payoff Table for the Real Estate Investment Example
Chapter 12 - Decision Analysis 20
Economic analyst provides additional information for real estate investment decision, forming conditional probabilities:
g = good economic conditions
P(Pg) = 0.80
P(Pp) = 0.10
Chapter 12 - Decision Analysis
P(Ng) = 0.20
P(Np) = 0.90
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Prior probabilities for good or poor economic conditions in real estate decision: P(g) = 0.60; P(p) = 0.40 Posteria probabilities by Bayes rule:
Decision Analysis with Additional Information Computing Posterior Probabilities with Tables
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Decision Analysis with Additional Information Decision Trees with Posterior Probabilities (1 of 4)
Decision tree with posterior probabilities differ from earlier versions in that: Two new branches at beginning of tree represent report outcomes.
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Decision Analysis with Additional Information Decision Trees with Posterior Probabilities (2 of 4)
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Decision Analysis with Additional Information Decision Trees with Posterior Probabilities (3 of 4)
EV (apartment building) = $50,000(0.923) + 30,000(0.077) = $48,460 EV (strategy) = $89,220(0.52) + 35,000(0.48) = $63,194
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Decision Analysis with Additional Information Decision Trees with Posterior Probabilities (4 of 4)
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Status quo
Sell
650,000
980,000
Expand
Status quo Sell
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Sell
Step 2 (part b): Determine Decisions with EV and EOL. Expected value decision: Maintain status quo
Expand
Status quo Sell
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Sell
Step 3 (part c): Compute EVPI. EV given perfect information = 1,300,000(0.7) + 500,000(0.3)
= $1,060,000
EV without perfect information = $1,300,000(0.7) - 150,000(0.3) = $865,000
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