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331-16 Carmen

# 331-16 Carmen - Chapter 8 continued Decision Analysis...

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Chapter 8 continued: Decision Analysis Adding RISK

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Decision Making Under Risk Probabilities of outcomes are available Expected Monetary Value (EMV) uses the probabilities to calculate the average payoff for each alternative EMV (for alternative i ) = (probability of outcome) x (payoff of outcome)
A Simple Example Ohio Lottery Pick 3 Select three numbers from 0-9 with repeats OK Buy a ticket for \$1 for a single payout of \$ 500 for guessing correctly The probability of guessing one number is 1/10; the probability of guessing three in exact sequence (= straight bet ) is 1/10 x 1/10 x 1/10 or 0.001

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A Simple Example EMV (for Winning the Pick 3 Lottery) = (probability of outcome) x (payoff of outcome) = 0.001 x \$500 + 0.999 x \$0 = \$0.50 Is the Pick 3 a good bet?
Alternatives Outcomes (Demand) High Moderate Low Large plant \$200,000 \$100,000 -\$120,000 Small plant \$90,000 \$50,000 -\$20,000 No plant \$0 \$0 \$0 Probability of outcome 0.3 0.5 0.2 EMV \$86,000 \$48,000 \$0 Expected Monetary Value (EMV) Method Choose the large plant

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Expected Opportunity Loss (EOL) How much regret do we expect based on the probabilities of the different outcomes? EOL (for alternative i ) = ∑(probability of outcome) x (regret of outcome)
Alternatives Outcomes (Demand) High Moderate Low Large plant \$0 \$0 \$120,000 Small plant \$110,000 \$50,000 \$20,000 No plant \$200,000 \$100,000 \$0 Probability of outcome 0.3 0.5 0.2 EOL \$24,000 \$62,000 \$110,000 Choose the large plant Regret (Opportunity Loss) Values

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Perfect Information Perfect Information would tell us with certainty which outcome is going to occur
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