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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)
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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?
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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)
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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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