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# The principle of insufficient reason 2013 27 qso 510

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The Principle of Insufficient Reason 2013 27 QSO 510 Principle of Insufficient Reason

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Decision Alternatives States of Nature Criterion: Sum Large Rise Small Rise No Change Small Fall Large Fall Payoff Gold -100 100 200 300 0 500 Bond 250 200 150 -100 -150 350 Stock 500 250 100 -200 -600 50 C/D account 60 60 60 60 60 300 Principle of Insufficient Reason To find an optimal decision: For each decision, find the sum (average) of all the payoffs. Select the decision with the largest sum (average). 2013 QSO 510 28
Criterion of Realism Approach This criterion might appeal to a decision maker who is neither pessimistic nor optimistic. It is “realistic” in that instead of selecting the row minimum or maximum, a weighted average of the minimum and the maximum is used. Weighted Average = (row max) + (row min) The weights used depend on the coefficient of realism ( ). If , then it becomes the same as the pessimistic approach If , then it becomes the same as the optimistic approach 2013 QSO 510 29

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Decision Alternatives States of Nature Weighted Large Rise Small Rise No Change Small Fall Large Fall Payoff Gold -100 100 200 300 0 100 Bond 250 200 150 -100 -150 50 Stock 500 250 100 -200 -600 -50 C/D account 60 60 60 60 60 60 Criterion of Realism Approach To find an optimal decision: For each decision, find the max and min payoff, and calculate the weighted average. Weighted Average = (row max) + (row min) Select the decision with the largest weighted average. 2013 QSO 510 30 (0.5)(300)+(0.5)(-100) = 100
The Maximax (Optimistic) Criterion 2013 31 QSO 510 Solomon’s Gas Station Decision: Size of gas station Good Market Fair Market Poor Market Criterion: Row Max Small 50,000 20,000 -10,000 50,000 Medium 80,000 30,000 -20,000 80,000 Large 100,000 30,000 -40,000 100,000 Very large 300,000 25,000 -160,000 300,000

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The Principle of Insufficient Reason 2013 32 QSO 510 Solomon’s Gas Station Decision: Size of gas station Good Market Fair Market Poor Market Criterion: Sum of Row Small 50,000 20,000 -10,000 60,000 Medium 80,000 30,000 -20,000 90,000 Large 100,000 30,000 -40,000 90,000 Very large 300,000 25,000 -160,000 165,000
Criterion of Realism Approach 2013 33 QSO 510 Solomon’s Gas Station Decision: Size of gas station Good Market Fair Market Poor Market Criterion: Weighted Ave Small 50,000 20,000 -10,000 20,000 Medium 80,000 30,000 -20,000 30,000 Large 100,000 30,000 -40,000 30,000 Very large 300,000 25,000 -160,000 70,000

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Payoff Table Decision Making Under Uncertainty Decision Making Under Risk Decision Tree* Decision Analysis 2013 34 QSO 510
Decision Making Under Risk The probability estimate for the occurrence of each state of nature (if available) can be incorporated in the search for the optimal decision. For each decision calculate its expected payoff. (The summation is calculated across all the states of nature) Select the decision with the best expected payoff 2013 QSO 510 35 Expected Payoff = Σ ( Probability * Payoff)

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