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MSA.640.CHAPTER3

# MSA.640.CHAPTER3

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07/08/2013

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CHAPTER 3 DECISION ANALYSISDiscussion Questions
3-5.1.What techniques are used to solve decision ±making problems under uncertainty?a. Maximax (optimistic) b. Maximin (pessimistic)c. Criterion of realism (Hurwicz)d. Equally likely (Laplace)e. Minimax regret2. Which technique results in optimistic decision?a. The decision criterion locates the alternative with the highest possible gain; it has beencalled an optimistic decision criterion.3. Which technique results in a pessimistic decision?a. This decision criterion locates the alternative that gives the best of the worst payoff,and thus it has been called a pessimistic decision criterion.3-6.Define
opportunity loss
± The amount you would lose by not picking the best alternative. For any state of nature, this is the difference between the consequences of any alternative and the best possible alternative.What decision ±making criteria are used with an opportunity loss table?Minimax regret criterion is based on opportunity loss3-7. What information should be placed on a decision tree?1.

Define the problem2.

List the possible outcomes3.

Identify the possible outcomes4.

List the payoff of each combination of alternatives and outcomes5.

Select a mathematical decision theory model6.

Apply the model and make decision

3-8.Describe how you would determine the best decision using the EMV criterion with a decisiontree.
Problems
3-16. Avrat Singh is the principal owner f Murugan Oil, Inc. After quitting his universityteaching job, Avrat has been able to increase his annual salary by a factor of over
100
. At the present time, Avrat is forced to consider purchasing some more equipment for Murugan Oil because of competition. His alternatives are shown in the following table:Avrat decides that his alternatives are to
y

Decision making under uncertainty
(environments)
y

M
aximax criterion
( uncertainty)
y

Sub 100
3-18. The
L
ubricant
is an expensive oil newsletter to which many oil giants subscribe, includingAvrat Sing. In the last issue, the letter described how the demand for oil products would beextremely high. Apparently, the American consumer will continue to use oil products even if the price of the Lubricant states threat the chances of a favorable market for oil products was 70%,while the chance of an unfavorable market was only 30%.
Avrat would like to use these probabilities in determining the best decisions
.
a.

What decision model should be used?
M
aximizing Probabilities E
MV
expected monetaryvalue
b.

What is the optimal decision?
Avrat purchases a Sub
100
c.

Avrat believes that the \$300,000 figures for the Sub 100 with a favorable market are toohigh. How much lower would this figure have to be for Avrat to change his decisionmade in part b? \$7143 or lower

3-19. Shir Khan is considering investing some money that he inherited. The following pay off table gives the profits that would be realized during the next year for each of three investmentalternatives Shir is considering State of NatureDecision Good Poor Alternative Economy EconomyStock Market 80,000 -20,000Bonds 30,000 20,000CDs 23,000 23,000Probability 0.5 0.5a.

What decision would maximize expected profits?EVPI = Expected value with perfect information ± maximum EMV1.

The best alternative for the state of nature ³favorable market´ is build in the Stock Market with a payoff of 80,000. The alternative for the state of nature ³unfavorablemarket´ is ³do nothing´, with a payoff of \$0.EVwPI = (\$80,000)(0.5) + (\$0)(0.5)= \$40,000Thus, if we had perfect information, the payoff would average \$40,000 b.

What is the maximum amount that should be paid for a perfect forecast of the economy?1.

The maximum, EMV without additional information is \$30,000Therefore, the increase in EMV isEVPI = (expected value with perfect information) ± (maximum EMV)= \$80,000 - \$30,000= \$50,000

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