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Step-by-Step Exercises on Decision Making under Risk

- Minimum EOL Approach BSNS2120, J. Wang
Name __J. Wang_______
A payoff table is given as below.
States of Nature
A
B
C
Alternatives P(A)=0.7 P(B)=0.1 P(C)=0.2
1
120
-100
60
2
90
100
70
3
80
100
80
4
-50
80
90
Col. Max
120
100
90
Part 1. Select the best decision by using the Minimum EOL Approach.
(EOL = Expected Opportunity Loss)
Do the three steps below (Show your calculations):
Step 1.
Construct the opportunity loss table.
(a) Calculate the maximum payoff of each column (each state of nature); Put you result
into the table above.
(b) Calculate the opportunity loss of each cell below.
Example: Opportunity loss for cell ‘A2’
= maximum payoff in column A – payoff in cell ‘A2’.
Opportunity loss for cell ‘C3’
= maximum payoff in column C – payoff in cell ‘C3’.
The opportunity loss table (Regret table).
States of Nature
A
B
C
Alternatives P(A)=0.7 P(B)=0.1 P(C)=0.2
1
0
200
30
2
30
0
20
3
40
0
10
4
170
20
0
Is the following statement true or false?
Opportunity losses can never be negative.
a. True
b. False

1 + 10*0.1 +0*0. 2 .7 + 0*0. EOL(Alt. with EOL= 25. a.1 + 20*0. which is Alt.2 = 26 30*0.2 = 25 40*0.7 + 0*0.1 + 10*0.7 + 20*0.1 + 20*0.2 = 121 (2) Circle and label the best decision and its EOL in the table.7 + 20*0.2 = 25. Compare the result we have here to those we had in Exercise on EMV and EVPI. (1) Put your results in Part 1 into the extended opportunity loss table below.7 P(B)=0.7 + 0*0. False .Step 2. Minimum EOL = EVPI.2 = 26.2 1 0 200 30 2 30 0 20 3 40 0 10 4 170 20 0 Expected Opportunity Loss (EOL) 0*0.1 + 30*0.1 + 0*0. EOL(Alt. 4) = 170*0. Calculate the expected opportunity loss for each alternative. Pick up the alternative with Minimum EOL.2 = 30. EOL(Alt.7 + 200*0. Calculations in Part 1 can be put in the extended opportunity loss table. Part 3.2 = 30 170*0.1 + 30*0. Step 3.2 = 121. The decision from the Minimum EOL Approach is the same as the decision from the Maximum EMV Approach is. EOL(Alt. 1.7 + 0*0. 3) = 40*0. Extended opportunity losses (regrets) table: States of Nature A B C Alternatives P(A)=0. False 2.1 P(C)=0. 2) = 30*0. Part 2.7 + 200*0. True b. 1) = 0*0. a. True b.