Decision-making conditions: Decision is made under three conditions: certainty, risk and uncertainty.

Certainty: When we have a feeling of complete belief or complete confidence in a single answer to the question is called certainty e.g. Decisions such as deciding on a new carpet for the office or installing a new piece of equipment or promoting an employee to a supervisory position are made with a high level of certainty. While there is always some degree of uncertainty about the eventual outcome of such decisions but there is enough clarity about the problem, the situation and the alternatives to consider the conditions to be certain. Risk: A state of uncertainty where some possible outcomes have an undesired effect or significant loss. Measurement of risk: A set of measured uncertainties where some possible outcomes are losses, and the magnitudes of those losses - this also includes loss functions over continuous variables. Uncertainty: The lack of certainty, A state of having limited knowledge where it is impossible to exactly describe existing state or future outcome, more than one possible outcome. Measurement of uncertainty: A set of possible states or outcomes where probabilities are assigned to each possible state or outcome - this also includes the application of a probability density function to continuous variables.

Example: Political Systems Inc. (PSI), a newly formed computer service firm specializing in information services such as surveys and data analysis for individuals running for political office. PSI is in the final stage of selecting a computer system for its Midwest branch located in Chicago .While the firm has decided on a computer manufacturer, it is currently attempting to determine the size of the computer system that would be the most economical to lease. Solution by using Payoff Tables: The first step is to identify the alternatives. For PSI, the final decision will be lease one of the three computer systems which differ in size and capacity. The three different alternatives denoted by d1, d2 and d3. D1=lease the large computer systems D2= lease the medium sized computer systems D3= lease the small computer systems Thus the PSI states of nature denoted S1 and S2, are as follows: S1= high customer acceptance of PSI services. S2= low customer acceptance of PSI services. For example, what profit would PSI experience if the firm has decided to lease the large computer system D1 and market acceptance was high S1? What profit would PSI experience if the firm has decided to lease the large computer system D1 and market acceptance was low S2? And so on. Payoff Table for the PSI Computer Leasing Problem Decision Alternatives Large System Medium System Small System d1 d2 d3 States of Nature High Acceptance Low Acceptance S1 S2 200000 -20000 150000 20000 100000 60000

Criteria for Decision Making under Uncertainty without using Probabilities: Three of the most popular criteria available for this case is maximin, maximax, minimax (regret). Maximin: The Maximin decision criterion is a pessimistic or conservative approach to arriving at a decision. In this approach the decision maker attempts to maximize the minimum possible profits; hence the term maximin. PSI minimum payoff ($) for each decision alternatives Minimum Payoff Large System Medium System Small System Maximax: Maximax provides an optimistic approach. Using this approach for maximization problems the decision maker selects the decision that maximizes the maximum payoff; hence the name maximax. PSI maximum payoff ($) for each decision alternative Maximum Payoff Large System Medium System Small System d1 d2 d3 200000 150000 100000 d1 d2 d3 -20000 20000 60000

Minimax Regret: The difference between the optimal payoff ($200,000) and the payoff experience ($100,000) is referred to as the opportunity loss or regret associated with our decision d3 when state s1 occurs i.e. 200,000-100,000=$100,000 and so on. Regret or opportunity loss for the PSI problem States of Nature Decision Alternatives Large System d1 High Acceptance S1 0 50000 100000 Low Acceptance S2 80000 40000 0

Medium System d2 Small System d3

The next step in applying the minimax regret criterion requires the decision analysis to identify the maximum regret for each decision alternative. The final decision is made by selecting the alternative corresponding to the minimum of the maximum regret values; hence the name minimax regret. For the PSI problem the decision to lease a medium size computer system with a corresponding regret of $50,000, is the recommended minimax regret decision. PSI maximum regret for each decision alternative

Decision Alternatives Large System Medium System Small System d1 d2 d3

Maximum Regret or Opportunity Loss 80000 50000 100000

Example 2:

Allison Tate runs a small company that manufacturers low-cost ergonomic chairs, sold via the Internet. Her firm has several popular models, each with annual sales of $200,000 to $450,000. She has an opportunity to invest in a new technology of manufacturing chairs. Tate knows that a new facility will cost $300,000 and is unsure whether there will be sufficient demand for the chair to cover this large investment. If the market is good, she thinks sell 8,000 chairs at a profit of $100 each, generating a cash flow with present value of $800,000. On the other hand, if the market is poor, she thinks she might sell only 1,000 chairs, generating a cash flow with present value of $100,000.How should she make decision?

Solution of Example 2 using Decision Tree

320,000 Mkt. Favor 320,000 0.4 Mkt. Un Favor 800,000

0.6 120,000

200,000