DECISION MAKING WITH PROBABILITIES

- Also known as Probabilistic Decision Criteria

- obtain probability assessments for the states of nature
- when probabilities are available, we can use expected value approach to identify the
best decision alternative

1. EXPECTED VALUE APPROACH

The expected value of a decision alternative is the sum of weighted payoffs for the
decision alternative. The weight for a payoff is the probability that the payoff will occur or the
probability associated state of nature.

Summary of Decision Tree Approach:

1. Draw the decision tree consisting of decision and state-of-nature nodes and branches that
describe the sequential nature of the problem.
2. For the expected value approach, determine the probabilities for each of the state-of-
nature branches.
3. Calculate the expected value at each state-of-nature node.
4. Select the decision branch leading to the state-of-nature node with the best (highest)
expected value. The decision alternative associated with this branch is the recommended
decision.

2. EXPECTED VALUE OF PERFECT INFORMATION

- To determine the potential value by assuming that the study could provide perfect
information regarding the state of nature.

3. EXPECTED OPPORTUNITY LOSS

Regardless of whether the decision analysis involves maximization or minimization, the
minimum expected opportunity loss always provides the best decision alternative. The
minimum expected opportunity loss is always equal to the expected value of perfect
information.

EOL(best decision) = EVPI