Decision under risk

(tabular)
 SN1 - price of raw materials is SN2 - price of raw SN3 - price of raw
increasing materials is constant materials is decreasing
p1=0,5 p2=0,3 p3=0,2

C1 - C2 - C3 -
investment production quality of
C1 C2 C3 C1 C2 C3
volume cost the final
(mil EUR) (k EUR) product
A1 120 40 Extra 106 40 I 100 33 Extra
A2 200 30 I 110 35 Extra 110 32 III
A3 130 33 II 106 30 I 130 30 I
A4 160 32 II 100 35 II 106 35 II
MIN MIN MAX
Steps in solving the problem:

Step 1: We know the probabilities for

the States of Nature (SN) to occur – pi so
that Spi =1.
 Step 2: We determine the nature of
the criteria (MIN or MAX).

• C1 – Investment volume – MIN

• C2 – Production cost – MIN

• C3 – Quality of the final product – MAX

 Step 3: We calculate the individual
utilities (uij) taking into consideration the
values from the entire table.

• The most favourable consequence

receives „1”.

• The most unfavourable consequence

receives „0”.
c. The rest of the uij are calculated as
follows:

• c1. If the values are equally distributed or

the criteria are qualitative (text) we make
a scale.
• c2. If the values are not equally distributed
we use the formulas:

• For a MAX Criteria:

• For a MIN Criteria:
Individual utilities for C1 –
Investment volume - MIN
Individual utilities for C2
– Production cost - MIN
 0 0.33 0.66 1
Individual utilities for C3
III II I Extra – Quality of the final
product – MAX
 Step 4. We fit the individual utilities in
the table, replacing accordingly the original
values.
 uijk - individual utilities
SN1 p1=0,5 SN2 p2=0,3 SN3 p3=0,2
C1 C2 C3 C1 C2 C3 C1 C2 C3
A1 0.80 0 1 0.94 0 0.66 1 0.70 1
A2 0 1 0.66 0.90 0.50 1 0.90 0.80 0
A3 0.70 0.70 0.33 0.94 1 0.66 0.70 1 0.66
A4 0.40 0.80 0.33 1 0.50 0.33 0.94 0.50 0.33
MIN MIN MAX
 Step 5. We add the individual utilities
from within the same SN and we obtain a
combined (global) utility for each SN.
 uijk - individual utilities
SN1 p1=0,5 SN2 p2=0,3 SN3 p3=0,2
C1 C2 C3 C1 C2 C3 C1 C2 C3
A1 0.80 0 1 0.94 0 0.66 1 0.70 1
A2 0 1 0.66 0.90 0.50 1 0.90 0.80 0
A3 0.70 0.70 0.33 0.94 1 0.66 0.70 1 0.66
A4 0.40 0.80 0.33 1 0.50 0.33 0.94 0.50 0.33
MIN MIN MAX

A1 1.80 1.60 2.70

A2 1.66 2.40 1.70

A3 1.73 2.60 2.36

A4 1.53 1.83 1.77

 Step 6. We multiply each combined
(global) utility with the adequate pi on that
column.
 Step 7. The values obtained at Step 6
are added on the line obtaining the
Expected Monetary Value (EMV).
EMV(A1) = 0.5*1.80+0.3*1.60+0.2*2.70 = 1.92
EMV(A2) = 0.5*1.66+0.3*2.40+0.2*1.70 = 1.89
EMV(A3) = 0.5*1.73+0.3*2.60+0.2*2.36 = 2.11
EMV(A4) = 0.5*1.53+0.3*1.83+0.2*1.77 = 1.66
 uik– combined utilities

SN1 p1=0,5 SN2 p2=0,3 SN3 p3=0,2 EMV

A1 1.80 1.60 2.70 1.92

A2 1.66 2.40 1.70 1.89

A3 1.73 2.60 2.36 2.117

A4 1.53 1.83 1.77 1.668

 Step 8. The alternative with the
maximum EMV is considered the BEST
alternative (the optimal alternative).
Order of Alternatives:
1.A3
2.A1
3.A2
4.A4