DECISION THEORY Payoff Matrix = S2 2250

Decision Making – continuous process which involves

selecting the best among several decisions
CATEGORIES
I. Decision under certainty – a deterministic
decision because all information is available
II. Decision under risk – availability of
information is partial, can be classified for
probability distribution
III. Decision under uncertainty – Available
information is incomplete
[in case it was a cost matrix instead of payoff
matrix, apply same the same formula, select the
least value]
Cost Matrix = S1 212.50
2. Criterion of Optimism
- Maximax Criterion = applicable for payoff
matrix
First: find out the maximum value

DECISION UNDER UNCERTAINTY N1 N2 N3 N4 Max.

S1 1000 1500 750 0 1500
1. Laplace criterion/ equal probability/ rationality S2 250 2000 3750 3000 3750
– (Bayes Criterion) S3 -500 1250 3000 4750 4750
First: find the expected value of each strategy S4 -1250 500 2250 4000 4000
Choose from the max, which has the highest value
Formula : 1/n [P1+P2+….+Pn]
And that is S3 4750 = best alternative
Problem: The following matrix gives the payoff of
- Minimum Criterion = applicable for cost
different strategies (alternatives) S1,S2, S3, and S4
matrix
against conditions (events) N1,N2,N3, and N4
N1 N2 N3 N4 Min
N1 N2 N3 N4
S1 1000 1500 750 0 0
S1 1000 1500 750 0
S2 250 2000 3750 3000 250
S2 250 2000 3750 3000
S3 -500 1250 3000 4750 -500
S3 -500 1250 3000 4750
S4 -1250 500 2250 4000 -1250
S4 -1250 500 2250 4000
Minimum of the min value
Select best alternative
Use formula where we can get the value of each Therefore, S4 -1250 is the best alternative
strategy
Expected Payoff= 1/n [P1+P2+….+Pn] 3. Criterion of Pessimism (Wald Criterion)
- Maximin Criterion = applicable for payoff
N = number of events
matrix
P1,P2,P3,P4 = payoff value of each alternatives Find the minimum value and after you have to make
S1 = ¼ [1000+1500+750+0] = 812.50 the decision basing on the max value

S2 = ¼ [250+2000+3750+3000] = 2250 N1 N2 N3 N4 Min

S1 1000 1500 750 0 0
S3 = ¼ [-500+1250+3000+4750] = 2125 S2 250 2000 3750 3000 250
S4 = ¼ [-1250+500+2250+4000] = 1375 S3 -500 1250 3000 4750 -500
S4 -1250 500 2250 4000 -1250
N1 N2 N3 N4 EP Choose the highest or maximum based on the
S1 1000 1500 750 0 812.50 minimum value, so that would be S2 250, best
S2 250 2000 3750 3000 2250 alternative
S3 -500 1250 3000 4750 2125
S4 -1250 500 2250 4000 1375 - Minimax Criterion = applicable for cost
Since it is a payoff matrix, we need to select the matrix
highest payoff or profit which is the 2250 Find out the maximum value of each alternative and
S2 is the best alternatives, has the maximum payoff then choose the smallest or the minimum
 N1 N2 N3 N4 Max. S3 750 750 2250 4750
S1 1000 1500 750 0 1500 S4 0 0 2500 4000
S2 250 2000 3750 3000 3750 Apply Minimax Criterion
S3 -500 1250 3000 4750 4750
S4 -1250 500 2250 4000 4000 N1 N2 N3 N4 Max
Therefore S1, 1500 is the best alternative S1 2250 1000 0 0 2250
S2 1500 1500 3000 3000 3000
4. Minimax Regret Criterion (Savage Criterion) S3 750 750 2250 4750 4750
- Maximization Problem = S4 0 0 2500 4000 4000
Choose the lowest value in the max column
Formula :
S1 2250 = Best alternative
RT (regret table) = Max payoff – payoff
5. Hurwicz Criterion (Criterion of Realism)
- Minimization Problem
- Maximization Problem – Payoff matrix
Formula : RT = Cost- Mini Cost
3 steps
MAXIMIZATION PROBLEM: - payoff matrix 1st = find the max value
2nd = find the minimum value
N1 N2 N3 N4 3rd = Weighted Outcomes WO
S1 1000 1500 750 0
S2 250 2000 3750 3000 N1 N2 N3 N4 Max. Min WO
S3 -500 1250 3000 4750 S1 1000 1500 750 0 1500 0 900
S4 -1250 500 2250 4000 S2 250 2000 3750 3000 3750 250 2350
Maximum Pay off N1 column = 1000 S3 -500 1250 3000 4750 4750 -500 2650
Subtract it with the value or pay off of each column S4 -1250 500 2250 4000 4000 - 1900
N1 N2 N3 N4 1250
S1 0 500 3000 4750 Formula of Weighted outcome
S2 750 0 0 1750
S3 1500 750 750 0
S4 2250 1500 1500 750 Alpha Symbol =0.6
Apply Minimax Criterion
WO = Alpha . Max + (1- Apha). Min
N1 N2 N3 N4 MAX
S1 0 500 3000 4750 4750 S1 = (0.6x1500) + (1-0.6) x 0
S2 750 0 0 1750 1750
= 900+0
S3 1500 750 750 0 1500
S4 2250 1500 1500 750 2250 =900
Choose the smallest value in the Max column
S2 = (0.6x3750) +(0.4x250)
S3 1500 = best alternative
=2250+100
MINIMIZATION PROBLEM – cost matrix
=2350
N1 N2 N3 N4
S1 1000 1500 750 0 S3 = (0.6x4750) + (0.4x-500)
S2 250 2000 3750 3000 =2850-200
S3 -500 1250 3000 4750
S4 -1250 500 2250 4000 =2650
Find the minimum value of each column then subtract
S4 = (0.6x4000) + (0.4x-1250)
it with the other cost in each column
= 2400-500
N1 N2 N3 N4
S1 2250 1000 0 0 =1900
S2 1500 1500 3000 3000
[Choose the maximum weighted outcome as the best
alternative]

2650 S3 = is the best alternative

- Minimization Problem

Range of alpha is from 0 to 1

The value of alpha will be decided depending on the

decision-making situations

If the alpha is not given = assume that it is 0.5

Find = Min, Max, WO

WO = Alpha. Min+ (1-alpha) . Max

N1 N2 N3 N4 Min Max. WO
S1 1000 1500 750 0 0 1500 750
S2 250 2000 3750 3000 250 3750 2000
S3 -500 1250 3000 4750 -500 4750 2125
S4 -1250 500 2250 4000 - 4000 1375
1250
S1 = (0.5x0) + (0.5x1500)

= 0+750

=750

S2 =(0.5x250) + (0.5x3750)

= 125+1875

=2000

S3 = (0.5x-500) + (0.5x470)

=-250+2375

=2125

S4= (0.5x-1250) + (0.5x4000)

= -625+2000

=1375

[Choose based on the minimum value of the WO]

S1 750 is the best alternative