 Decisions

 The States of Nature – actual events that may occur in the future.

 For example, you have an idle funds of one million pesos. You evaluated several options on
where to put your money so you would get the best result possible.

 Among the choices you have the following:

Option 1: Buy a warehouse for lease

Option 2: Buy an office building for lease
Option 3: Buy stocks in a local stock market
Option 4: Save in a time deposit
Option 5: Buy a car-for-rent

 Your adviser, an economist, presented to you the following possibilities:

 The Maximax Criterion

 The Maximin Criterion
 The Minimax Regret Criterion
 The Hurwicz Criterion
 The Equal Likelihood Criterion

 The decision maker selects the decision that will result in the maximum of the maximum
payoffs.

GOOD POOR
OPTIONS
CONDITIONS CONDITIONS
Warehouse for Lease 80,000.00 40,000.00
Office Building for 100,000.00 25,000.00
Lease
Stocks 170,000.00 50,000.00
Time Deposit 30,000.00 20,000.00
Car-for-rent 96,000.00 33,000.00

 The decision maker selects the decision that will reflect the maximum of the minimum payoffs
 Only to discover that economic conditions in the future were better than expected.
 Naturally, the investor would be disappointed that he had not purchased the stocks.
 GOOD POOR
OPTIONS
CONDITIONS CONDITIONS
Warehouse for Lease 80,000.00 40,000.00
Office Building for 100,000.00 25,000.00
Lease
Stocks 170,000.00 50,000.00
Time Deposit 30,000.00 20,000.00
Car-for-rent 96,000.00 33,000.00

 In fact, the investor would regret the decision to purchase the warehouse.
 And, the degree of regret would be P90,000.00, the difference between the payoff for the
investor’s choice and the best choice.
(170,000.00 – 80,000.00)
 The decision maker attempts to avoid regret by selecting the decision alternative that minimizes
the maximum regret.

STEPS:
1. A decision maker first selects the maximum payoff under each state of nature.
2. The maximum payoff under good economic conditions is P170,000, and the maximum payoff
under poor economic conditions is P140,000
3. All other payoffs under the respective states of nature are subtracted from these amounts.

1-2.

GOOD POOR
OPTIONS
CONDITIONS CONDITIONS
Warehouse for Lease 80,000.00 40,000.00
Office Building for
100,000.00 25,000.00
Lease
Stocks 170,000.00 50,000.00
Time Deposit 30,000.00 20,000.00
Car-for-rent 96,000.00 33,000.00

3.

GOOD POOR GOOD POOR

OPTIONS
CONDITIONS CONDITIONS CONDITIONS CONDITIONS
Warehouse for
170,000 – 80,000 40,000 – 40,000 90,000 0
Lease
Office Building
170,000 – 100,000 40,000 - 15,000 70,000 15,000
for Lease
Stocks 170,000 - 170,000 40,000 – (-50,000) 0 90,000

Time Deposit 170,000 - 30,000 40,000 - 20,000 140,000 20,000

Car-for-rent 170,000 - 96,000 40,000 - 33,000 74,000 7,000

 70,000 under the good conditions has the least regret.

 The principle underlying this decision criterion is that the decision maker is neither totally
optimistic (as the maximax criterion assumes) nor totally pessimistic (as the maximin criterion
assumes).
 With the Hurwicz criterion, the decision payoffs are weighted by a coefficient of optimism, a
measure of the decision maker’s optimism.
 The coefficient of optimism, which we will define as a is between zero and one.
0 < a < 1.0

 If a = 1.0, then the decision maker is said to be completely optimistic

 If a = 0, then the decision maker is completely pessimistic.
 The Hurwicz criterion requires that for each decision alternative, the maximum payoff be
multiplied by a and the minimum payoff be multiplied by 1 – a. For instance, assume that
a = 0.60.

 Warehouse
(80,000 x 0.60) + (40,000 x 0.40) = 64,000
 Office Building
(100,000 x 0.60) + (25,000 x 0.40) = 70,000
 Stocks
(170,000 x 0.60) + (-50,000 x 0.40) = 82,000
 Time Deposit
(30,000 x 0.60) + (20,000 x 0.40) = 26,000
 Car-for-rent
(96,000 x 0.60) + (33,000 x 0.40) = 70,800

 The equal likelihood, or LaPlace Criterion weight each state of nature equally, thus assuming
that the states of nature are equally likely to occur.

 Warehouse
(80,000 x 0.50) + (40,000 x 0.50) = 60,000
 Office Building
(100,000 x 0.50) + (25,000 x 0.50) = 62,500
 Stocks
(170,000 x 0.50) + (-50,000 x 0.50) = 60,000
 Time Deposit
(30,000 x 0.50) + (20,000 x 0.50) = 25,000
 Car-for-rent
(96,000 x 0.50) + (33,000 x 0.50) = 64,500

CRITERION DECISION (PURCHASE)

Maximax Stocks
Maximin Warehouse
Minimax Regret Office Building
Hurwicz Stocks
Equal Likelihood Car-for-rent