Chapter

Decision Analysis

Chapter 3 - Decision Analysis 1

Chapter Topics

Components of Decision Making

Decision Making without Probabilities
Decision Making with Probabilities
Decision Analysis with Additional Information
Utility

Chapter 3 - Decision Analysis 2

Decision Analysis
Components of Decision Making
A state of nature is an actual event that may occur in the
future.
A payoff table is a means of organizing a decision situation,
presenting the payoffs from different decisions given the
various states of nature.

Table 3.1
Payoff Table
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Decision Analysis
Decision Making without Probabilities
Decision situation:

Table 3.2
Payoff Table for the Real Estate Investments
• Decision-Making Criteria: maximax, maximin, minimax (minimal
regret), Hurwicz, and equal likelihood

Chapter 3 - Decision Analysis 4

Decision Making without Probabilities
Maximax Criterion
In the maximax criterion the decision maker selects the
decision that will result in the maximum of maximum payoffs;
an optimistic criterion.

Table 3.3
Payoff Table Illustrating a Maximax Decision
Chapter 3 - Decision Analysis 5
Decision Making without Probabilities
Maximin Criterion
In the maximin criterion the decision maker selects the
decision that will reflect the maximum of the minimum (best
of the worst-case) payoffs; a pessimistic criterion.
conservative

Table 3.4
Payoff Table Illustrating a Maximin Decision

Chapter 3 - Decision Analysis 6

Decision Making without Probabilities
Minimax Regret Criterion
Regret is the difference between the payoff from the best
decision and all other decision payoffs.
The decision maker attempts to avoid regret by selecting the
decision alternative that minimizes the maximum regret.

Highest Maximal
payoff
regrets
$ 50,000
$ 70,000
$ 70,000

$100,000
- $50,000
Table 3.6
Regret Table Illustrating the Minimax Regret Decision
Chapter 3 - Decision Analysis 7
Decision Making without Probabilities
Hurwicz Criterion
The Hurwicz criterion is a compromise between the maximax
(optimist) and maximin (conservative) criterion.
A coefficient of optimism, , is a measure
of the decision maker’s optimism.
The Hurwicz criterion multiplies the best payoff by  and the
worst payoff by (1- ), for each decision, and the best result is
selected.
Decision Values
 = 0.4
Apartment building $50,000(.4) + 30,000(.6) = 38,000
Office building $100,000(.4) - 40,000(.6) = 16,000
Warehouse $30,000(.4) + 10,000(.6) = 18,000

Chapter 3 - Decision Analysis 8

Decision Making without Probabilities
Equal Likelihood Criterion
The equal likelihood ( or Laplace) criterion multiplies the
decision payoff for each state of nature by an equal weight,
thus assuming that the states of nature are equally likely to
occur.
For 2 states of nature, the =.5 case of the Hurwicz method
In general, it is essentially different !
Decision Values
Apartment building $50,000(.5) + 30,000(.5) = 40,000
Office building $100,000(.5) - 40,000(.5) = 30,000
Warehouse $30,000(.5) + 10,000(.5) = 20,000

Chapter 3 - Decision Analysis 9

• A farmer wants to decide which of the three crops he should plant on his hundred
acre farm. The profit from each is dependent on the rainfall during the growing
season. The farmer has categorized the amount of rainfall as high, medium and
low. His estimated profit for each is shown in the table below:
Rainfall Estimated Conditional Profit
  Crop A Crop B Crop C
High 8000 3500 5000
Medium 4500 4500 5000
Low 2000 5000 4000

If the farmer wants to plant only one crop, decide which should be his best crop using,
• Maximax criterion
• Maximin criterion
• Hurwicz criterion
• Laplace criterion
• Minimax regret criterion
(α =0.6 where applicable.)

Chapter 3 - Decision Analysis 10