Problem: Jasim

Jasim is a writer of action novels. A movie

company and a TV network both want exclusive
rights to one of his more popular works. If he
signs with the network, he will receive a single
lump sum, but if he signs with the movie
company, the amount he will receive depends
on the market response to his movie. What
should he do?
 Jasim - How to Decide?

 What would be his decision based on:

Expected Value?
Maximax?
Maximin?
Minimax Regret?
Payouts and Probabilities
 Movie company Payouts
 Small box office - $200,000
 Medium box office - $1,000,000
 Large box office - $3,000,000
 TV Network Payout
 Flat rate - $900,000
 Probabilities
 P(Small Box Office) = 0.3
 P(Medium Box Office) = 0.6
 P(Large Box Office) = 0.1
 Jasim - Payoff Table
States of Nature

Small Box Medium Box Large Box

Decisions Office Office Office

Sign with Movie

$200,000 $1,000,000 $3,000,000
Company

Sign with TV
$900,000 $900,000 $900,000
Network
Prior
0.3 0.6 0.1
Probabilities
Using Expected Value Criteria

EVmovie=0.3(200,000)+0.6(1,000,000)+0.1(3,000,000)
= $960,000 = EVUII or EVBest
EVtv =0.3(900,000)+0.6(900,000)+0.1(900,000)
= $900,000
Therefore, using this criteria, Jasim should select the
movie contract.
Something to Remember
Jasim’s decision is only going to be made one time,
and he will earn either $200,000, $1,000,000 or
$3,000,000 if he signs the movie contract, not the
calculated EV of $960,000!!

Nevertheless, this amount is useful for decision-

making, as it will maximize Jasim’s expected returns
in the long run if he continues to use this approach.
Expected Value of Perfect Information
(EVPI)

What is the most that Jasim should be

willing to pay to learn what the size of
the box office will be before he
decides with whom to sign?
 Jasim – EVPI Calculation
States of Nature

Small Box Medium Box Large Box

Decisions Office Office Office

Sign with Movie

$200,000 $1,000,000 $3,000,000
Company

Sign with TV
$900,000 $900,000 $900,000
Network
Prior
0.3 0.6 0.1
Probabilities
 EVPI Calculation
EVwPI (or EVc)
=0.3(900,000)+0.6(1,000,000)+0.1(3,000,000) = $1,170,000
EVBest (calculated to be EVMovie from the previous page)
=0.3(200,000)+0.6(1,000,000)+0.1(3,000,000) = $960,000
EVPI = $1,170,000 - $960,000 = $210,000

Therefore, Jasim would be willing to spend up to $210,000

to learn additional information before making a decision.
Maximax – Risk-taker
 The maximax rule involves selecting the alternative that maximises
the maximum payoff available.
 This approach would be suitable for an optimist, or 'risk-seeking’
person, who seeks to achieve the best results if the best happens.
The manager who employs the maximax criterion is assuming that
whatever action is taken, the best will happen; he/she is a risk-taker.

States of Nature
Small Box Medium Box Large Box
Decisions Office Office Office
Sign with Movie
$200,000 $1,000,000 $3,000,000
Company
Sign with TV
$900,000 $900,000 $900,000
Network
Prior
0.3 0.6 0.1
Probabilities
Maximin – Pessimist
 The maximin rule involves selecting the alternative that maximises the minimum
pay-off achievable. This person would look at the worst possible outcome for
each option, then selects the highest one of these. The decision maker therefore
chooses the outcome which is guaranteed to minimise his losses. In the
process, he loses out on the opportunity of making big profits.
 This approach would be appropriate for a pessimist who seeks to achieve the
best results if the worst happens.

States of Nature
Small Box Medium Box Large Box
Decisions Office Office Office
Sign with Movie
$200,000 $1,000,000 $3,000,000
Company
Sign with TV
$900,000 $900,000 $900,000
Network
Prior
0.3 0.6 0.1
Probabilities
Minimax regret – Sore loser
 The minimax regret strategy is the one that minimises the maximum
regret. It is useful for a risk-neutral decision maker. Essentially, this is
the technique for a 'sore loser' who does not wish to make the wrong
decision.
 'Regret' in this context is defined as the opportunity loss through having
made the wrong decision.

States of Nature
Small Box Medium Box Large Box
Decisions Office Office Office
Sign with Movie $200,000 $1,000,000 $3,000,000
Company [700,000] [100,000] [2,100,000]
Sign with TV $900,000 $900,000 $900,000
Network [0] [0] [0]
Prior
0.3 0.6 0.1
Probabilities
 Class Exercise: A Glass Factory
AAglass
glassfactory
factoryspecializing
specializinginincrystal
crystalis
isexperiencing
experiencingaa
substantial
substantialbacklog,
backlog,and
andthethefirm's
firm'smanagement
managementis is
considering
consideringthree
threecourses
coursesof ofaction:
action:
A)
A) Arrange
Arrangefor
forsubcontracting
subcontracting
B)
B) Construct
Constructnewnewfacilities
facilities
C)
C) Do
Donothing
nothing(no
(nochange)
change)

The
Thecorrect
correctchoice
choicedepends
dependslargely
largelyupon
upondemand,
demand,which
which
may
maybebelow,
low,medium,
medium,ororhigh.
high. By
Byconsensus,
consensus,management
management
estimates
estimatesthetherespective
respectivedemand
demandprobabilities
probabilitiesas
as0.1,
0.1,0.5,
0.5,
and
and0.4.
0.4.

Given
Giventhe
thepayoffs
payoffson
onthe
thenext
nextpage,
page,manually
manuallycreate
createand
and
solve
solvethis
thisproblem
problemusing
usingaadecision
decisiontree.
tree.
 A Glass Factory: The Payoff Table
The
The management
management estimates
estimates the the profits
profits when
when
choosing
choosing from
from the
the three
three alternatives
alternatives (A,(A, B,
B, and
and
C)
C) under
under the
the differing
differing probable
probable levels
levels of
of
demand.
demand. These
These profits,
profits, in
in thousands
thousands of of dollars
dollars
are
are presented
presented inin the
the table
table below:
below:
0.1 0.5 0.4
Low Medium High
A 10 50 90
B -120 25 200
C 20 40 60
Optimal Production
 How many salads should we make?