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DECISION MAKING UNDER CONDITIONS OF RISK

HOW DO WE NEED TO MAKE DECISION UNDER CONDITIONS OF RISK?

DECISION MAKING UNDER CONDITIONS OF RISK


Expected value criterion Expected opportunity loss criterion

EXPECTED VALUE CRITERION


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Construct a conditional pay-off table listing the alternative decisions and the various states of nature. Enter the conditional profit for each decision-event combination along with the associative probabilities Calculate the EMV (expected monetary value) for each decision alternative by multiplying the conditional profits by assigned probabilities and adding the resulting conditional values. Select the alternative that yields the highest EMV

A newspaper boy has the following probabilities of selling a magazine

No of copies sold Probability 10 0.10 11 0.15 12 0.20 13 0.25 14 0.30 Cost of copy is 30 paise and sale price is 50.he cannot return unsold copies. How many copies should he order?

Possible demand

Probabilit y

10 copies

11 copies

12 copies

13 copies

14 copies

10
11 12 13 14 Possible Demand 10 11

0.10
0.15 0.20 0.25 0.30 Probability 0.10 0.15

200
200 200 200 200 10 copies 20 30

170
220 220 220 220 11 copies 17 33

140
190 240 240 240 12 copies 14 28.5

110
160 210 260 260 13 copies 11 24

80
130 180 230 280 14 copies 8 19.5

12
13 14 Total expected profit

0.20
0.25 0.30

40
50 60 200

44
55 66 215

48
60 72 222.5

42
65 78 220

36
57.5 84 205

EXPECTED OPPORTUNITY LOSS CRITERION


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Prepare the conditional profit table for each decision-event combination and write the associated probabilities For each event, determine the conditional opportunity loss (COL) by subtracting the payoff from the maximum payoff for that event Calculate the expected opportunity loss (EOL) for each decision alternative by multiplying the COLs by the associated probabilities and then adding the values Select the alternative that yields the lowest EOL

Possible demand 10 11 12 13 14
Possible demand 10 11 12 13 14

Probability

10 copies

11 copies

12 copies

13 copies

14 copies

0.10 0.15 0.20 0.25 0.30


Probability 0.10 0.15 0.20 0.25 0.30

200 200 200 200 200


10 copies 0 20 40 60 80

170 220 220 220 220


11 copies 30 0 20 40 60

140 190 240 240 240


12 copies 60 30 0 20 40

110 160 210 260 260


13 copies 90 60 30 0 20

80 130 180 230 280


14 copies 120 90 60 30 0

Possible demand

Probability

10 copies

11 copies

12 copies

13 copies

14 copies

10
11 12 13 14 Expected

0.10
0.15 0.20 0.25 0.30

0
3 8 15 24 50

3
0 4 10 18 35

6
4.5 0 5 12 27.5

9
9 6 0 6 30

12
13.5 12 7.5 0 45