Decision theory Decision-making means a process

which results in the selection from a set

of alternative courses of action, that

course of action which is regarded to

meet the objectives of the decision

problem more satisfactorily as compared

to others.

Process of decision making includes:

Defining the problem, Analysis of the

problem, Identification of alternatives,

Evaluation of alternatives, Decision

environment.

Terminology: Acts or alternatives- denoted by a1,a2,a3.

Events- denoted by e1,e2,e3.

Pay off-measures the net benefit to

decision maker, which results from a given

combination.

Pay-off table- various pay-off can be put in

a shape of table to form a pay off table.

Opportunity loss or regret-the difference

between pay off realized and the maximum

payoff which could have been realized if

another strategy was chosen.

SITUATIONS OF DECISION

MAKING

DECISION-MAKING

UNDER CERTAINTY DECISION-MAKING

UNDER

UNCERTAINTY

DECISION-MAKING

UNDER RISK

Decision making under

certainty: In decision making under certainty, the

decision maker knows with certainty the consequences of every alternative. The decision maker has to choose the alternative with the maximum pay-off in terms of utility under event which will occur. The main techniques used in it :

Liner programming

Input-output analysis

Inventory models

Goal programming

Break-even analysis etc.

Decision making under

uncertainty: The choice of a decision is very largely

based on company’s policy, experience and the judgment of the decision maker. The methods used in it are:

Maxi-max criterion: under this criterion it is assumed, the decision maker is optimistic. First the maximum outcome within every alternative is located and then the alternative with maximum pay-off is selected.

Maxi-min criterion: under this method it is assumed that the decision maker is pessimist and chooses the strategy which gives the highest minimum pay-off.

Contd.. Mini-max criterion: under this criterion the

decision maker would select the strategy in which the maximum regret is the lowest.

Coefficient of optimism criterion-Hurwicz criterion- under this criterion the decision maker’s degree of optimism is represented by α(alpha), the coefficient of optimism varying between 0 and 1.

Laplace criterion: under this criterion three steps are followed, assigning equal opportunity to each event, calculating the expected pay-offs, selecting the strategy with maximum expected pay-off.

Decision making under risk:

Under this condition, the decision maker faces several events and he cannot predict the outcome of an event. Under this the following decision criterions are used:

Expected monetary value criterion(EMV):under this criterion the decision maker chooses that strategy which has highest EMV.

Expected opportunity loss criterion(EOL): under this criterion the expected opportunity loss is minimized.

Expected value of perfect information(EVPI):under this it is assumed that the decision maker has authentic and perfect information available. EVPI=EPPI-EMV=MINIMUM EOL

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