Lesson 4 - Decision Theory

Question 1

Decision Theory

Answer 1

Set of possible future conditions that will have a bearing on the result of the decision (states of nature), a list of alternatives a manager can choose from, with a known payoff for each alternative under each possible condition

Question 2

Causes of poor decisions

Answer 2

Manager’s unwillingness to admit mistake, manager’s style Bounded rationality (limits to human ability, costs, time,..), sub optimization (decisions getting departmentalized, therefore being difficult to be optimal for whole organization)

Question 3

Classification of certainty present

Answer 3

• Certainty: relevant parameters (cost, demand, capacity) have known values
• Risk: Means that certain parameters have probabilistic outcomes
• Uncertainty means that it’s impossible to assess likelihood of future events

Question 4

Maximin

Answer 4

Determine worst possible payoff for each and take best “worst”

Question 5

Maximax

Answer 5

Determine best possible payoff for each and take best “best”

Question 6

Laplace

Answer 6

Determine Avg. payoff for each and take the best “average”

Question 7

Minimax regret

Answer 7

Determine worst regret (best payoff-give payoff) and take best
“worst”

Question 8

Decision Tree

Answer 8

chematic representation of alternatives available and their consequences,
particularly useful for sequential decisions