Tutorial

Decision Theory
Decision Theory Numerical

• Cost price of Book Rs.80/- Sale price of Book Rs. 100/- Loss
per unsold Book Rs.50/-
• Demand 18 – 23copies

Various Possibilities are

• Annual Demand Events E1 to E6 respectively 18 – 23 copies
• Alternatives in Buying A1 to A6 respectively 18 – 23 copies
Modelling

• Create Payoff Table

• Given D is demand in units and Q is the Quantity purchased.

• P = 20Q if D ≥ Q and P = 70D – 50Q if D < Q

Payoff Table
A1/18 A2/19 A3/20 A4/21 A5/22 A/23

E1/18 360 310 260 210 160 110

E2/19 360 380 330 280 230 180

E3/20 360 380 400 350 300 250

E4/21 360 380 400 420 370 320

E5/22 360 380 400 420 440 390

E6/23 360 380 400 420 440 460

Opportunity Loss or Regret Table

• Amount of Payoff forgone by not adopting the optimal course of

action
• Obtained by subtracting from the highest profit value in each row, all
other values in the row

A1/18 A2/19 A3/20 A4/21 A5/22 A/23

E1/18 0 50 100 150 200 250
E2/19 20 0 50 100 150 200
E3/20 40 20 0 50 100 150
E4/21 60 40 20 0 50 100
E5/22 80 60 40 20 0 50
E6/23 100 80 60 40 20 0
Possible Decisions as per Rules : Uncertainty

• Laplace Principle – Various events under an action treated equally

probable. Hence expected payoff is the arithmetic mean. Eg for A2
Pay off = 368.3
• Maximin or Minimax Principle – eg. Maximin Strategy A1.
• Maximax or Minimin Principle – The highest or the lowest payoff.
• Hurwicz Principle – which has an index of optimism α for the
maximum payoff and (1 - α) for the minimum payoff.
• Savage Principle – of Regrets and Calls. Maximum regrets for each
action is determined and lowest among them is selected. Eg. A3.
Decision under Risk: Principles

• Maximum Likelihood Principle – Payoffs for the

Event of Maximum probability. Here 21 copies, with
maximum payoff Rs.420/-. This ignores other events
and available information.

• Expectation Principle – Payoff for each Action

calculated on basis of the probability and maximum
chosen.
 Decision under Risk (Payoff Table)

Probabi A1/18 A2/19 A3/20 A4/21 A5/22 A/23

lity
E1/18 0.05 360 310 260 210 160 110
E2/19 0.10 360 380 330 280 230 180
E3/20 0.30 360 380 400 350 300 250
E4/21 0.40 360 380 400 420 370 320
E5/22 0.10 360 380 400 420 440 390
E6/23 0.05 360 380 400 420 440 460
Expecte 360 376.5 386 374.5 335 288.5
d Payoff
 Decision under Risk (Opportunity Loss Table)

Probab A1/18 A2/19 A3/20 A4/21 A5/22 A/23

ility
E1/18 0.05 0 50 100 150 200 250
E2/19 0.10 20 0 50 100 150 200
E3/20 0.30 40 20 0 50 100 150
E4/21 0.40 60 40 20 0 50 100
E5/22 0.10 80 60 40 20 0 50
E6/23 0.05 100 80 60 40 20 0
Expected 51 34.5 25 36.5 76 122.5
Payoff
EPPI and EVPI
• Expected Payoff of Perfect Information (EVwPI)

EVwPI= 0.05 X 360 + 0.10 X 380 + 0.30 X 400 + 0.4 X 420 + 0.10 X
440 + 0.05 X 460 = 411

• EVPI or Expected Value for weighted Perfect Information is equal to

the expected regret value of the optimal act.

EVPI = EVwPI- EMV = 411 - 386 = 25 (For A3)

• Also EVwPI= Expected Profit + Expected Regret

eg. For A1 EP = 360 ER = 51 EPPI = 411