Exam 3: Decision Analysis

In decision making under ________, there are several possible outcomes for each alternative, and the decision maker knows the probability of occurrence of each outcome.

Robert Weed is considering purchasing life insurance.He must pay a $180 premium for a $100,000 life insurance policy.If he dies this year, his beneficiary will receive $100,000.If he does not die this year, the insurance company pays nothing and Robert must consider paying another premium next year.Based on actuarial tables, there is a 0.001 probability that Robert will die this year.If Robert wishes to maximize his EMV, he would not buy the policy if the EMV were negative for him.He has determined that the EMV is, negative for him, but decides to purchase the insurance anyway.Why?

List the five major decision criteria used when making decisions under uncertainty.

Mark M.Upp has just been fired as the university bookstore manager for setting prices too low (only 20 percent above suggested retail).He is considering opening a competing bookstore near the campus, and he has begun an analysis of the situation.There are two possible sites under consideration.One is relatively small, while the other is large.If he opens at Site 1 and demand is good, he will generate a profit of $50,000.If demand is low, he will lose $10,000.If he opens at Site 2 and demand is high, he will generate a profit of $80,000, but he will lose $30,000 if demand is low.He also has the option of not opening either.He believes that there is a 50 percent chance that demand will be high.Mark can purchase a market research study.The probability of a good demand given a favorable study is 0.8.The probability of a good demand given an unfavorable study is 0.1.There is a 60 percent chance that the study will be favorable.Should Mark use the study? Why? What is the maximum amount Mark should be willing to pay for this study? What is the maximum amount he should pay for any study?

Why do people make decisions that don't maximize their expected monetary value? Explain why and offer three examples of such behavior.

Optimistic decision makers tend to discount favorable outcomes.

A utility curve that shows utility increasing at a decreasing rate as the monetary value increases represents the utility curve of a risk seeker.

A manager needs to hire short-term employees to meet production demands.The manager would like to hire one of three possible short-term workers. (a)Which alternative is most optimistic? (b)Which alternative is most pessimistic? (c)Using the Hurwicz criterion with a coefficient of realism, α = 0.70, what is the best alternative?

David S Pumpkins is planning to open a sporting goods store.However, the initial investment is $120,000.He currently has this money in a certificate of deposit earning 10 percent.He may leave it there if he decides not to open the store.If he opens the store and it is successful he will generate a profit of $50,000.If it is not successful, he will lose $90,000.What would the probability of a successful store have to be for David to prefer this to investing in a CD?

The decision making criterion of realism only applies to maximizing expected payoff.

Consider the following payoff table. How much should be paid for a perfect forecast of the state of nature?

The decision theory processes of maximizing expected monetary value (EMV)and minimizing expected opportunity loss (EOL)should lead us to choose the same alternatives.

The following figure illustrates a utility curve for someone who is a risk seeker.

The following is a payoff table giving costs for various situations. What decision should be made based on the minimax regret criterion?

A decision maker is faced with a decision making under uncertainty situation in a national election.He lays out his decision table and begins to enter equal probabilities for all states of nature into his spreadsheet.He feels uneasy doing so, reasoning that it can't possibly be as likely that one candidate will win every tossup state.Advise the decision maker on an appropriate course of action in completing the decision table.

Which of the following is not one of the steps considered in the "Six Steps in Decision Making"?

Mark M.Upp has just been fired as the university bookstore manager for setting prices too low (only 20 percent above suggested retail).He is considering opening a competing bookstore near the campus, and he has begun an analysis of the situation.There are two possible sites under consideration.One is relatively small while the other is large.If he opens at Site 1 and demand is good, he will generate a profit of $50,000.If demand is low, he will lose $10,000.If he opens at Site 2 and demand is high he will generate a profit of $80,000, but he will lose $30,000 if demand is low.He also has decided that he will open at one of these sites.He believes that there is a 60 percent chance that demand will be high.He assigns the following utilities to the different profits: U(50,000)= 0.72 U(-10,000)= 0.22 U(80,000)= 1 U(-30,000)= 0 Using expected utility theory, what should Mark do?

The maximax decision criterion is used by pessimistic decision makers and maximizes the maximum outcome for every alternative.

The following payoff table provides profits based on various possible decision alternatives and various levels of demand. The probability of a low demand is 0.4, while the probability of a medium and high demand is each 0.3. (a)What decision would an optimist make? (b)What decision would a pessimist make? (c)What is the highest possible expected monetary value? (d)Calculate the expected value of perfect information for this situation.

A plant manager considers the operational cost per hour of five machine alternatives.The cost per hour is sensitive to three potential weather conditions: cold, mild, and warm.The following table represents the operations cost per hour for each alternative-state of nature combination: Using the equally likely criterion, which alternative is best?