QUESTION : Decision Analysis Guide to marks: 20 marks- 6 for a, 2 each for b1 &

Question

QUESTION : Decision Analysis

Guide to marks: 20 marks- 6 for a, 2 each for b1 & b2, 3 each for b3 & b4, 4 for b5

Show all calculations to support your answers.
You may follow the methods shown in the mp4 on Decision Analysis for a way to do part (b) of this question if you wish.

(a) Discuss the differences among decision making under certainty, under risk and under complete uncertainty.

(b) Bikram Shrestha is considering investing some money that he inherited. The following payoff matrix gives the profits that would be realised during the next year for each of the investments that Bikram is considering.

Answer the following questions. Each answer must be supported with appropriate calculations and/or a table of figures, and you must state for questions 1 to 4 which alternative would be selected.

1 Which alternative would an optimist choose?
2 Which alternative would a pessimist choose?
3 Which alternative is indicated by the criterion of regret?
4 Assuming probability of a good economy = 0.3 using expected monetary values what is the optimum action?
5 What is the expected value of perfect information?

Good Economy Poor Economy Share market $80,000 ($20,000) Bonds 30,000 20,000 Real estate 25,000 15,000

Explanation / Answer

(a)

Taking Decisions Under Certainty

Taking Decisions Under Risk

Taking Decisions Under Uncertainty

(b) 1.

The optimist would choose best of best approach.

Best of Share Market = $80,000

Best of Bonds = $30,000

Best of Real state = $25,000

Maximum among these three is payoff of the Share Market.

So, the optimist would choose Share market.

2.

The pessimist would choose best of worst approach.

Worst of Share Market = -$20,000

Best of Bonds = $20,000

Best of Real state = $15,000

Maximum among these three is payoff of the Bonds.

So, the optimist would choose Bonds.

3.

Regret = Best Payoff - Payoff received

Below is the reget table for the given payoff table.

Maximum regret of Share Market = $40,000

Maximum regret of Bonds = $50,000

Maximum regret of Real state = $55,000

Minimum regret among these three is payoff of the Share Market.

So, the alternative indicated by the criterion of regret is Share market.

4.

Probability of a good economy = 0.3

Probability of a bad economy = 1 - 0.3 = 0.7

Expected monetary value of Share Market = 0.3 * $80,000 - 0.7 * $20,000 = $10,000

Expected monetary value of Bonds = 0.3 * $30,000 + 0.7 * $20,000 = $23,000

Expected monetary value of Real Estate = 0.3 * $25,000 + 0.7 * $15,000 = $18,000

Maximum among these three is payoff of the Bonds.

So, using expected monetary values, the optimum action is to choose Bonds.

5.

Expected value without perfect information = Maximum expected monetary value = $23,000

Expected value with perfect information = 0.3 * Maximum of all payoff in good economy + 0.7 * Maximum of all payoff in bad economy = 0.3 * $80,000 + 0.7 * $20,000 = $38,000

Expected value of perfect information = Expected value with perfect information - Expected value without perfect information = $38,000 - $23,000 = $15,000

Good Economy Bad Economy Share market $80,000 - $80,000 = 0 $20,000 -(-$20,000) = $40,000 Bonds $80,000 - $30,000 = $50,000 $20,000 - $20,000 = 0 Real Estate $80,000 - $25,000 = $55,000 $20,000 - $15,000 = $5,000

Related Questions

Navigate

• Browse (All)
• Browse Q
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.