Introduction to Decision theory
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This document discusses key concepts in decision theory. It defines decision making as selecting the best course of action according to a predetermined standard. There are four main types of decision making environments: decision making under certainty, where the consequences of each alternative are fully known; decision making under uncertainty, where multiple outcomes exist but probabilities are unknown; decision making under risk, where probabilities can be assigned to potential outcomes; and decision making under conflict. The document also outlines the basic steps in decision making and defines important terminology like decision maker, state of nature, course of action/acts, payoff, and payoff table.
Introduction to Decision theory
- 2. Decision Making A decision may be defined as the selection of the action by the decision maker which is considered to be the best according to some predetermined standard from amongst the available options
- 3. Steps in Decision Making STEP 1 STEP 2 STEP 3 STEP 4 Identification of all possible outcomes called as state of nature or events Identification of all courses of action called as acts Determination of Payoff Function Choosing from among the alternatives, the best possible action on the basis of some criterion
- 4. Terminologies The Decision Maker The decision maker may be an individual or a group of individuals who is responsible for making the selection of the course of action from a set of possible courses of action State of Nature They are also known as events. States of Nature are various possible outcomes or occurrences which are outside the decision makers control and they determine the level of success for a given act Course of Action or Acts The acts are alternative course of action or strategies that are available to the decision maker. The decision maker has control over the choices of these acts.
- 5. Terminologies Payoff It measures the net benefit resulting from each combination of a state of nature and a course of action . The payoff values are also known as conditional profit values or conditional economic consequences. Payoff Table A tabular arrangement of conditional payoff values is known as payoff matrix Suppose there are m possible states of nature or events 𝑆1, 𝑆2, 𝑆3, … , 𝑆 𝑚 And n course of action or acts or strategies 𝐴1, 𝐴2, 𝐴3, … , 𝐴 𝑛 𝑃𝑖𝑗 = the payoff corresponding to the strategy 𝐴𝑗 of the decision maker under the state of nature 𝑆𝑖 Totally there are mn payoff values
- 6. Terminologies State of Nature Acts 𝐴1 𝐴2 𝐴3 --- ---- 𝐴 𝑛 𝑆1 𝑃11 𝑃12 𝑃13 𝑃1𝑛 𝑆2 𝑃21 𝑃22 𝑃23 𝑃2𝑛 𝑆3 𝑃31 𝑃32 𝑃33 𝑃3𝑛 ----- 𝑆 𝑚 𝑃 𝑚1 𝑃 𝑚2 𝑃 𝑚3 𝑃𝑚𝑛
- 7. Types of Decision Making Environments 1 2 3 4 Decision making under certainty Decision making under uncertainty Decision making under risk Decision making under conflict
- 8. Decision Making Under Certainty In this case the decision maker has the complete knowledge of the consequences of every alternative or decision choice. Here the decision maker presumes hat only one state of nature is relevant for this purpose. He identifies this state of nature , takes it for granted and presumes complete knowledge as to its occurrence.
- 9. Decision Making Under Uncertainty In this case the decision maker faces multiple state of nature but has no means to arrive aat the probability values to the likelihood of occurrences of these state of nature .
- 10. Decision Making Under Risk In this case the decision maker has to faces several state of nature. But he has some knowledge or experience to assign probabilities value to the likely occurrences of these states of nature. The objective is to maximize the expected profit or minimize the expected opportunity loss.