Question

MATRIC NO: 000pe 013 DECISİON MAKING IN BUSINESS QUESTION 1(20 MARKS) a. List TWO (2) major decision criteria used when making decisions under uncertainty 2 marks) Fateh is considering opening a book store near the campus, and he has begun an analysis of the situation. There 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 proft of RM50, 000. If demand is low, he will lose RM10, 000. If he opens at Site 2 and demand is high, he will generate a profit of RM80, 000, but he will lose RM30, 000 if demand is low. He also has the option of not opening at either site. He believes that there is a 50% chance that the demand will be high. A market research study will cost RM5, 000. The probability of a good demand given an unfavorable study is 0.8. The probability of a good demand given an unfavorable study is 0.1. There is a 60% chance that the study will be favorable. b. i. What is the appropriate diagram to be developed for the above problem? (1 mark) Based on your answer in (i.), develop the stated diagram to analyze the decision. (15 marks) ii.

Answer 1

A decision problem, where a decision-maker is aware of various possible states of nature but has insufficient information to assign any probabilities of occurrence to them, is termed as decision-making under uncertainty. A decision under uncertainty is when there are many unknowns and no possibility of knowing what could occur in the future to alter the outcome of a decision. We feel uncertainty about a situation when we can't predict with complete confidence what the outcomes of our actions will be. We experience uncertainty about a specific question when we can't give a single answer with complete confidence. Launching a new product, a major change in marketing strategy or opening your first branch could be influenced by such factors as the reaction of competitors, new competitors, technological changes, changes in customer demand, economic shifts, government legislation and a host of conditions beyond your control. These are the type of decisions facing the senior executives of large corporations who must commit huge resources.

The small business manager faces, relatively, the same type of conditions which could cause decisions that result in a disaster from which he or she may not be able to recover.
A situation of uncertainty arises when there can be more than one possible consequences of selecting any course of action. In terms of the payoff matrix, if the decision-maker selects A₁, his payoff can be X₁₁, X₁₂, X₁₃, etc., depending upon which state of nature S₁, S₂, S₃, etc., is going to occur.

The methods of decission making under certainity are.There are a variety of criteria that have been proposed for the selection of an optimal course of action under the environment of uncertainty. Each of these criteria make an assumption about the attitude of the decision-maker.

1. Maximin Criterion: This criterion, also known as the criterion of pessimism, is used when the decision-maker is pessimistic about future. Maximin implies the maximisation of minimum payoff. The pessimistic decision-maker locates the minimum payoff for each possible course of action. The maximum of these minimum payoffs is identified and the corresponding course of action is selected.
2. Maximax Criterion: This criterion, also known as the criterion of optimism, is used when the decision-maker is optimistic about future. Maximax implies the maximisation of maximum payoff. The optimistic decision-maker locates the maximum payoff for each possible course of action. The maximum of these payoffs is identified and the corresponding course of action is selected.
3. Hurwicz Criterion: The maximax and the maximin criteria, discussed above, assumes that the decision-maker is either optimistic or pessimistic. A more realistic approach would, however, be to take into account the degree or index of optimism or pessimism of the decision-maker in the process of decision-making. If a, a constant lying between 0 and 1, denotes the degree of optimism, then the degree of pessimism will be 1 - a. Then a weighted average of the maximum and minimum payoffs of an action, with a and 1 - a as respective weights, is computed. The action with highest average is regarded as optimal.