Chapter 3 Decision theory - York U

Chapter 3 Decision INTRODUCTIOND ecision theory deals with methods for determining the optimal course ofaction when a number of alternatives are available and their consequencescannot be forecast with is difficult to imagine a situation which doesnotinvolve such decisionproblems, but we shall restrict ourselves primarily to problems occurring inbusiness, with consequences that can be described in dollars of profitorrevenue, cost or loss. For these problems, it may be reasonable to consideras the best alternative that which results in the highest profit or revenue,or lowest cost or loss, on the average, in the long run. This criterion ofoptimality is not without shortcomings, but it should serve as a useful guideto action in repetitive situations where the consequences are not critical.

average pro Þt, is simply the mean ofY: (4)(0.1)+(14)(0.2)+ (24)(0.7) = 20. The expected proÞt of all alternatives is shown in the last row of the payoff table. In this case, it would be quite reasonable to use expected proÞtasthe criterion for selecting the best alternative. The alternative with the highest

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