DECISION ANALYSIS UNDER CERTAINTY - Quantitative Techniques for management

Decision Making Under Certainty Uncertainty and Risk Examples

Decision-making is needed whenever an individual or an organization (private or public) is faced with a situation of selecting an optimal (or best in view of certain objectives) course of action from among several available alternatives.

For example, an individual may have to decide whether to build a house or to purchase a flat or live in a rented accommodation; whether to join a service or to start own business; which company's car should be purchased, etc. Similarly, a business firm may have to decide the type of technique to be used in production, what is the most appropriate method of advertising its product, etc.

The decision analysis provides certain criteria for the selection of a course of action such that the objective of the decision-maker is satisfied. The course of action selected on the basis of such criteria is termed as the optimal course of action.

Every decision problem has four basic features, mentioned below:

  1. Alternative Courses of Action or Acts: Every decision-maker is faced with a set of several alternative courses of action A1, A2, ...... Am and he has to select one of them in view of the objectives to be fulfilled.
  2. States of Nature: The consequences of selection of a course of action are dependent upon certain factors that are beyond the control of the decision-maker. These factors are known as states of nature or events. It is assumed that the decisionmaker is aware of the whole list of events S1, S2, ...... Sn and exactly one of them is bound to occur. In other words, the events S1, S2, ...... Sn are assumed to be mutually exclusive and collective exhaustive.
  3. Consequences: The results or outcomes of selection of a particular course of action are termed as its consequences. The consequence, measured in quantitative or value terms, is called payoff of a course of action. It is assumed that the payoffs of various courses of action are known to the decision-maker.
  4. Decision Criterion: Given the payoffs of various combinations of courses of action and the states of nature, the decision-maker has to select an optimal course of action. The criterion for such a selection, however, depends upon the attitude of the decision-maker.

If Xij denotes the payoff corresponding to a combination of a course of action and a state of nature, i.e., (Ai, Sj), i = 1 to m and j = 1 to n, the above elements of a decision problem can be presented in a matrix form, popularly known as the Payoff Matrix.

decision problem

Given the payoff matrix for a decision problem, the process of decision-making depends upon the situation under which the decision is being made. These situations can be classified into three broad categories : (a) Decision-making under certainty, (b) Decision -making under uncertainty and (c) Decision-making under risk.

Decision-making under Certainty

We experience certainty about a specific question when we have a feeling of complete belief or complete confidence in a single answer to the question. Decisions such as deciding on a new carpet for the office or installing a new piece of equipment or promoting an employee to a supervisory position are made with a high level of certainty. While there is always some degree of uncertainty about the eventual outcome of such decisions there is enough clarity about the problem, the situation and the alternatives to consider the conditions to be certain.

The conditions of certainty are very rare particularly when significant decisions are involved. Under conditions of certainty, the decision-maker knows which particular state of nature will occur or equivalently, he is aware of the consequences of each course of action with certainty. Under such a situation, the decision-maker should focus on the corresponding column in the payoff table and choose a course of action with optimal payoff.

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