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decision maker receives a reward rij. We refer to this model as the state-of-the-world
decision-making model.
In this chapter, we consider 7 decision criteria that can be used to make decisions
under uncertainty.
Expressed mathematically, this requires that the decision-maker takes action az,
where
rz 0 max min
rij
j
i
Example 1: A firm has to decide on its advertising campaign for the following
quarter. It has a choice between television, newspaper and poster advertising, there
being only sufficient funds for one medium. The actual return on the advertising
outlay is measured by the estimated total exposure of the campaign, that is the
number of potential customers who have the opportunity to see each medium. This
1
will be depend on the weather, poor weather favoring television viewing and
newspaper reading, whereas better weather gets people outdoors. Estimates of the
actual exposures (in thousands of potential customers) are given in Table 1.
The minimum payoff values for the three actions are 140, 150 and 130,
showing that the maximin strategy is action 2, newspaper advertising.
Table 1
Medium
Poor
220
180
130
Television
Newspapers
Bill posters
Weather
Moderate
Good
210
190
170
160
160
160
160
160
Excellent
140
150
160
(i j )
(i j )
10
Reward in
worst State
30
10
-10
-30
-50
30
35
15
-5
-25
30
35
40
20
0
30
35
40
45
25
30
35
40
45
50
30
10
-10
-30
-50
Thus, the maximin criterion recommends ordering 6 papers. This ensures that
Phyllis will, no matter what the state of the world, earn a profit of at least 30 cents.
The maximin criterion is concerned with making the worst possible outcome as
pleasant as possible. Unfortunately, choosing a decision to mitigate the worst case may
prevent the decision maker from taking advantage of good fortune. For example, if
2
Phyllis follows the maximin criterion, she will never make less than 30 cents, but she
will never make more than 30 cents.
The maximin criterion arises from a very pessimistic or conserva tive attitude on
the part of the decision-maker. It assumes that Nature is likely to take a most
uncooperative action and that the decision-maker therefore has to counter this
approach as well as he can.
actually s j . Then for any action ai and state s j the opportunity loss or regret for ai
in s j is ri*( j ), j rij .
For each state of Nature and each action of the decision-maker, we can therefore
calculate what is known as the regret. Denoting the regret for actions i and states j
taken by the decision-maker and Nature respectively by ij , we have
ij max
rkj rij
k
Thus there is a matrix of these regret terms, where each column contains at least
one zero value.
Example 3: Advertising budget problem. The regret matrix is as shown in Table
3.
Table 3
Weather
Poor
Medium
Moderate
Good
Excellent
Television
Newspapers
0
40
0
40
0
30
20
10
Bill posters
90
50
30
Applying an approach which, like maximin, guards against the worst state by
3
Nature, we now determine for each of the decision-maker's actions the largest regret.
Having done this we select the action with the smallest value, and term this the
minimax regret action. It is now defined fully as action a y , where
max yj min max ij
i
In example 3 the maximum regrets are 20, 40 and 90 for the media television,
newspapers and bill posters respectively, and therefore the television medium (i = 1)
would be recommended under the minimax regret criterion. Note that this differs
from the maximin action (newspapers), demonstrating a fact which can be proved,
namely that the maximin and minimax regret criteria do not necessarily result in the
same action being taken.
Example 4: Newspaper order problem.
Table 4 shows the opportunity cost or regret matrix. The minimax regret criterion
chooses an action by applying the minimax criterion to the regret matrix. In other
words, the minimax regret criterion attempts to avoid disappointment over what might
have been. From the regret matrix in Table 4, we obtain the minimax regret decision in
Table 5. Thus, the minimax regret criterion recommends ordering 6 or 7 papers.
Table 4
Papers
Ordered
6
7
8
9
10
6
30-30=0
30-10=20
30+10=40
30+30=60
30+50-80
7
35-30=5
35-35=0
35-15=20
35+5=40
35+25=60
Papers Demanded
8
9
40-30=10
40-35=5
40-40=0
40-20=20
40-0=40
45 - 30 = 15
45-35=10
45-40=5
45-45=0
45-25=20
10
50-30 =20
50-35=15
50-40=10
50-45=5
50-50=0
Table 5
Papers ordered
6
7
8
9
10
Maximum regret
20
20
40
60
80
The minimax regret criterion has some of the disadvantages of the maximin
criterion, but often to a lesser extent. If, for example, an extreme state by Nature is
fairly uniformly bad for all the decision-maker's actions, this will not necessarily be the
main influencing factor in the decision. For both criteria only the relative value of each
payoff has to be considered, but for the minimax regret criterion the relativity is only
4
within the column. How much worse these values generally are when compared with
other more moderate states by Nature then becomes irrelevant.
State Yielding
Best Outcome
Best Outcome
6 , 7 ,8 , 9 , 10
30
7
8
9
10
7,8,9, 10
8,9, 10
9, 10
10
35
40
45
50
actions i, the maximum payoff R io and the minimum payoff rio are weighted to form
hi rio (1 ) Rio
hx max hi
i
action 1 (television)
0.80 1
action 2 (newspapers)
In attempting to obtain the best of the maximin and maximax criteria, the
Hurwicz strategy has unfortunately not succeeded in shedding the serious
disadvantage of their criteria, namely their dependence on extreme payoffs. In
6
Poor
Moderate
Good
Probability
0.2
0.4
0.3
Excellent
0.1
the range of the probabilities for which the same action (1) remains the optimum. The
main benefit of this would be to see if we need to reconsider any of the probabilities
for a more accurate assessment, particularly if they are largely subjective. A study of
this type is known as a sensitivity analysis.
Example 6: The expected value criterion would recommend ordering 6 or 7
papers (see Table 7).
Table 7
Papers ordered
6
7
8
9
10
Expected reward
(30+30+30+30+30)/5=30
(10+35+35+35+35)/5=30
(-10+15+40+40+40)/5=25
(-30-5+20+45+45)/5=15
(-50-25+0+25+50)/5=0
'moderate' weather. Against this the best payoff (210) comes from the television
medium.
This criterion is reasonable when the probability of one state is significantly larger
than the probability of any other state.
K u k u a ( x a ) f ( x)dx , a x
K K u K o k u a ( x a ) f ( x)dx k o 0 (a x) f ( x)dx
So we can obtain the optimum quantity ordered by solving the following equation:
9
K
0
a
ku
*
, F (a * ) 0a f ( x)dx (continuous variable)
ku ko
Or
a * 1
p( x)
x 0
a*
ku
p( x) (discrete variable)
k u k o x0
Example 7: Suppose you have a record of newspaper sales for 200 days.
Sales
days
5
20
6
40
7
80
8
30
9
30
you pays the company 20 cents for each paper and sells the papers for 50 cents
each. Newspapers that are unsold at the end of the day are worthless. So
k o 20
k u 50 20 30
ku
30
0.6
k u k 0 30 20
5
0.1
0.1
6
0.2
0.3
7
0.4
0.7
Thus, a*=7
10
8
0.15
0.85
9
0.15
1.0