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Bayesian Methods
There is a continuing debate among statisticians, little known to those outside the field, over the proper definition of probability. The frequentist definition sees probability as the long-run expected frequency of occurrence. P(A) = n/N, where n is the number of times event A occurs in N opportunities. The Bayesian view of probability is related to degree of belief. It is a measure of the plausibility of an event given incomplete knowledge.
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Urn 2
Select a sample, and then make inferences about the population (Unknown Population) Want P(B/A)
Bayes Theorem
Used to revise probabilities based upon new data
Prior probabilities New data Posterior probabilities
Probability
0.5
0.5
Probability of favorable market is same as probability of unfavorable market. Each state of nature has a 0.50 probability.
The good news is that Bayes Theorem can be used to combine the information, and we can use our decision tree to find EVSI, the Expected Value of Sample Information. In order to perform these calculations, we first need to know how reliable the potential test may be.
Assuming that the above information is available, we can combine these conditional probabilities with our prior probabilities using Bayes Theorem.
The calculations here will be identical to the EMV calculations performed without a decision tree. The top of the tree is the test part of the analysis; therefore, the posterior probabilities are assigned to these events.
= EV of the top of the tree - EV of the bottom of the tree This calculation ignores the cost of the test. Once you compute the EVSI, you can compare it to the cost of the test to determine the desirability to test. The ratio of the EVSI to the EVPI times 100 will also give you a measure of efficiency of the proposed test, expressed as a percentage.
Decision Tree Class Exercise: Jenny Lind, Part 2 (see text, #8-16 and 8-37)
Jenny Lind may hire a market research firm to conduct a survey at a cost of $100,000. The result of the survey would be either a favorable (F) or unfavorable (U) public response to the movie. The firm s ability to assess the market is: P(F/S) = 0.3 P(U/S) = 0.7 P(F/M) = 0.6 P(U/M) = 0.4 P(F/L) = 0.8 P(U/L) = 0.2 Should Jenny conduct the survey? What is the most she should be willing to pay for the survey? What is the efficiency of this survey?