Decision Theory
A framework for making logical choices in difficult situations.
Decision Environments
- Certainty: We know exactly what will happen. (Rare).
- Risk: We know the probabilities of outcomes.
- Uncertainty: We don't know the probabilities.
Decision Making under Uncertainty
When we have no idea about probabilities, we use criteria based on our attitude:
- Maximax (Optimist): Choose the alternative with the best possible payoff. "Go for gold."
- Maximin (Pessimist): Choose the alternative with the best "worst-case" scenario. "Play it safe."
- Minimax Regret: Minimize the opportunity loss (regret).
Decision Making under Risk
We use Expected Monetary Value (EMV).
$$ EMV = \sum (Payoff \times Probability) $$
Choose the alternative with the highest EMV.
Decision Trees
A visual map of decisions and outcomes. We solve it backwards (right to left) by calculating EMV at each node.
Test Yourself
Q1: Which criterion would a pessimist use?