GROUP 2

DECISIONS UNDER UNCERTAINTY

Decision making under uncertainty refers to the process of making
choices when the likely outcomes of random variables are a matter of
opinion rather than being based on known probabilities.

In the theory of decision making in the face of uncertainty, it is commonplace to

distinguish between problems that require choice probability distributions on the
outcomes (e.g., betting on the outcome of a spin of the roulette wheel) and
problems that require choice among random variables whose likely outcomes is a
matter of opinion (e.g., betting on the outcome of a horse race).

Problems of the former type are referred to as decision making under risk
and problems of the latter type as decision making under uncertainty
DECISION MAKING UNDER RISK
Probabilities are primitive aspect of the depiction of the choice set. In
making decision under risk, you can predict the possibility of a future
outcome. It involves choosing among options when the outcomes are
uncertain, but the probabilities of the different outcomes are known.

DECISION MAKING UNDER UNCERTAINTY

Occurs when the probabilities of outcomes are unknown. This situation is
more complex than decision-making under risk because it involves
dealing with incomplete information.
 FEEL OR INTUITION IN BUSINESS DECISION MAKING

Refers to the use of instinctive judgements and gut feelings rather than purely analytical
processes. It plays a significant role in several ways:

1. Experience-Based Insight – Experience decision-makers often develop a sense of

intuition based on their accumulated knowledge and past experiences. This can help in
quickly assessing situations and making decisions even when data is limited.

2. Speed of Decision-Making – In fast-paced environments where decisions need to be

made quickly, intuition can provide a rapid response without the time required for extensive
analysis.

3. Complex and Ambiguous Situations – When faced with complex problems or incomplete
information intuition can help fill gaps and guide decisions when analytical tools are not
sufficient.
 FEEL OR INTUITION IN BUSINESS DECISION MAKING

4. Creativity and Innovation – Intuition often plays a role in creative and innovative thinking,
helping lenders envision possibilities and opportunities that might not be evident through
data alone.

5. Human Element – Intuitive decisions can reflect personal values, emotions, and social
dynamics, which might be overlooked by purely rational approaches but are important in
organizational culture and interpersonal relations. 

While intuition can be valuable, it should ideally complement analytical methods rather than
replace them balancing instinct with data-driven insights to make well-rounded business
decisions.
 DECISION STRATEGIES: MINIMAX

 The minimax decision strategy is a technique used primarily in decision-making under

uncertainty, especially in competitive situations or games. It focuses on minimizing the
potential maximum loss. This approach is particularly useful in adversarial scenarios where
the decision-maker anticipates the worst possible outcome from each choice.

Process:
1. Identify Possible Decisions – List all possible actions or decisions available.
2. Determine Outcomes – Assess the potential outcomes for each decision, including the
worst-case scenarios.
3. Evaluate Worst Outcomes – For each decision, determine the worst possible outcome.
4. Choose the Best Option – select the decision that has the least severe worst-case
outcome.
 DECISION STRATEGIES: MINIMAX

Application:
1. Game Theory – In two-player zero-sum games (where one player’s gain is the other
player’s loss) the minimax strategy helps in finding a strategy that minimizes the maximum
loss. For example, in chess or other strategic games, players often use minimax to predict
and counter the opponent’s moves to minimize their own maximum potential loss.

2. Risk Management – In business or financial decisions, minimax can help in choosing

strategies that mitigate the worst possible losses in scenarios of high uncertainty.

Example: Consider a business facing two potential investments, A and B. Investment A

could lead to a loss of P10,000 or a gain of P20,000, while investment B could result in a
loss of P5,000 or a gain of P15,000.
 DECISION STRATEGIES: MIXIMAX

 The maximax decision strategy is an optimistic approach used to make decisions when
outcomes are uncertain. It focuses on maximizing the maximum possible gain. This
approach is used by decision-makers who are optimistic and focus on achieving the
highest possible reward.

Process:
1. Identify Possible Decisions – List all available options or decisions.
2. Determine Outcomes – Assess all potential outcomes for each decision.
3. Evaluate Best Outcomes – For each option, identify the best possible outcome (i.e., the
maximum gain).
4. Choose the Option with the Highest Maximum – Select the decisions that has the
highest best-case outcome.
 DECISION STRATEGIES: MIXIMAX

Application:
1. Optimistic Scenarios – Suitable for environments where risk-taking is acceptable, and
potential rewards are significant. It is often used in situations where there is a high potential
for success and the decision-maker is willing to accept the associated risks.

2. Investment Decisions – In finance, an investor might use maximax to choose the

investment with the highest potential return, focusing on the best possible outcome rather
than the risk involved.

Example: Consider a company deciding between two projects, A and B. Project A could
result in a profit of P10,000 or a loss of P5,000, while project B could result in a profit of
P15,000 or a loss of P1,000.
 THE EXPECTED VALUE

The expected value (EV) of a future happening is a measure used to estimate the average
outcome of an event or decision based on its potential future values their probabilities. It
helps in evaluating decisions by summarizing the anticipated average result over many
iterations or scenarios. The objective is to quantify the average or expected outcome of the
future event based on the probabilities and values of all possible outcomes.

Future Happening – refers to an event or decision whose outcome is uncertain but can be
described by a range of possible values and their associated probabilities.
 THE EXPECTED VALUE

Calculation Steps:
1. Identify Possible Outcomes – Determine all the potential results or values that the future
event could produce.
2. Determine Probabilities – Assign a probability to each possible outcome. The
probabilities should sum up to 1 (or 100%).
3. Assign Values – Determine the value or payoff associated with each outcome.
4. Calculate Expected Value – Multiply each outcome’s value by its probability and sum
these products to get the expected value. (EV= (P1 * V1) + (P2 * V2) + (P3 * V3) …)

Where: P1 = Probability of outcome 1. V1= Value of outcome 1.

 THE EXPECTED VALUE

Example:
Imagine you are considering a business investment with the following potential outcomes:

Outcome 1 – Gain P200, with a probability of 0.3.

Outcome 2 – Gain P100, with a probability of 0.5.
Outcome 3 – Loss P50, with a probability of 0.2.

What is the expected value?

 THE EXPECTED VALUE

Applications:

1. Investment Decisions – Helps investors understand the average expected return or loss
from an investment.

2. Risk Management – Assists in assessing potential outcomes and making informed

choices by providing a measure of the average result.

3. Project Evaluation – Useful in forecasting the average benefit or cost of future projects or
ventures.
 DECISION TREE
 A decision tree is a graphical tool used to make decisions by mapping out different
possible outcomes decisions and their associated probabilities. It helps visualize the
consequences of various choices, facilitating decision-making through structured analysis.

Components of a Decision Tree

1. Nodes: 
*Decision Nodes – Represent points where a choice must be made 
*Chance Nodes – Represent points where an uncertain event or outcome occurs. 
*End Nodes (Terminal Nodes) – Represent the final outcomes or result of a decision path.
2. Branches – Connect nodes and represent the possible outcome. Each branch leads to
another decision node, chance node, or end node.
3. Probabilities – Assign probabilities to each branch emerging from a chance node
representing the likelihood of each outcome.
4. Payoffs – Values associated with each end node, indicating the result or payoff of
reaching that node.
 STEPS TO CREATE A DECISION TREE
1. Define the Decisions – Start with the initial decision or choice that needs to be made.

2. Identify the possible options – For each decision node, list all possible options or actions.

3. Map Out Chance Events – For each option, potential outcomes and their probabilities at
chance node.

4. Assign Payoffs – Determine the payoff or value associated with each and node.

5. Calculate Expected Values – Compute the expected values for each branch by
multiplying the probabilities by their corresponding payoffs and summing these values.

6. Analyze the Tree – Compare the expected values or outcomes of different decision
paths to determine the best option.
Example:
Imagine a company deciding to launch a new product.

The decision tree might look like this:

1. Decision Node – Launch or do not launch the product 
Branch 1 – Launch the product 
Chance Node – Market Conditions. 
Outcome 1 – Favorable market.
Probability 0.6
Payoff: P500,000 
Outcome 2 – Unfavorable market
Probability 0.4
Payoff: -P200,000 
Branch 2 – Do not launch the product 
Outcome – No gain or loss
Payoff: P0
 DECISION TREE

Applications:

1. Business Strategy – Helps in evaluating strategic options and their potential outcomes.

2. Risk Management – Assists in assessing the risks and rewards associated with different
decisions.

3. Project Evaluation – Useful in forecasting the impact of various decisions on project

outcomes.
THANK YOU