Decisions Under Risk and Uncertainty - UP.pptx

DECISION UNDER RISK AND UNCERTAINTY

1. “Everything you gain in life will rock and fall apart, and all that will be left of you is what was in your heart.”

2. Decisions Under Risk and Uncertainty Managerial Economics

3. Decision-making may be defined as the process of selecting the suitable action from among several alternative courses of action. Managerial Economics The decision making process is constituted from eight steps: 1. Identification of problem 2. Identification of criteria for decision making 3. Distribution of importance / weight of criteria 4. Development of alternatives 5. Analyse of alternatives 6. Selection of alternative 7. Execution of decision 8. Evaluation of effectiveness of decision

4. Risk and Uncertainty Managerial Economics Risk refers to a situation in which possible future events can be defined and probabilities assigned. Uncertainty refers to situations in which there is no viable method of assigning probabilities to future random events.

5. Decision-making under Risk Managerial Economics Decision-making under Uncertainty When a manager lacks perfect information or whenever an information asymmetry exists, risk arises. Risk is where you are unsure of what can happen, but you know the likelihood of a particular outcome. The decision-maker is not aware of all available alternatives, the risks associated with each, and the consequences of each alternative or their probabilities.

6. 2 Managerial Economics Deductive and it goes by the name a priori measurement Based on statistical analysis of data and is called a posteriori Concept of Decision-Making Environment

7. 2 Priori method- the decision-maker is able to derive probability estimates without carrying out any real world experiment or analysis. Managerial Economics Posteriori measuremen t of probability is based on the assumption that past is a true representative of the future.

8. Modern Approaches to Decision-making under Uncertainty: Risk analysis - involves quantitative and qualitative risk assessment, risk management and risk communication Decision trees - involves a graphic representation of alternative courses of action and the possible outcomes and risks associated with each action. Preference theory -is based on the notion that individual attitudes towards risk vary -Risk averters -Gamblers Managerial Economics

9. Managerial Economics

10. Characteristics of a Decision Problem 1. A decision-maker 2. Alternative courses of action (strategies) 3. Events or outcomes 4. Consequences or payoffs. Managerial Economics

11. Managerial Economics The Payoff Matrix A payoff matrix is an essential tool of decision-making. It is a nice way of summarizing the interactions of various alternative action and events.

12. Managerial Economics Alternatives=Decision Alternatives Economic Conditions=State of Nature Profits=Payoffs

13. Managerial Economics The best of the bests: 45,70,53 Decision : Invest in Stocks Maximizes the maximum payoffs (Best of best)

14. Managerial Economics Maximizes the minimum Payoffs (Best of Worst) Best of worst: 5,-13, -5 Decision: Invest in Bonds

15. Managerial Economics Minimizes the Maximum Regret Regret is the diffrence between best payoff and actual payoff received Growing economy: best payoff is 70-40= 30(Regret)

16. Managerial Economics Maximum 30 18 17 The minimum regret is 17 Decision: Invest in Mutual Funds

17. THANK YOU! Managerial Economics