FLORENTINA ANDRE YP52A

21914312
Revising judgments in the light of new information
Bayes theorem
In Bayes theorem an initial probability estimate is known as a prior probability. Thus the
marketing managers assessment that there was an 80% probability that sales of the calculator
would reach break-even level was a prior probability. When Bayes theorem is used to modify
a prior probability in the light of new information the result is known as a posterior
probability.
The effect of new information on the revision of probability judgments
It is interesting to explore the relative inuence which prior probabilities and new
information have on the resulting posterior probabilities. Suppose that a geologist is involved
in a search for new sources of natural gas in southern England. In one particular location he is
asked to estimate, on the basis of a preliminary survey, the probability that gas will be found
in that location. Having made his estimate, he will receive new information from a test
drilling.
Applying Bayes theorem to a decision problem
We will now consider the application of Bayes theorem to a decision problem: a process
which is sometimes referred to as posterior analysis. This simply involves the use of the
posterior probabilities, rather than the prior probabilities, in the decision model. We can use
Bayes theorem to modify the retailers prior probabilities in the light of the new information
Assessing the value of new information
New information can remove or reduce the uncertainty involved in a decision and thereby
increase the expected payoff However, in many circumstances it may be expensive to obtain
information since it might involve, for example, the use of scientic tests, the engagement of
the services of a consultant or the need to carry out a market research survey. If this is the
case, then the question arises as to whether it is worth obtaining the information in the rst
place or, if there are several potential sources of information, which one is to be preferred
(sometimes the process of determining whether it is worth obtaining new information is
referred to as preposterior analysis).
The expected value of perfect information
In many decision situations it is not possible to obtain perfectly reliable information, but
nevertheless the concept of the expected value of perfect information (EVPI) can still be
useful. There is an alternative way of looking at the value of information. New information
can be regarded as being of no value if you would still make the same decision regardless of
what the information told you. If the farm manager were to go ahead and plant a crop of
potatoes whatever the test indicated then there would clearly be no point in buying the test.
Information has value if some of its indications would cause you to take a different decision
than the one you would take without the benet of the information.
Practical considerations
We will now outline a number of examples of the application of the methods we have just
discussed and consider some of the practical problems involved. Clearly, it is easier to
identify the expected value of perfect as opposed to imperfect information, and we
recommend that, in general, calculating the EVPI should be the rst step in any informationevaluation exercise. The EVPI can act as a useful screen, since some sources of information
may prove to be too expensive, even if they were to offer perfectly reliable data, which is
unlikely.