Professional Documents
Culture Documents
1. Prior Analysis
Decision-maker(DM) uses the available
information and his subjective estimates of
probabilities as the basis of business
decision.
If the DM wants to improve or to
revise his probabilities, he needs a market
survey for that. But, the survey cost should
not exceed the value of the additional
information obtained. Hence, he needs
step-2.
2. Pre-posterior analysis
It employs Bayes theorem to revise the
prior probabilities, given certain facts
about the additional data(survey). If and
only if, the value of additional information
exceeds the total survey cost, the survey is
justified.
3. Posterior analysis
The DM will use the revised probabilities
as the basis for selecting the best strategy.
Decision Trees
A decision tree is a diagram consisting of
decision nodes (squares)
chance nodes (circles)
decision branches (alternatives)
chance branches (state of natures)
terminal nodes (payoffs or utilities)
ALTERNATIVES
a1
a2
.
am
STATES OF NATURE
...
1
2
n
...
x11
x12
x1n
...
x21
x22
x2n
.
.
...
.
...
xm1
xm2
xmn
a1
a2
x11
x1n
am
1
xm1
xmn
Example 1
A chance
node
t
c
tru lant
s
n p
o
C rge
A decison la
node
Construct
small plant
Do
no
thi
ng
Favorable market
$200,000
(0.6)
Unfav. market
(0.4)
-$180,000
-$20,000
$0
A chance
node
1
t
c t
u
r
EV =
t lan
s
n p
o
$48,000
C rge
A decison la
node
Construct
2
small plant
EV =
Do
no
$52,000
thi
ng
$0
Favorable market
$200,000
(0.6)
Unfav. market
(0.4)
-$180,000
-$.20,000
Example 2
Lets say that DM has two decisions to make, with the
second decision dependent on the outcome of the first.
Before deciding about building a new plant, DM has the
option of conducting his own marketing research survey,
at a cost of $10,000.
The information from his survey could help him decide
whether to construct a large plant, a small plant, or not to
build at all.
Example
Example
New data
Posterior
probabilities
Bayesian Analysis
Example:
Market research specialists have told DM that,
statistically, of all new products with a favorable
market, market surveys were positive and predicted
success correctly 70% of the time.
30% of the time the surveys falsely predicted
negative result
On the other hand, when there was actually an
unfavorable market for a new product, 80% of the
surveys correctly predicted the negative results.
The surveys incorrectly predicted positive results the
remaining 20% of the time.
Favorable
Market (FM)
Unfavorable
Market (UM)
Positive (predicts
favorable market
for product)
P(survey positive|FM)
= 0.70
P(survey positive|UM)
= 0.20
Negative (predicts
unfavorable
market for
product)
P(survey
negative|FM) = 0.30
P(survey negative|UM)
= 0.80
FM
UM
0.70
0.20
* 0.50
* 0.50
r
rio lity
ste bi
Po oba
Pr
P(Survey
of
positive|State
Nature of Nature
ity
int bil
Jo oba
Pr
r
io ity
Pr abil
ob
Pr
State
0.35
0.35 = 0.78
0.45
0.10
0.10 = 0.22
0.45
0.45
1.00
State P(Survey
FM
UM
0.30
0.80
* 0.50
* 0.50
0.15
0.15
0.55
= 0.27
0.40
0.40 = 0.73
0.55
1.00
0.55