Decision Theory

The basic elements in a decision theory are:

-          Alternative courses of action (strategies)

-          Various states of nature.

-          Knowledge about likelihood of occurrence of each state of nature.

-          Net value (pay-off) to decision maker for each outcome.

-          Decision maker objectives.

The basic premise of decision theory is that the behaviour of the future is probability and not deterministic. Various probabilities are assigned to the state. Of nature on the basis of available information or subjective judgment and the likely outcomes of the alternative course ofo action are evaluated accordingly before a particular alternative is selected.

            This technique of decision making is based on expected monetary value and utility. By analyzing the monetary value of utility from a given set of circum stances, a model is constructed and accordingly decisions are taken. It is a well know fact that the environment within which decisions are take can logically be divided into three parts: Certainty risk and uncertainty. Certainty exists when one can specify exactly what will happen during the period for which the decision is being made. Risk refers to a situation where one can specify a probability distribution over the possible outcomes. Uncertainty refers to the condition when one cannot specify the relative likelihood of the outcomes. Although some business decisions can be made under conditions nearing certainty, elements risk and uncertainty underline most of which the managers make.

According to the function cycle of management the managerial activity as whole includes five phases or life processes which are planning, organization, direction, supervisor and control. In performing all of these activities the management has to face several such situations where they have to make a choice of the best among a number of alternative courses of action. This choice making is technically termed as 'decision making'. A decision is simply a selection from two or more courses of action.

Decision making may be defined as a 'process which results in selection from a set of alternative courses of action, that course of action which is considered to meet the objectives of the decision problem more satisfactorily then others as judges by the decision maker.

Scientific decision making process is characterized by adoption of systematic, logical and through going reasoning to understand problem situations and to arrive at the best possible decisions through process of abstraction, observation, investigation, experimentation, measurement and analysis of data in the relevant real word decision environment.

There are at least five stages in decision making process.

a.       Perceiving the need and opportunity for decision making on any particular problem.

b.      Determination of the objectives thought by solution of the problem.

c.       Collection of relevant information pertinent to the problem on hand

d.      Developing and evaluating alternative courses of action

e.      Choosing one of the alternatives

Structure of decision making problem

Decision theory commences with the assumption that regardless of the type of decision whether it involves long range or short range consequences whether it is in finance, production or marketing, or some other area, whether it is at a relatively high or low level of managerial responsibility - certain common characteristics of the decision problems are to be discussed.

The decision problem under study may be represented by a model in terms of the following elements

1.       The decision maker

2.       Courses of Action

3.       Sates of Nature

4.       Payoff

5.       Payoff Table

6.       Regret or Opportunity loss table

Types of decision making criteria

a.       Decision making under certainty

The various techniques used for solving problems under certainty are

1.       Breakeven Analysis

2.       Linear Programming Models

3.       Transportation Techniques

4.       Inventory Models under certainty

5.       Analysis of cost, volume and profit

b.      Decision making under risk

c.       Expected monetary volume EMV

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