Many decision problems have the following simple structure. A decision maker has two possible deci-sions, 1 and 2. If decision 1 is made, a sure cost of c is incurred. If decision 2 is made, there are two possibleoutcomes, with costs c1 and c2 and probabilities p and1 2 p. We assume that c1 , c , c2. The idea is thatdecision 1, the riskless decision, has a moderate cost,whereas decision 2, the risky decision, has a low costc1 or a high cost c2.a. Calculate the expected cost from the riskydecision.b. List as many scenarios as you can think of thathave this structure. (Here’s an example to get youstarted. Think of insurance, where you pay a surepremium to avoid a large possible loss.) For eachof these scenarios, indicate whether you wouldbase your decision on EMV or on expected utility.
Many decision problems have the following simple
structure. A decision maker has two possible deci-
sions, 1 and 2. If decision 1 is made, a sure cost of c is
incurred. If decision 2 is made, there are two possible
outcomes, with costs c1 and c2 and probabilities p and
1 2 p. We assume that c1 , c , c2. The idea is that
decision 1, the riskless decision, has a moderate cost,
whereas decision 2, the risky decision, has a low cost
c1 or a high cost c2.
a. Calculate the expected cost from the risky
decision.
b. List as many scenarios as you can think of that
have this structure. (Here’s an example to get you
started. Think of insurance, where you pay a sure
premium to avoid a large possible loss.) For each
of these scenarios, indicate whether you would
base your decision on EMV or on expected utility.
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