Many decision problems have the following simple structure. A decision maker has two possible decisions, 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
Many decision problems have the following simple
structure. A decision maker has two possible decisions, 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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