Decision & Valuation Chapter 3

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3
DECISION & VALUATION

CHAPTER OVERVIEW

DECISION & VALUATION

Relations and numbers

The comparative value terms

Completeness

Transitivity

Using preferences in decision-

making

Numerical

Using utilities in decision-making

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 LEARNING OBJECTIVES:

After studying this chapter, you should be able to:

1. Describe the concept of “relation” in options and the use of “number” in

representing options and alternatives.
2. Differentiate the use of comparative value terms within relation and
preference
3. Understand the completeness issue in relation, preference and domain
4. Understand and describe the concept of transitivity
5. Describe the use of preference relations in decision making
6. Transform and apply numerical system for alternatives
7. Assign and use utilities in making decision

3.1 INTRODUCTION

This chapter presents preliminary discussions about decision that include short
overview, relationship between decision and theoretical question with examples and
theories or approach of decision as critical parts in discussing the decision subject.
The goal of this presentation is the nurture of firm understanding on the essential
tenets about decision.

3.1 RELATIONS AND NUMBERS

When a person has to choose one option or alternative from a set of alternatives, say
a house or a car from available set of houses and cars, two common models can be
used. Those models are relation and number. The relational model for the house or
car may be expressed as;

House/Car A better than House/Car B

House/Car B better than House/Car C
House/Car A better than House/Car C
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Following this relational model, the person would definitely choose House/Car A for it
better than two other houses or cars. The relation “better” is critical in this example.
Any other terms that stand similar meaning with “better” can be used in this case.
Adjective words then seems appropriate for representing relation.

The problem of choosing a preferred house/car as above may also be made using
numerical model, in which a numeric value is assigned to individual option as
alternative to relation. Using numerical model, the expression would be changed to;

House/Car A = 20 marks
House/Car B = 15 marks
House/Car C = 10 marks

In this numerical representation, House/Car A is chosen since it has a higher value

than either House B or House C.

3.2 THE COMPARATIVE VALUE TERMS

As in relational representation above, the value pattern is often referred to in

making decision. While comparing alternatives in hand, a person uses ordinary
terms like “better than”, “cheaper than”, “worse than” and etcetera, that compare
and relate alternatives. These comparative value terms play critical role in decision
making. In mathematics, the notation of "A>B" or “A<B” are used.

On top of “better than” and “worse than”, the comparative value terms of "equal in
value to" and "at least as good as" are widely used in helping a person making
decision. The symbol of ≡ is used to denote “equal in value to" in which A ≡ B means
that House A and House B have the same value of preference. The symbol of ≥ is
used to represent the value term of "at least as good as", in which "A≥B" denotes that
House A is least preferred than House B.

These three notions i.e "better than" (>), "equal in value to" (≡) and "at least as good
as" (≥) are essential parts of the formal language of preference logic in that “>”
represents strong preference, “≥” represents weak preference, and ≡ represent
indifference. In decision context, mathematical properties of ≥, > and ≡ have two
properties that are widely referred to as completeness and transitivity.

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3.3 COMPLETENESS

Preference relation refers to a set of entities over which it is defined. For example, if a
buyer prefers House A, then the preference is applied to housing circumstances, not
other things. The formal property of completeness is defined upon a relation and its
domain or entities. For this relation to be complete, the buyer must be able to
compare two houses.

Decision making is based on preference and preference guide actions. For example,
when choosing a brand of car, say Car A, Car B and Car C, a buyer clearly prefers
Car A instead of other cars. As long as Car A is available, the buyer does not need to
think up to prefer Car B and Car C or consider both Car B and Car C are equal in
value. It is expected that the preferences that guide decisions are in many cases
incapable of being represented by a complete preference relation. However, in DT,
preference completeness usually accepted as a simplifying assumption.

3.4 TRANSITIVITY

In many circumstances, A thing is considered better than B thing and B thing is better
than C thing. However, C thing can be better than A thing even though it is worse
than B thing. The statement that C thing is better than A thing is weird following the
properties of transitivity.

In a circumstance that a buyer likes Car A more than Car B, and he likes Car B more
than Car C but he likes Car C more than Car A, the buyer cannot make decision that
he can be satisfied. If a buyer chooses Car A, then he knows that he would have
been more satisfied with Car C. However, if he chooses Car C, he knows that Car B
better than Car C. Choosing Car B would not solve his problem since he believes Car
A better than Car B. In DT, it is commonly supposed that not only strict preference (>)
but also weak preference (≥) and indifference () are transitive. All the three relation
should be considered together in making good decision. The following two rules are
assumed to ponder together:

A weak preference relation “≥” is transitive if and only if it holds for all
elements A, B, and C of its domain that if A≥B and B≥C, then A≥C.

An indifference relation “” is transitive if and only if it holds for all elements A,
B, and C of its domain that if AB and BC, then AC.
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Transitivity, just like completeness, is a common but problematic assumption in

decision theory.

3.5 USING PREFERENCES IN DECISION-MAKING

When making decision, preference relations often used to find the best alternative.
The general is “if an alternative is best then choose it” and the alternative is best if
and only if it is better than all other alternative. However, there are many cases in
which no alternative is found as best, since the “best” is "shared" by two or more
alternatives as reflected in the following example, and the decision is to have one
preferred out of two.

Handphone A and Handphone B are equally good (A≡B)

Handphone A is better than Handphone C (A>C)
Handphone B is better than Handphone C (B>C)

The individual’s preference ordering over the two acts is determined by the ex-ante
expected value of the utility associated with choosing one act when he could have
chosen the other.

3.6 NUMERICAL PREFERENCES

Numerical assignment can also be used to represent the values of the alternatives
that decision maker decides between. For each item considered, the numerical
values are given as follows;

Nokia 90
Sony Ericsson 80
Samsung 75
Toshiba 50

Nokia is thought better than any other brand since its numerical value is highest. The
information provided by the numerical value is sufficient to obtain a relational
representation. The preference and indifference may also be gained from this
numerical assignment. The problem with this approach is that the meaning of number
representation is unclear since the measure for number associated with each gadget
is arbitrary.

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3.7 USING UTILITIES IN DECISION-MAKING

Despite the arbitrarily in number assignment, numeric values or utilities are easy to
use in decision-making following the rule “choose the alternative with the highest
utility”. The decision maker needs to be careful because this rule cannot be simply
applied if there are two alternatives with equal maximal value as in the following
example;

Supermarket Giant 80
Supermarket Carrefour 80
Supermarket Econsave 70

In this circumstance, the rule “choose the alternative with the highest utility. If more
than one alternative has the highest utility, pick one of them” would not be applied.
Choosing both alternatives as in this example is called maximization. Maximization is
helpful since most of economic theory is based on the idea that individuals maximize
their holdings, as measured in money. Utilitarian moral theory postulates that
individuals should maximize the utility resulting from their actions.

3.8 CONCLUSION

This chapter discusses the relational and numerical values that assist in decision
making. In relational, the positive terms value such as “better”, “cheaper” and “more”
that indicate strict or strong preference annotated with “>” are easy and widely used.
However, there also exists weak preference and indifference annotated with “≥” and
“” respectively. These preferences must be considered and combined with strict
preference to let decision making more intuitive and meaningful. Numerical values
also help decision maker in valuing and weighing the merit of each of the
alternatives.

POINT TO PONDER

Students should think about

 The use of relation and numerical models to represent option in making decision

 Completeness of the preference relation follows from the assumption that element of
preference has nonempty values.

 A preference relation “>” is transitive if and only if it holds for all elements A, B, and C
of its domain that if A>B and B>C, then A>C.
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 The evaluation of a course of action in the face of uncertainty involves the decision
maker’s taste for the possible consequences and his beliefs regarding their likely
realization.

 In uncertain or risky situations, individuals act as if they choose on the basis of

expected utility – the utility of expected outcomes rather than expected value.

ACTIVITIES

Student should further explore;

 Broader concept of relation and numbers and their relationship with decision
 Other binary relation symbols used in representing comparative value term
 The concept of preference
 The variation of preference i.e weak preference and indifference and their role in decision
making
 The concept of expected utility theory (EUT)
 How to use EUT in decision making under uncertainty

STUDY QUESTIONS
PART A: DEFINITION
Please define the following terms:
1. Relation
2. Binary relation symbols
3. Completeness
4. Transitivity
5. Preference, weak preference and indifference
6. Expected utility
7. Subjective expected utility

PART B: SHORT ANSWER

Answer the following questions:
1. Define the relation with examples

2. Discuss the role of strict, weak and indifference preferences in decision making.

3. Differentiate the completeness and transitivity

4. Why should a decision maker consider completeness and transitivity in making

decision

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 5. Explain the method to use utilities in decision making with example.

FURTHER READING

Hansson, S. O. (1994). Decision Theory : A Brief Introduction. Department of Philosophy

and the History of Technology, Royal Institute of Technology (KTH). Stockholm.
Grant, S. & Van Zandt, T. (2008). Expected Utility Theory. In P. Anand, P. Pattanaik & C.
Puppe (Eds.) Handbook of Rational and Social Choice, Oxford University Press.
Karni, E. (2005). Savages' Subjective Expected Utility Model. Online:
http://www.econ.jhu.edu/people/Karni/savageseu.pdf.
Gee, C. (2009) An Axiomatisation of Regret Theory, University of Cambridge. Mimeo.
Online. http://www.econ.cam.ac.uk/phd/xcg296/research_files/CGRegAx.pdf