LECTURE 6

DECISION-MAKING MODELS
DECISION
THEORY AND Decision theory and utility theory are concepts that help
UTILITY individuals make rational decisions by considering various
THEORY factors and assessing the utility or value associated with
different choices.
DECISION THEORY

 Decision theory is a field of study that examines

how individuals make choices when faced with
uncertainty or multiple options.
 It provides a framework for analyzing decision-
making processes, evaluating potential outcomes,
and selecting the best course of action.
 Decision theory considers factors such as
preferences, probabilities, and consequences to
guide decision-making.
UTILITY THEORY

Utility theory is a concept within decision

theory that quantifies the value or satisfaction
an individual derives from different outcomes
or choices.
It assumes that individuals make decisions
based on the expected utility they associate
with each alternative.
Utility is a subjective measure and can vary
across individuals and contexts.
PREFERENCES

Preferences refer to an individual's subjective rankings or evaluations

of different options or outcomes.
Preferences are influenced by personal values, beliefs, attitudes, and
goals.
In decision theory, preferences are used to assess the desirability or
utility of various alternatives.
EXPECTED UTILITY

Expected utility combines probabilities and utilities to determine the

overall expected value of a decision or choice.
It involves multiplying the utility of each potential outcome by its
probability of occurring and summing them up.
The option with the highest expected utility is considered the optimal
choice.
RISK AND UNCERTAINTY

Decision theory deals with situations involving risk and uncertainty,

where the probabilities of outcomes are not known with certainty.
It examines how individuals make decisions under various degrees of
risk and uncertainty and how they incorporate risk preferences into
their choices.
DECISION-MAKING MODELS

Decision theory offers various decision-making models, such as the

expected utility model, prospect theory, and bounded rationality
models.
These models provide frameworks and mathematical tools to analyze
decision problems, assess trade-offs, and understand how individuals
make choices.
APPLICATIONS

Decision theory and utility theory have applications in economics,

finance, psychology, business, public policy, and other fields.
They are used to analyze investment decisions, risk management
strategies, consumer behavior, policy-making, and more.
Understanding decision theory and utility theory can
help individuals and organizations make more
informed and rational decisions by considering
trade-offs, uncertainties, and value assessments. By
applying these concepts, decision-makers can
evaluate alternatives, estimate their expected
utilities, and choose options that align with their
preferences and objectives.
MULTI-CRITERIA DECISION ANALYSIS (MCDA) IS A STRUCTURED APPROACH
USED TO EVALUATE AND COMPARE ALTERNATIVES BASED ON MULTIPLE
CRITERIA OR FACTORS. IT HELPS DECISION-MAKERS CONSIDER DIFFERENT
DIMENSIONS AND THEIR RELATIVE IMPORTANCE WHEN MAKING COMPLEX
DECISIONS.

Criteria Weighting Scoring

Identification Criteria Alternatives

Decision-
Aggregation Sensitivity
making and
Methods Analysis
Interpretation
 Decision trees and influence diagrams are powerful tools
DECISION for structuring decision problems, evaluating alternatives,
and making informed choices. They assist in quantifying
TREES AND
uncertainties, assessing probabilities and payoffs, and
INFLUENCE considering dependencies between variables, ultimately
DIAGRAMS aiding decision-makers in identifying the most favorable
outcomes.
DECISION TREES AND INFLUENCE DIAGRAMS ARE GRAPHICAL TOOLS
USED IN DECISION ANALYSIS TO MODEL AND ANALYZE COMPLEX
DECISION PROBLEMS

Modeling
Decision Influence
Decision
Trees Diagrams
Problems

Analysis and
Probabilities
Decision
and Payoffs
Making