DECISION THEORY

People constantly make decisions in their private lives as well as in their work. Some decisions are qualitative in terms of their implications and significance, like, If I do not have coffee in the morning, I will feel flat throught the day and if I have, I will feel fresh. Other decisions involve elements which are quantifiable like, If I work on the machine for 6 hours per day the production would be 2,500 units and if I work for 8 hours per day the production would be 3,500 units.  

Decision making environments in which consequences of decisions are quantifiable.

Our discussion of decision theory is based on the following assumptions:

1. The decision maker can define all decision alternatives or strategies which are being considered.
2. He can define the various states of nature for the decision setting which are not under his control. Examples of states of nature might include possible economic conditions (boom, stagnation, recession, etc.) the various responses of competing decision makers, various weather conditions and so on. The states of nature can be categorical like above-average, below-average, average, etc. or numerical.
3. He can estimate quantitatively the consequences (benefits or costs) of selecting any decision alternative and having any state of nature occurrence.

Decision making can be of three categories:

1. Decision making under conditions of certainty – Complete certainty on the part of the decision maker as to which state of nature is going to occur.
2. Decision making under conditions of uncertainty – No knowledge about the likelihood of occurrence of the various states of nature.
3. Decision making under conditions of risk – Has sufficient knowledge about the states of nature to assign probabilities to their likelihood of occurrence.