Question

If your company makes a particular decision in the face of uncertainty, you estimate that it will either gain $10,000, gain $1000, or lose $5000, with probabilities 0.40, 0.30, and 0.30, respectively. You (correctly) calculate the EMV as $2800. However, you distrust the use of this EMV for decision-making purposes. After all, you reason that you will never receive $2800, you will receive $10,000, $1000, or lose $5000. Discuss this reasoning

Answer 1

Solution

To discuss: The reasoning for the situation.

Decision making under uncertainty:

The decision-making process will have the possibility of having more than one possible consequence of action for a decision that is being made.

It is correct in this situation that it is not possible to make the expected monetary value (EMV) of $2,800. But, if there are a lot of decisions made just like this decision, it is advisable to use the EMV criterion as an average of all the decisions made.

The EMV criterion might be the best when a firm is not looking to take the risk as the possible gains and losses are important for a firm. In this scenario, it is better to make a decision based on the expected utility.