Page 595 -

UTILITY AND DECISION MAKING 575

Summary

l Decision analysis is used to evaluate alternative decisions where the outcomes are uncertain.
l A payoff table shows the payoffs or outcomes for a decision problem.
l A decision tree shows the decision problem graphically.
l For decision problems without probability information, three alternative approaches can be used: the
optimistic, or maximax approach; the conservative or maximin approach; the minimax regret approach.
l When probability information is available the expected value approach can be used.
l Decision analysis can be used to assess the value of additional information about the decision problem.
l A risk profile provides a probability distribution for the possible payoffs and can help in assessing the
risks associated with different decision alternatives.
l The expected utility approach can be used in situations where monetary value is not the only measure
of performance.

WORKED EXAMPLE

he Development Team of Potsdam City Council in Germany have a remit to support economic development
T in the city. The city has a small airport and AirXpress, a German budget airline, has indicated to the Team
that if the airport is upgraded and refurbished the airline would seriously consider establishing the airport as one
of its regional centres. This would bring income and further investment into the city with an estimated value of
E3.5 million. However, the cost to the city council of upgrading the airport would be around E2 million. AirXpress
will not consider using the airport unless it is upgraded. In addition, a medical equipment manufacturer,
Diagnostic Research International (DRI) is considering building a manufacturing plant in the city which again
would increase the city’s prosperity by an estimated E4.5 million. The Development Team are of the view that
upgrading the airport would increase the chance of DRI locating to Potsdam. However, the city council is under
severe financial pressure and E2 million would put considerable pressure on its budget. The following informa-
tion has been obtained. What advice can we offer the Development Team?

Upgrade the airport
Outcomes Probability
AirXpress establish a regional centre 0.1
DRI builds manufacturing plant 0.4
AirXpress establish a regional centre and DRI builds manufacturing plant 0.3
Neither AirXpress or DRI locate to the city 0.2
No upgrade of the airport
Outcomes Probability

DRI does not build manufacturing plant 0.4
DRI builds manufacturing plant 0.6

Solution

We have a decision problem with probability information. The decision facing the city is whether to upgrade the
airport or not. If the decision is taken to upgrade the airport then there are four possible outcomes with differing
financial consequences for the city (Exhibit 13.2).

Copyright 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has
deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it.