1.
2.
The branches emanating from a circle are therefore labeled with probabilities which
represent the decision makers estimate of the probability that a particular branch will be
followed. Example :
It can be seen that the rollback method allows a complex decision problem to be
analyzed as a series of smaller decision problems. Judgment is therefore needed to determine
where the tree should end. Clearly, the calculations involved in analyzing a large decision tree
can be rather tedious.
Decision Trees and Utility
In the previous section we made the assumption that the decision maker was neutral to
risk. Let us now suppose that the engineer is concerned that his career prospects will be
blighted if the development of the processor leads to a great loss of money for the company.
The figure shows the decision tree, with the utilities replacing the monetary values. After
applying the rollback method it can be seen that now the optimum policy is to develop the
electric-powered design and, if it fails, to abandon the project.
Influence diagrams are designed to summarize the dependencies that are seen to exist
among events and acts within a decision. Given certain conditions, influence diagrams can be
converted to trees. The advantage of starting with influence diagrams is that their graphic
representation is more appealing to the intuition of decision makers who may be unfamiliar
with decision technologies. In addition, influence diagrams are more easily revised and
altered as the decision maker iterates with the decision analyst. The definition used in
influenced diagrams :
The figure shows the key concept, As with the decision tree, event nodes are
represented by circles and decision nodes by squares. Arrowed lines between nodes indicate
the influence of one node to another. Arrow pointing to a decision node indicates that either
the decision is influenced by a prior decision or on the occurrence (or not) of prior events.
The step procedure for turning an influenced diagrams into the decision tree is as follows :
1.
Identify a node with no arrows pointing into it (since there can be no loops at least
6. Repeat the above procedure until all the nodes have been removed from the influence
diagram.
theory will attempt to develop the idea intuitively and then show how a probability tree can
be used to revise prior probabilities.
A more general view of the relationship between the vagueness of the prior
probabilities and the reliability of the new information can be seen in Figure 8.6. In the figure
the horizontal axis shows the prior probability that gas will be found, while the vertical axis
represents the posterior probability when the test drilling has indicated that gas will be found.
For example, if the prior probability is 0.4 and the result of the test drilling is 70% reliable
then the posterior probability will be about 0.61. The graph shows that if the test drilling has
only a 50% probability of giving a correct result then its result will not be of any interest and
the posterior probability will equal the prior, as shown by the diagonal line on the graph.
Low sales
High sales
$80 000
$140 000
respectively. These probabilities replace the prior probabilities in the decision tree, as shown
in Figure 8.7(c).
Summary
In this chapter we have discussed the role that new information can play in revising the
judgments of a decision maker. We argued that Bayes theorem shows the decision maker
how his or her judgments should be modified in the light of new information, and we showed
that this revision will depend both upon the vagueness of the prior judgment and the
reliability of the new information. Of course, receiving information is often a sequential
process. Your prior probability will reflect the information you have received up to the point
in time when you make your initial probability assessment. As each new instalment of
information arrives, you may continue to revise your probability. The posterior probability
you had at the end of last week may be treated as the prior probability this week, and be
revised in the light of this weeks information.
We also looked at how the value of new information can be assessed. The expected value
of perfect information was shown to be a useful measure of the maximum amount that it
would be worth paying for information. Calculating the expected value of imperfect
information was seen to be a more involved process, because the decision maker also has to
judge the reliability of the information. Because of this, we stressed the importance of
sensitivity analysis, which allows the decision maker to study the effect of changes in these
assessments.