How to take correct decision under extraordinary circumstances?
An organisation has to take a decision under extraordinary circumstances. A condition of risk exists when a decision must be made on the basis of incomplete but reliable information.
Here, there is no longer just one outcome for each strategy but a number of possible outcomes – one for each possible state of nature – where the probability of each outcome is known, calculated or assigned and an expected value for each alternative or strategy is obtained. The strategy that yields the best expected value is selected as a decision.
Decisions are said to be taken under risk when there is more than one possible pay off resulting from the selection of an option and the decision maker is assumed to know the probability of occurrence of each of these payoffs.
The variation of payoffs can be considered to be the result of factors occurring outside the control of the decision maker. Assuming that a number of these factors can occur and that the probabilities of occurrence are known, the chance of various combinations of these factors (Sometimes called states of nature) can be calculated.
This type of decision may seem to be rather artificial when compared to real life conditions. On the other hand, many problems occur in areas where considerable experience has been gained in the past. In such cases, reasonable accurate estimates of the number of possible states of nature and their probabilities of occurrence can be estimated. The manner in which these estimates are made may be dependent on human behaviour and judgment.
Decisions of this type can be viewed as a sort of game against nature, with the following steps:
1. The decision maker chooses an option from a set of available options, having calculated the outcome or payoff for each of the set of options under each of a set of future states of nature, the probabilities of occurrence of which are known;
2. The decision maker having made his choice, “nature” chooses a state that actually occurs;
3. The decision maker receives the payoff corresponding to the actual state of occurring.
The decision problem is put in the form of a matrix. A matrix is simply a two-dimensional array of figures arranged in rows and columns. The rows represent the available strategies of courses and the columns represent the state of nature (one column for a payoff matrix or in the form of an opportunity cost matrix).
In the case of the payoff matrix the entry at the intersection of each row and column represents the payoff or profit for a given strategy and its corresponding state of nature. Each state of nature is assigned a probability which identifies the odds that such a state of nature would prevail. Typically, in many organisational problems, the probabilities of various states of nature are known by virtue of determining as to how frequently they occurred in the past.