Decision Analysis

Probabilities are normally used in decision making under risk. You are involved in a decision making process that involves three decision alternatives and three states of nature. Discuss the methods you will use to assign probabilities to the states of nature. What conditions must be satisfied for the probabilities to exist and also how would you use the probabilities to make informed decisions? If you need to improve your decision making process for this problem, what would you have to do? And how would you be sure that this effort is worthwhile. After the discussion forum, develop a two-page report detailing your approach to this problem as stated. The report should be typed double-spaced.

In addition to your two page report, solve the problem below to show how you have applied the concepts you have outlined in your report.

Lawson’s Department Store faces a buying decision for a seasonal product for which demand can be high, medium, or low. The purchaser for Lawson’s can order one, two, or three lots of the product before the season begins but cannot reorder later. Profit projections (in thousands of dollars) are shown.

1. If the prior probabilities for the three states of nature are 0.3, 0.3, and 0.4, respectively, what is the recommended order quantity?
2. At each preseason sales meeting, the vice president of sales provides a personal opinion regarding potential demand for the product. Because of the vice president’s enthusiasm and optimistic nature, the predictions of market conditions have always been either “excellent” E or “very good” (V). Probabilities are as follows:

P(E) = 0.70 P(s₁/E) = 0.34 P(s₁/V) = 0.20

P(V) = 0.30 P(s₂/E) = 0.32 P(s₂/V) = 0.26

P(s₃/E) = 0.34 P(s₃/V) = 0.54

What is the optimal decision strategy?

1. Use the efficiency of sample information and discuss whether the firm should consider a consulting expert who could provide independent forecasts of market conditions for the product.