Managerial Economics: Foundations of Business Analysis and Strategy.

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Slide 1: Title slide Decision Making Under Risks and Uncertainty Slide 2: Introduction In today's business world, decision-makers are often faced with situations where the outcome is uncertain. This can be due to a variety of factors, such as changes in the market, the introduction of new competitors, or natural disasters. In these situations, it is important for decision-makers to have a process for making decisions under risks and uncertainty. Slide 3: Decisions Made Under Certainty When making decisions under certainty, the decision-maker knows with certainty what the outcome of each possible decision will be. This is often the case when making decisions based on historical data or when there are few unknown factors. For example, a company that knows the demand for its product can make a decision about how much to produce with certainty. Slide 4: Risky and Uncertain Decisions In many cases, decision-makers do not have certainty about the outcome of their decisions. This is because there are too many unknown factors or because the situation is constantly changing. These decisions are said to be risky or uncertain. For example, a company that is considering entering a new market does not know with certainty how successful it will be. Slide 5: Measuring Risk There are a number of ways to measure risk. One common way is to use probability. Probability is a measure of the likelihood that an event will occur. For example, the probability of flipping a coin and getting heads is 1/2. Another way to measure risk is to use loss. Loss is the amount of money or other resources that a decision-maker could lose as a result of a decision. For example, the loss of a company that enters a new market could be the cost of developing and marketing the product, as well as the loss of sales from its existing products. Slide 6: Rules for Decision Making Under Uncertainty There are a number of rules that decision-makers can use to make decisions under uncertainty. These rules include:

• Maximin rule: This rule states that the decision-maker should choose the option that has the maximum minimum outcome. In other words, the decision-maker should choose the option that minimizes their downside risk.
• Minimax regret rule: This rule states that the decision-maker should choose the option that minimizes their maximum regret. Regret is the difference between the outcome of the best decision and the outcome of the decision that was actually made.
• Expected value rule: This rule states that the decision-maker should choose the option that has the highest expected value. The expected value of an option is the average of the possible outcomes, weighted by their probability.

Slide 7: Expected Utility Expected utility is a more complex way of measuring risk than probability or loss. Expected utility takes into account the decision-maker's attitude towards risk. For example, some people are risk-averse, meaning that they prefer to avoid risk even if it means giving up potential gains. Others are risk-seeking, meaning that they are willing to take risks in the hope of making large gains. Slide 8: The Maximin Rule The maximin rule is a decision-making rule that minimizes the maximum loss. In other words, the decision-maker chooses the option that has the lowest possible worst-case scenario. The maximin rule is often used in situations where the decision-maker is facing a lot of uncertainty and the potential losses are high. For example, a company that is considering entering a new market might use the maximin rule to choose the option that minimizes the potential losses if the market fails. Slide 9: Why Management May Use the Maximin Rule There are a number of reasons why management may use the maximin rule. These include:

• The company is risk-averse.
• The company does not have a lot of information about the decision.
• The potential losses are high.
• The decision is irreversible.

Conclusion Making decisions under risks and uncertainty is a complex process. There is no one-size-fits-all solution, and the best approach will vary depending on the specific situation. However, by understanding the different factors involved, decision-makers can make more informed choices that are less likely to lead to negative outcomes.