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Unit 8: Expected Value with Perfect Information (EVPI)
8.5 Keywords Notes
Cost of Uncertainty: This concept is similar to the concept of EVPI. Cost of uncertainty is the
difference between the EOL of optimal action and the EOL under perfect information.
Bayes' Theorem: It is possible to revise these probabilities in the light of current information
available by using the Bayes' Theorem.
8.6 Self Assessment
1. ..................... is used when the number of states of nature is considerably large. Using this
analysis, it is possible to locate the optimal course of action without the computation of
EMV's of various actions.
2. The ..................... of various states of nature, discussed so far, were prior probabilities.
3. The ..................... are often used to understand and solve a decision problem. Using such
diagrams, it is possible to describe the sequence of actions and chance events.
4. A ..................... is represented by a circle and various event branches stem from it.
8.7 Review Questions
38. A newspaper distributor assigns probabilities to the demand for a magazine as follows:
Copies Demanded : 1 2 3 4
Probability : 0.4 0.3 0.2 0.1
A copy of magazine sells for Rs 7 and costs Rs 6. What can be the maximum possible
expected monetary value (EMV) if the distributor can return the unsold copies for Rs 5
each? Also find EVPI.
39. A management is faced with the problem of choosing one of the three products for
manufacturing. The potential demand for each product may turn out to be good, fair or
poor. The probabilities for each type of demand were estimated as follows :
Demand ®
Good Fair Poor
Product ¯
A 0.75 0.15 0.10
B 0.60 0.30 0.10
C 0.50 0.30 0.20
The estimated profit or loss (in Rs) under the three states of demand in respect of each
product may be taken as :
A 35,000 15,000 5,000
B 50,000 20,000 - 3,000
C 60,000 30,000 20,000
Prepare the expected value table and advise the management about the choice of the
product.
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