When probabilities can be assigned to the occurrence of states of nature in the future the situation is referred to as decision-making under uncertainty?

The environment of Decision Making Under Risk is very similar to Uncertainty, with one key difference.  Under Risk, the decision maker can determine and assign probabilities of occurrence to each State of Nature. 

This is a very important distinction, and completely changes the decision making landscape.  Once probabilities are assigned to each State of Nature, we use a technique called Expected Monetary Value to determine the best decision.  Module 4 will cover this in greater detail.

For now, just know that under Risk, we can know the probability that a certain State of Nature will occur, and under Uncertainty, we can't.

As a quick example of knowing the probabilities, suppose that a decision maker commissioned a marketing research organization to study the market for his product. They might come back to him with some basic probabilities of occurence of market outcomes, such as a 30% probability of an excellent market, a 50% probability of a fair market, and a 10% probability of a poor market.

In this case, three States of Nature were identified. Before assigning the probablilities, the decision maker would have to operate in an environment of Uncertainty. After knowing the probabilities the environment shifted over to Risk.

Page 4 of 6

Page 2

The following table summarizes the key differences among the decision making environments.

Page 5 of 6

Page 3

Complete the exercise to demonstrate your mastery of the decision making environments.

[Exercise goes here]

This is the end of this Module. Click one of the links at the left to move on to a different module, or to restart this one.

Page 6 of 6