The expected value decision rule is a very rational way of analyzing alternatives given the probabilities of each alternative happening and the expected value to be gained from each them. In the expected value rule, the alternative with the highest expected value will be chosen. The expected value rule is best when a decision is to be done repeatedly and the probabilities are always the same every time .
The expected value decision rule is commonly used by decision makers because of the simplicity of computation. A caveat though in using this rule is that assigning probabilities is often very subjective, depending on the decision maker. If the probabilities assigned are not accurate, then there is a danger of making the wrong decision. The decision maker’s attitude to risk is also another factor that must be considered in using the expected value rule.
One used the expected value decision rule when faced with a decision of what stock to purchase in the stock market. A decision has to be made considering the current price of the stock market and the possible future value of the stock the following year. One assigned probabilities for three scenarios, that is, when the stock market is on a high, low and status quo. The expected prices of the stocks at the different scenarios were also determined. After computing the expected value, one was able to come up with the decision on what stock to purchase.
The expected value decision rule is helpful in making decisions based on the estimated risk of a project and its corresponding yield.
Works Cited
(n.d.). Chapter 15 - Decisions under risk and uncertainty. McGraw-Hill. Retrieved from http://highered.mcgraw-hill.com/sites/dl/free/0073375918/786817/10e_15_Chap_Student_Workbook.pdf
Engler, T. W. (2011). Decision analysis for petroleum exploration. Retrieved from infohost.nmt.edu: http://infohost.nmt.edu/~petro/faculty/Engler472/PET472-DecisionAnalysis-student.pdf
The maximum expected value rule. (n.d.). Retrieved from db.lib.uidaho.edu: http://db.lib.uidaho.edu/ereserve/courses/s/stats/271_00/412_The_Maximum_Expected_Value_Rule.pdf
