If your company makes a particular decision in the face of uncertainty, you estimate that it will either gain $10,000, gain $1000, or lose $5000, with probabilities 0.40, 0.30, and 0.30 respectively. you (correctly) calculate the emv as $2800. however, you distrust the use of this emv for decision making purposes. after all, you reason that you will never receive $2800; you will receive $10,000, $1000, or lose $5000. discuss this reasoning.

Question

01-05-2018
Business

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If your company makes a particular decision in the face of uncertainty, you estimate that it will either gain $10,000, gain $1000, or lose $5000, with probabilities 0.40, 0.30, and 0.30 respectively. you (correctly) calculate the emv as $2800. however, you distrust the use of this emv for decision making purposes. after all, you reason that you will never receive $2800; you will receive $10,000, $1000, or lose $5000. discuss this reasoning.

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csheehan csheehan · Answer 1 · 2018-05-04T20:46:09+02:00

EMV is the Expected monetary value of a particular decision. But a decision implies at least 2 choices. Calculating the EMV only makes sense when it is done for all choices. In this example, if your company does A, the EMV of this decision is $2,800. In order to decide what to do, you need to know the EMV of choice B.
Since there is no further information, let's assume that choice B is "doing nothing" and has no costs and no potential gain. Then the EMV for B is $0. A rational decision-maker will chose the option with the highest EMV. In this case, Choice A. It is not about the $2,800, it is about the highest EMV.