Chapter 4 Making Choices

Making Hard Decisions Chapter 4 Making Choices Slide of 58

Texaco Versus Pennzoil In early 984, Pennzoil and Getty Oil agreed to the terms of a merger. But before any formal documents could be signed, Texaco offered Getty a substantially better price, and Gordon Getty, who controlled mos of the Getty Stock, reneged on the Pennzoil deal and sold to Texaco. Naturally, Pennzoil felt as if it had been dealt with unfairly and immediately files a lawsuit against Texaco alleging that Texaco had interfered illegally in the Pennzoil-Getty negotiations. Pennzoil won the case: in late 985, it was awarded $. billion, the largest judgment ever in the United States. A Texas appeal court reduced the judgement to $2 billion, but interest and penalties drove the total back up to $.3 billion. James Kinnear, Texaco s Chief executive officer, had said that Texaco would file for bankruptcy if Pennzoil obtained court permission to secure the judgment by filing liens against Texaco s assets. Slide 2 of 58

Texaco Versus Pennzoil - Continued Furthermore, Kinnear had promised to fight the case all the way to the U.S. Supreme Court if necessary, arguing in part that Pennzoil had not followed Security and Exchange Commission regulations in its negotiations with Getty. In April 987, just before Pennzoil began to file liens, Texaco offered to Penzoil $2 billion dollars to settle the entire case. Hugh Liedtke, chairman of Pennzoil, indicated that his advisors were telling him that a settlement between $3 billion and $5 billion would be fair. What should Hugh Liedtke do?. Accept $2 Billion 2. Refuse $2 Billion and counter offer $5 Billion Slide 3 of 58

Texaco Versus Pennzoil Decision Tree Accept $2 Billion Max Settlement Amount ($ Billion ) 2 Texaco Accepts $5 Billion 5 High.3 Counteroffer $5 Billion Texaco Refuses Counteroffer Final Court Decision Medium Low 5 High.3 Texaco Counter - offers $3 Billion Refuse Final Court Decision Accept $3 Billion Medium Low 5 3 Slide 4 of 58

Texaco Versus Pennzoil - Continued Given tough negotiation positions of the two executives, their could be an even chance (5%) that Texaco will refuse to negotiate further. Liedtke and advisor figure that it is twice as likely that Texaco would counter offer $3 billion than accepting the $5 billion. Hence, because there is a 5% of refusal, there must be a 33% chance of a Texaco counter offer and a 7% chance of Texaco accepting $5 billion. What are the probabilities of the final court decision? Liedtke admitted that Pennzoil could lose the case. Thus there is a significant possibility the outcome would be zero. It s probability is assessed at 3%. Given the strength of the Pennzoil case it is also possible that the court will upheld the judgment as it stands. It s probability is assessed at 2%. Finally, the possibility exists that the judgment could be reduced somewhat to $5 billion. Thus there must be a chance of 5% of this happening. Slide 5 of 58

Texaco Versus Pennzoil - Continued Given tough negotiation positions of the two executives, it could be an even chance (5%) that Texaco will refuse to negotiate further. Liedtke and advisor figures that it is twice as likely that Texaco would counter offer $3 billion than accepting the $5 billion. Hence, because there is a 5% of refusal, there must be a 33% chance of a Texaco counter offer and a 7% chance of Texaco accepting $5 billion. What are the probabilities of the final court decision? Liedtke admitted that Pennzoil could lose the case. Thus there is a significant possibility the outcome would be zero. It s probability is assessed at 3%. Given the strength of the Pennzoil case it is also possible that the court will upheld the judgment as it stands. It s probability is assessed at 2%. Finally, the possibility exists that the judgment could be reduced somewhat to $5 billion. Thus there must be a chance of 5% of this happening. Slide 6 of 58

Texaco Versus Pennzoil Decision Tree Accept $2 Billion Max Settlement Amount ($ Billion ) 2 Texaco Accepts $5 Billion (.7) 5 High (.2).3 Counteroffer $5 Billion Texaco Refuses (.5) Counteroffer Final Court Decision Medium (.5) Low (.3) 5 High (.2).3 Texaco (.33) Counter - offers $3 Billion Refuse Final Court Decision Accept $3 Billion Medium (.5) Low (.3) 5 3 Slide 7 of 58

Decision Tree and Expected Monetary Value (EMV) When objective is measured in dollars First Suggestion: Solve decision problem by choosing that alternative that maximizes the EMV Expected value of discrete random variable Y: E Y [ Y ] = n i= y i Pr( Y = y i ) = n i= y i p i Slide 8 of 58

A double-risk dillema Trade Ticket EMV= $4 Win (.2) $25 Max Profit $24 y Pr(Y=y) y*pr(y=y) $24..2 $4.8 -$..8 -$.8 $4. = EMV EMV= $4.5 -$ Keep Ticket $ EMV= $4.5 Lose (.8) $ Win (.45) $ Lose (.55) $ -$ $ $ y Pr(Y=y) y*pr(y=y) $..45 $4.5 $..55 $. $4.5 =EMV Interpretation EMV: Playing the same lottery a lot of times will result over time in an average pay-off equal to the EMV Slide 9 of 58

Texaco Versus Pennzoil Decision Tree Accept $2 Billion Max Settlement Amount ($ Billion ) 2 Texaco Accepts $5 Billion (.7) 5 High (.2).3 Counteroffer $5 Billion Texaco Refuses (.5) Counteroffer Final Court Decision Medium (.5) Low (.3) 5 High (.2).3 Texaco (.33) Counter - offers $3 Billion Refuse Final Court Decision Accept $3 Billion Medium (.5) Low (.3) Solve tree using EMV by folding back the tree 5 3 Slide of 58

Decision Tree and Expected Monetary Value (EMV) Step : Calculate EMV of court decision uncertainty node EMV= $4.56 Final Court Decision High (.2) Medium (.5) Low (.3).3 5 Step y Pr(Y=y) y*pr(y=y).3.2 $2.6 5..5 $2.5..3 $. $4.56 =EMV Slide of 58

Decision Tree and Expected Monetary Value (EMV) Step 2: Evaluate decision regarding Texaco s counter offer EMV= 4.56 High (.2).3 EMV= 4.56 Refuse Final Court Decision Medium (.5) Low (.3) 5 Accept $3 Billion 3 Slide 2 of 58

Decision Tree and Expected Monetary Value (EMV) Step 3: Calculate EMV Texaco s reaction uncertainty node Accept $2 Billion 2 y Pr(Y=y) y*pr(y=y) 5..7 $.85 4.56.5 $2.28 4.56.33 $.5 $4.63 = EMV Texaco Accepts $5 Billion (.7) 5 EMV= 4.63 Counteroffer Texaco Refuses (.5) EMV= 4.56 $5 Billion Counteroffer Texaco Counter - offers $3 Billion (.33) EMV= 4.56 Slide 3 of 58

Decision Tree and Expected Monetary Value (EMV) Step 4: Evaluate the immediate decision EMV= 4.63 Accept $2 Billion Max Result 2 Counteroffer EMV= 4.63 $5 Billion Optimal decision: Counteroffer $5 Billion Optimal decision strategy: Counteroffer $5 Billion and if Texaco counteroffers $3 Billion, then refuse this counteroffer. Slide 4 of 58

Folding back the Decision Tree from right to left using EMV EMV= 4.63 Accept $2 Billion Texaco Accepts $5 Billion (.7) Max Result 2 5 Counteroffer $5 Billion EMV= 4.63 Texaco Refuses (.5) Counteroffer EMV= 4.56 Final Court Decision High (.2) Medium (.5) Low (.3).3 5 EMV= 4.56 High (.2).3 Texaco (.33) Counter - offers $3 Billion EMV= 4.56 Refuse Final Court Decision Medium (.5) Low (.3) 5 Accept $3 Billion 3 Slide 5 of 58

Definitions Decision Path and Strategy Definition decision path: A path starting at the left most node up to the values at the end of a branch by selecting one alternative from decision nodes or by following one outcome from uncertainty nodes. Represents a possible future scenario. Definition decision strategy: The collection of decision paths connected to one branch of the immediate decision by selecting one alternative from each decision node along these paths. Represents specifying at every decision in the decision problem what we would do, if we get to that decision (we may not get there due to outcome of previous uncertainty nodes). Optimal decision strategy: That decision strategy which results in the highest EMV if we maximize profit and the lowest EMV if we minimize cost. Slide 6 of 58

Counting Strategies How many decision strategies in Example? How many decision strategies in Example 2? Example 2 Example Slide 7 of 58

Counting Strategies How many decision strategies in Example 3? Example 3 Slide 8 of 58

Counting Strategies How many decision strategies in Example? Example Strategy Strategy 2 Strategy 3 How many decision strategies in Example 2? Strategy Example 2 Strategy 2 () Strategy 3 () Strategy 4 () Strategy 5 () Slide 9 of 58

Counting Strategies How many decision strategies in Example 3? Strategy Example 3 Strategy 2 () Strategy 3 () Strategy 4 () Strategy 5 () Strategy 6 () Strategy 7 () Strategy 8 () Strategy 9 () Slide 2 of 58

Decision Strategies Texaco-Pennzoil Case How many decision strategies do we have in the Texaco Penzoil decision tree? First strategy: Accept $2 billion Accept $2 Billion 2 Slide 2 of 58

Decision Strategies Texaco-Pennzoil Case Second strategy: Counter $5 billion and if Texaco counter offers $3 billion refuse this counteroffer of $3 Billion Texaco Accepts $5 Billion (.7) 5 High (.2).3 Counteroffer $5 Billion Texaco Refuses (.5) Counteroffer Final Court Decision Medium (.5) Low (.3) 5 Texaco (.33) Counter - offers $3 Billion Refuse Final Court Decision High (.2) Medium (.5) Low (.3).3 5 Slide 22 of 58

Decision Strategies Texaco-Pennzoil Case Third strategy: Counter $5 billion and if Texaco counter offers $3 billion accept this counteroffer of $3 Billion Texaco Accepts $5 Billion (.7) 5 High (.2).3 Counteroffer $5 Billion Texaco Refuses (.5) Counteroffer (.33) Texaco Counter - offers $3 Billion Final Court Decision Accept $3 Billion Medium (.5) Low (.3) 5 3 Slide 23 of 58

Risk Profiles and Cumulative Risk Profiles RISK PROFILES = Graph that shows probabilities for each of the possible outcomes given a particular decision strategy. Note: Risk Profile is a probability mass function for the discrete random variable Y representing the outcomes for the given decision strategy. CUMMULATIVE RISK PROFILES = Graphs that shows cumulative probabilities associated with a risk profile Note: Cumulative risk profile is a cumulative distribution function for the discrete random variable Y representing the outcomes for the given decision strategy. Slide 24 of 58

Risk Profiles First strategy: Accept $2 billion Accept $2 Billion 2 Outcome x ($Billion) Pr(Outcome D) 2 Pr(Outcome D).8.6.4.2 Risk Profile D="Accept $2 Billion" - 2 5 8 Outcome ($Billion) Slide 25 of 58

Risk Profiles Second strategy: Counter $5 billion and if Texaco counter offers $3 billion refuse this counteroffer of $3 Billion Texaco Accepts $5 Billion (.7) 5 Calculation Prob.7.7 Counteroffer $5 Billion Texaco Refuses (.5) Counteroffer Final Court Decision High (.2).3 Medium (.5) 5 Low (.3).5*.2..5*.5.25.5*.3.5 Texaco Counter - (.33) offers $3 Billion Refuse Final Court Decision High (.2).3 Medium (.5) 5 Low (.3).33*.2.66.33*.5.65.33*.3.99 Total. Slide 26 of 58

Risk Profiles Second strategy: Counter $5 billion and if Texaco counter offers $3 billion refuse this counteroffer of $3 Billion Outcome x ($Billion) Calculation Pr(Outcome D).5+.99.249 5.7+.25+.65.585.3.+.66.66. Risk Profile D="Counter $5 Billion, refuse counter offer of $3 Billion if given" Pr(Outcome D).8.6.585.4.2.249.66-2 5 8 Outcome ($Billion) Slide 27 of 58

Risk Profiles Third strategy: Counter $5 billion and if Texaco counter offers $3 billion accept this counteroffer of $3 Billion Texaco Accepts $5 Billion (.7) 5 Calculation Prob.7.7 Counteroffer $5 Billion Texaco (.33) Counter - offers $3 Billion Texaco Refuses (.5) Counteroffer Final Court Decision Accept $3 Billion High (.2) Medium (.5) 5 Low (.3).3 3.5*.2..5*.5.25.5*.3.5.33.33 Total. Slide 28 of 58

Risk Profiles Third strategy: Counter $5 billion and if Texaco counter offers $3 billion accept this counteroffer of $3 Billion Outcome x ($Billion) Calculation Pr(Outcome D).5.5 3.33.33 5.7+.25.42.3... Risk Profile D="Counter $5 Billion, Accept Counter Offer of $3 Billion if given" Pr(Outcome D).8.6.4.33.42.2.5. - 2 5 8 Outcome ($Billion) Slide 29 of 58

Cumulative Risk Profiles First strategy: Accept $2 billion Outcome x ($Billion) Pr(Outcome D) 2 Pr(Outcome D).8.6.4.2 Risk Profile D="Accept $2 Billion" - 2 5 8 Outcome ($Billion) Outcome x ($Billion) Pr(Outcome x D) 2 Pr(Outcome x D).8.6.4.2 Cumulative Risk Profile D="Accept $2 Billion" - 3 5 7 9 Outcome ($Billion) Slide 3 of 58

Cumulative Risk Profiles Second strategy: Counter $5 billion and if Texaco counter offers $3 billion refuse this counteroffer of $3 Billion Outcome x ($Billion) Pr(Outcome D).249 5.585.3.66 Pr(Outcome D).8.6 Risk Profile D="Counter $5 Billion, refuse counter offer of $3 Billion if given".585.4.249.2.66-2 5 8 Outcome ($Billion) Cumulative Risk Profile D="Counter $5 Billion, refuse counter offer of $3 Billion if given" Outcome x ($Billion) Pr(Outcome x D).249 5.249 +.585 =.834.3.834 +.66 = Pr(Outcome x D).8.6.4.2.834.834.249.249-2 5 8 Outcome ($Billion) Slide 3 of 58

Cumulative Risk Profiles Third strategy: Counter $5 billion and if Texaco counter offers $3 billion accept this counteroffer of $3 Billion Outcome x ($Billion) Pr(Outcome D).5 3.33 5.42.3. Pr(Outcome D) Risk Profile D="Counter $5 Billion, Accept Counter Offer of $3 Billion if given".8.6.42.4.33.2.5. - 2 5 8 Outcome ($Billion) Outcome x ($Billion) Pr(Outcome x D).5 3.5 +.33 =.48 5.48 +.42 =.9.3.9 +. = Pr(Outcome x D).8.6.4.2 Cumulative Risk Profile D="Counter $5 Billion, accept counter offer of $3 Billion if given".5.9.9.48.48.5-2 5 8 Outcome ($Billion) Slide 32 of 58

Deterministic Dominance Original Tree Penzoill-Texaco FALSE. Accept $2 Billion 2. 2. Decision 4.635 Texaco Accept $5 Biilion Counteroffer $5 Billion TRUE Chance. 4.635 Texaco Refuses Counteroffer Texaco Counteroffers $3 Billion 7%.69 5. 5. High Award 2%..3.3 5% Chance. 4.6 Medium Award 5%.249 5. 5. Low Award 3%.5.. High Award branch TRUE Chance. 4.6 Medium Award Low Award 33% Decision. 4.56 branch FALSE. 3. 3. 2%.66.3.3 5%.66 5. 5. 3%... Slide 33 of 58

Deterministic Dominance Modified Tree Penzoill-Texaco FALSE. Accept $2 Billion 2. 2. Decision 5.257 Texaco Accept $5 Biilion Counteroffer $5 Billion TRUE Chance. 5.257 Texaco Refuses Counteroffer Texaco Counteroffers $3 Billion 7%.69 5. 5. High Award 2%..3.3 5% Chance. 5.3 Medium Award 5%.249 5. 5. Low Award 3%.5 2.5 2.5 High Award branch TRUE Chance. 5.3 Medium Award Low Award 33% Decision. 5.3 branch FALSE. 3. 3. 2%.66.3.3 5%.66 5. 5. 3%. 2.5 2.5 Slide 34 of 58

Deterministic Dominance Based on EMV analysis we still choose the alternative Counteroffer $5 Billion EMV= 5.26 Accept $2 Billion Max Result 2 Counteroffer EMV= 5.26 $5 Billion Could we have made a decision here without an EMV analysis? Slide 35 of 58

Deterministic Dominance Formal Definition: Deterministic Dominance: If the worst outcome of Alternative B is at least as good as that of the best outcome of Alternative A, then Alternative B deterministically dominates Alternative A. Deterministic dominance may also be concluded by drawing cumulative risk profiles and using the definition: Definition: Range of a Cumulative Risk Profile = [L,U], where L= Smallest % point in Cumulative Risk Profile and U= Largest % point in Cumulative Risk Profile Slide 36 of 58

Deterministic Dominance Deterministic dominance via cumulative risk profiles: Step : Draw cumulative risk profiles in one graph Step 2: Determine range for each risk profile Step 3: If ranges are disjoint or their intersections contain a single point then deterministic Cumulative dominance Risk Profiles is present Range : {2} Pr(Outcome x).8.6.4.2 Revised Texaco-Penzoil Case 2.5.3-2 5 8 Outcome ($Billion) Accept $2 Billion Counteroffer $5 Billion and Refuse $3 Billion Range 2: [2.5,.3] Ranges and 2 are disjoint. The Objective is Max Result, hence Green CRP deterministically dominates the Red one. Slide 37 of 58

Stochastic Dominance: Example Firm A: Original Tree Penzoill-Texaco FALSE. Accept $2 Billion 2. 2. Decision 4.635 Texaco Accept $5 Biilion Counteroffer $5 Billion TRUE Chance. 4.635 Texaco Refuses Counteroffer Texaco Counteroffers $3 Billion 7%.69 5. 5. High Award 2%..3.3 5% Chance. 4.6 Medium Award 5%.249 5. 5. Low Award 3%.5.. High Award branch TRUE Chance. 4.6 Medium Award Low Award 33% Decision. 4.56 branch FALSE. 3. 3. 2%.66.3.3 5%.66 5. 5. 3%... Slide 38 of 58

Stochastic Dominance: Example Firm B: Modified Tree Penzoill-Texaco FALSE. Accept $2 Billion 2. 2. Decision 4.78 Texaco Accept $5 Biilion Counteroffer $5 Billion TRUE Chance. 4.78 Texaco Refuses Counteroffer Texaco Counteroffers $3 Billion 7%.69 5. 5. High Award 2%..3.3 5% Chance. 4.7 Medium Award 5%.249 5.2 5.2 Low Award 3%.5.. High Award branch TRUE Chance. 4.7 Medium Award Low Award 33% Decision. 4.66 branch FALSE. 3. 3. 2%.66.3.3 5%.66 5.2 5.2 3%... Slide 39 of 58

Stochastic Dominance: Example Based on EMV analysis we still choose the alternative Firm B Max Result EMV= 4.72 Firm A Firm B EMV= 4.63 EMV= 4.72 Could we have made a decision here without an EMV analysis? Slide 4 of 58

Stochastic Dominance: Example Optimal Cumulative risk profiles in Firm A Tree and Firm B Tree Cumulative Risk Profiles: Firm A and Firm B Pr(Outcome x).8.6.4.2-2 5 8 Outcome ($Billion) Firm A Firm B Slide 4 of 58

Stochastic Dominance: Example Note that for all possible values of x: Pr(Outcome x Firm B) Pr(Outcome x Firm A) or equivalently: Pr(Outcome x Firm B) Pr(Outcome x Firm A) Pr(Outcome x).8.6.4.2 Cumulative Risk Profiles: Firm A and Firm B - 2 5 8 Outcome ($Billion) Firm A Firm B Hence the chances of winning with Firm B are always better than that of Firm A. Conclusion: Firm B stochastically dominates Firm A Slide 42 of 58

Stochastic Dominance: Example 2 Firm A: Original Tree Penzoill-Texaco FALSE. Accept $2 Billion 2. 2. Decision 4.635 Texaco Accept $5 Biilion Counteroffer $5 Billion TRUE Chance. 4.635 Texaco Refuses Counteroffer Texaco Counteroffers $3 Billion 7%.69 5. 5. High Award 2%..3.3 5% Chance. 4.6 Medium Award 5%.249 5. 5. Low Award 3%.5.. High Award branch TRUE Chance. 4.6 Medium Award Low Award 33% Decision. 4.56 branch FALSE. 3. 3. 2%.66.3.3 5%.66 5. 5. 3%... Slide 43 of 58

Stochastic Dominance: Example 2 Firm C: Modified Tree Penzoill-Texaco FALSE. Accept $2 Billion 2. 2. Decision 6.5 Texaco Accept $5 Biilion Counteroffer $5 Billion TRUE Chance. 6.5 Texaco Refuses Counteroffer Texaco Counteroffers $3 Billion 7%.69 5. 5. High Award 3%.5.3.3 5% Chance. 6.2 Medium Award 6%.299 5.2 5.2 Low Award %.5.. High Award branch TRUE Chance. 6.2 Medium Award Low Award 33% Decision. 6.2 branch FALSE. 3. 3. 3%..3.3 6%.99 5.2 5.2 %.33.. Slide 44 of 58

Stochastic Dominance: Example 2 Based on EMV analysis we still choose the alternative Firm C Max Result EMV= 6. Firm A Firm C EMV= 4.63 EMV= 6. Could we have made a decision here without an EMV analysis? Slide 45 of 58

Stochastic Dominance: Example 2 Optimal Cumulative risk profiles in Firm A Tree and Firm C Tree Cumulative Risk Profiles: Firm A and Firm C Pr(Outcome x).8.6.4.2-2 5 8 Outcome ($Billion) Firm A Firm C Slide 46 of 58

Stochastic Dominance: Example 2 Note that for all possible values of x: Pr(Outcome x Firm C) Pr(Outcome x Firm A) or equivalently: Pr(Outcome x Firm C) Pr(Outcome x Firm A) Pr(Outcome x).8.6.4.2 Cumulative Risk Profiles: Firm A and Firm C - 2 5 8 Outcome ($Billion) Firm A Firm C Hence the chances of winning with Firm C are always better than that of Firm A. Conclusion: Firm C stochastically dominates Firm A Slide 47 of 58

Stochastic Dominance: Examples & 2 Commonality CRP plots: Cumulative risk profiles in both plots do not cross The CRP that is toward the right and below stochastically dominates Pr(Outcome x) Cumulative Risk Profiles: Firm A and Firm B.8.6.4.2-2 5 8 Outcome ($Billion) Firm A Firm B Cumulative Risk Profiles: Firm A and Firm C The objective in both plots is to Maximize the Result What if the objective is Minimize the Result? Pr(Outcome x).8.6.4.2-2 5 8 Outcome ($Billion) Firm A Firm C Slide 48 of 58

Making Decisions with Multiple Objectives Two Objectives: Making Money (Measured in $) Amount of Fun Fun Having Fun (Measured on Constructed attribute scale, see page 38): Best(5), Good(4), Middle(3), Bad(2), Worst () Job Decision Salary Amount of Work Overall Satisfaction Slide 49 of 58

Making Decisions with Multiple Objectives Consequences Salary Fun Level 5 (.) $26. 5 Forest Job Fun level 4 (.25) 3 (.4) $26. $26. 4 3 2 (.2) $26. 2 (.5) $26. In-Town Job # hours per week 4 hours (.35) 34 hours (.5) 3 hours (.5) $273. $232.5 $247.5 3 3 3 Slide 5 of 58

Analysis Salary Objective Forest Job In-Town Job Salary Prob Salary*Prob Prob Salary*Prob $2,47.5.5 $37.3 $2,32.5.5 $,6.25 $2,6.. $2,6. $2,73..35 $955.5 E[Salary]= $2,6. E[Salary]= $2,422.88 Conclusion: Forest Job preferred Over In-Town job CRP s cross. Hence, No Stochastic Dominance Pr(Outcome x).8.6.4.2 $2, $2,2 $2,4 $2,6 $2,8 $3, Salary Forest Job In-Town Job Slide 5 of 58

Fun Level Objective Forest Job In-Town Job Outcome Fun Level Prob Fun Level*Prob Prob Fun Level*Prob 5 -BEST.%..% 4 -GOOD 9.%.25 22.5% 3 - MIDDLE 6.%.4 24.%. 6.% 2 - BAD 25.%.2 5.% - WORST.%.5.% E[Fun Level]= 6.5% E[Fun Level]= 6.% Conclusion: Forest Job preferred Over In-Town job CRP s cross. Hence, No Stochastic Dominance Pr(Outcome x).8.6.4.2 % 2% 4% 6% 8% % 2% Fun Level Forest Job In-Town Job Slide 52 of 58

Multiple Objective Analysis It is clear from both objective analyses that the Forest-Job is the strongly preferred, although neither Stochastic nor Deterministic Dominance can be observed in them. Careful as you are in your decisions you decide to trade-off the salary objective and having fun objective in a multiple objective analysis. Before trade-off analysis can be conducted both objectives have to be measured on a comparable scale. Slide 53 of 58

Multiple Objective Analysis: Construct - Scale Having Fun Objective already has a - scale: Transformed to - scale or %-% scale Set Best=%, Worst=%, Determine intermediate values Having Fun objective: Best(%), Good(9%), Middle(6%), Bad(25%), Worst (%) Construct - scale for Salary Objective: $273.=%, $247.5=% Intermediate dollar amount X: X $247.5 $273 $247.5 % Slide 54 of 58

Multiple Objective Analysis: Assess Trade-Off ks = weight for salary = weight for fun k s + k = f k f Using Expert Judgment: Going from worst to best in salary objective is.5 times more important than going from worst to best in having fun objective. Hence: k =.5 s k f k ks s + k f = =.5 k f.5 k f + k f ks =.5 k = f k k s f = = 2.5 3 2 3 5 2 = 5 3 = 5 Slide 55 of 58

Multiple Objective Analysis: Convert Scales Consequences Salary (.6) Fun Level (.4) 5 (.) 8% % Forest Job Fun level 4 (.25) 3 (.4) 8% 8% 9% 6% 2 (.2) 8% 25% (.5) 8% % In-Town Job # hours per week 4 hours (.35) 34 hours (.5) 3 hours (.5) % 4% % 6% 6% 6% Slide 56 of 58

Multiple Objective Analysis: Combine Objectives Forest Job Fun level 5 (.) 4 (.25) 3 (.4) 2 (.2) (.5) Total Score 88.6% 84.6% 72.6.% 58.6% 48.6% # hours per week 4 hours (.35) 84.% In-Town Job 34 hours (.5) 3 hours (.5) 48.% 24.% Slide 57 of 58

Analysis Overall Satisfaction Forest Job In-Town Job Overall Satisfaction Prob OS*Prob Overall Satisfaction Prob OS*Prob 88.57%. 8.9% 84.%.35 29.4% 84.57%.25 2.% 48.%.5 24.% 72.57%.4 29.% 24.%.5 3.6% 58.57%.2.7% E[OS]= 57.% 48.57%.5 2.4% E[OS]= 73.2% Conclusion: Forest Job preferred Over In-Town job CRP s do not cross. Hence, Stochastic Dominance present. Pr(Outcome x).8.6.4.2 % 2% 4% 6% 8% % Overall Satisfaction Forest Job In-Town Job Slide 58 of 58