A manufacturing company must decide whether to manufacture a component part or p

Question

A manufacturing company must decide whether to manufacture a component part or purchase the component from a supplier. The resulting profit depends on the demand for the product. Demand can be Low, Medium or High. The company has estimated the payoff (in thousands of dollars) as follows. The payoffs for manufacturing will be -20, 40, and 100 under Low, Medium and High demands respectively. For purchasing, the pay offs will be 10, 45 and 70 for Low, Medium and High demands. Construct a payoff table. What is the optimum decision under minimax regret criterion?

Explanation / Answer

Solution :- Minimax Regret Criterion :-

Here, we list the minimum pay off for each action (across all the states of nature) and then select
the action corresponding to the maximum of these minimums. This is called ‘maximizing the
lowest possible profit ‘However, if the payoffs are in terms of cost, list the maximum costs for
each alternative and then select the action with the lowest maximum (i.e maximum possible cost
is minimized). This criterion is based on making the best out of the worst possible condition, and
we choose Ai which satisfies.

Let us make the table.

State of Nature Maximum

We get maximum values {100,70}

Next we have to take minimum of them.

So 70 is the minimum.

It is the answer.

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