decision tree

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Decision tree

Schematic way of representing alternative sequential decisions and the possible outcomes from these decisions.

Decision Tree

In risk analysis, a diagram of decisions and their potential consequences. It is used to help determine the most straightforward (and cheapest) way to arrive at a stated goal. It is represented by potential decisions (drawn as squares), branching off into different proximate consequences (drawn as circles), and potential end results (drawn as triangles).
Fig.32 Decision tree. The businessman has two options: to open a new factory to boost production capacity or not to open a new factory; and he has to consider two states of nature or events which can occur economic boom or recession. The businessman must assess the likelihood of each of these events occurring and, in this case, based on his knowledge and experience, he estimates that there is a one-in-two chance of a boom and a 0.5 probability of a recession. Finally, the businessman estimates the financial consequences as an £80,000 profit for the new factory if there is a boom, and a £30,000 loss if there is a recession.click for a larger image
Fig.32 Decision tree. The businessman has two options: to open a new factory to boost production capacity or not to open a new factory; and he has to consider two states of nature or events which can occur economic boom or recession. The businessman must assess the likelihood of each of these events occurring and, in this case, based on his knowledge and experience, he estimates that there is a one-in-two chance of a boom and a 0.5 probability of a recession. Finally, the businessman estimates the financial consequences as an £80,000 profit for the new factory if there is a boom, and a £30,000 loss if there is a recession.

decision tree

an aid to decision-making in uncertain conditions, that sets out alternative courses of action and the financial consequences of each alternative, and assigns subjective probabilities to the likelihood of future events occurring. For, example, a firm thinking of opening a new factory the success of which will depend upon consumer spending (and thus the state of the economy) would have a decision tree like Fig. 32.

In order to make a decision, the manager needs a decision criterion to enable him to choose which he regards as the best of the alternatives and, since these choices involve an element of risk, we therefore need to know something about his attitudes to risk. If the manager were neutral in his attitude to risk then we could calculate the certainty equivalent of the ‘open factory’ alternative using the expected money value criterion, which takes the financial consequence of each outcome and weights it by the probability of its occurrence, thus:

which being greater than the £0 for certain of not opening the factory would justify going ahead with the factory project.

However, if the manager were averse to risk then he might not regard the expected money value criterion as being appropriate, for he might require a risk premium to induce him to take the risk. Application of a more cautious certainty equivalent criterion would reduce the certainty equivalent of the ‘open factory’ branch and might even tip the decision against going ahead on the grounds of the ‘downside risk’ of losing £30,000.See UNCERTAINTY AND RISK.

decision tree

a graphical representation of the decision-making process in relation to a particular economic decision. The decision tree illustrates the possibilities open to the decision-maker in choosing between alternative strategies. It is possible to specify the financial consequence of each ‘branch’ of the decision tree and to gauge the PROBABILITY of particular events occurring that might affect the consequences of the decisions made. See RISK AND UNCERTAINTY.
References in classic literature ?
When Christmas came, quite young trees were cut down: trees which often were not even as large or of the same age as this Fir Tree, who could never rest, but always wanted to be off.
I would fain know if I am destined for so glorious a career," cried the Tree, rejoicing.
At sight of me several of the savage creatures left off worrying the great brute to come slinking with bared fangs toward me, and as I turned to run toward the trees again to seek safety among the lower branches, I saw a number of the man-apes leaping and chattering in the foliage of the nearest tree.
And so I raced on toward the trees intending to pass beneath that which held the man-things and take refuge in another farther on; but the wolf-dogs were very close behind me--so close that I had despaired of escaping them, when one of the creatures in the tree above swung down headforemost, his tail looped about a great limb, and grasping me beneath my armpits swung me in safety up among his fellows.
So the Woodman took his axe and began to chop down small trees to make a raft, and while he was busy at this the Scarecrow found on the riverbank a tree full of fine fruit.
Rachel had balanced herself near Helen on the end of the tree trunk.
Numbers of those creatures were to be seen basking in the sunshine upon the thatching of the houses, and multitudes at all hours of the day showed their glittering sides as they ran frolicking between the spears of grass or raced in troops up and down the tall shafts of the cocoanut trees.
We were off and away, and the Chatterer gave us the chase of our lives through the trees.
At first she was greatly disappointed, because the nearer trees were all punita, or cotton-wood or eucalyptus, and bore no fruit or nuts at all.
Iwanich turned round, and saw a tall, gaunt-looking man, clad in miserable rags, leaning on a crooked staff and seated at the foot of an oak tree, which was so much the same colour as himself that it was little wonder the Prince had ridden past the tree without noticing him.
I have heard the settlers from the old countries say that their rich men keep great oaks and elms, that would make a barrel of pots to the tree, standing round their doors and humsteds and scattered over their farms, just to look at.
Mastered by his better self he would have returned reluctantly up the tree, but for one thing.