decision tree

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Decision tree

Schematic way of representing alternative sequential decisions and the possible outcomes from these decisions.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

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).
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved
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.

Collins Dictionary of Business, 3rd ed. © 2002, 2005 C Pass, B Lowes, A Pendleton, L Chadwick, D O’Reilly and M Afferson

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.
Collins Dictionary of Economics, 4th ed. © C. Pass, B. Lowes, L. Davies 2005
References in classic literature ?
In spring, when the swallows and the storks came, the Tree asked them, "Don't you know where they have been taken?
And the Wind kissed the Tree, and the Dew wept tears over him; but the Fir understood it not.
Releasing his hold upon the tree he dropped on all fours and at the same time swung his great, wicked tail with a force that would have broken every bone in my body had it struck me; but, fortunately, I had turned to flee at the very instant that I felt my blow land upon the towering back.
He had been thinking what was best to be done, and now he asked the Woodman to chop away the end of the tree that rested on their side of the ditch.
They seemed to be driving into the heart of the night, for the trees closed in front of them, and they could hear all round them the rustling of leaves.
"Look, look!" cried the Tree, "the rose is finished now"; but the Nightingale made no answer, for she was lying dead in the long grass, with the thorn in her heart.
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. But the remarkable beauty of these little animals and their lively ways were not their only claims upon my admiration.
The moon was riding in a cloudy heaven when Peter rose from his tree, begirt [belted] with weapons and wearing little else, to set out upon his perilous quest.
When we fell to playing, after breakfast, on the second day away from the caves, Lop-Ear led me a chase through the trees and down to the river.
“Hoe and plough!” roared the sheriff; “would you set a man hoeing round the root of a maple like this?” pointing to one of the noble trees that occur so frequently in that part of the country.
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 was not the least discouraged by the failure of his elder brothers, though they were both much older and stronger than he was, and when night came climbed up the tree as they had done, The moon had risen, and with her soft light lit up the whole neighbourhood, so that the observant Prince could distinguish the smallest object distinctly.