Decision Theory Definition
Simply put, decision theory is an analysis of decision-making process, it seeks to evaluate how choices are made. Decision theory is a logical study of how decisions are made in a structure or system where the decision environment is uncertain and the decision variables unknown.
Decision theory draws tools from mathematics, philosophy, statistics and psychology in analysing how decisions are made. This theory also has to do with how choices are logically made based on probabilities and uncertain consequences.
A Little More on What is Decision Theory
Decision theory relates with how activities leading to decision making are understood. This theory is sometimes studies in relation to the game theory. There are diverse types of decision making processes, hence, decision theory also covers diverse areas. There are three main areas of the decision theory, they are;
- Prescriptive decision theory: this theory aims to provide recommendations on how to make the best decisions even in an uncertain decision-making environment.
- Descriptive decision theory: this theory seeks to describe how irrational agents make certain decisions.
- Normative decision theory: based on a set of values, this theory provides direction for how decisions can be made.
Example of Decision Theory
The illustration below is decision theory exemplified;
In an uncertain decision-making environment, two individuals can be in a dilemma when an uncertain decision is made and the outcome cannot be easily determined because it is dependent on the personal decision of both individuals. In this situation, the two parties are unaware of what decision each of them made and the results that will emanate from the decision.
This scenario is best described as an optimal decision-making between the two individuals, these decisions have divergent risks depending on their outcome. Mathematical and statistical models can be employed in assessing what should be the optimal decision, psychology and philosophy on the other hand, suggest the likely outcome using human factors and behaviours.
Reference for “Decision Theory”
- https://www.investopedia.com › Investing › Financial Analysis