Laplace Criterion of Rationality

Laplace criterion uses expected monetary value. What is this referred to as EXPECTED monetary value?

The answer is the “product of monetary value and the probability given”. That is as good as mean, average or normal outcome. For you know, average value of observations uses either the arithmetic mean or probability. Now what are the steps to achieve this?

Step one: Assigning of Probability on the available options

In this case, the decision maker allocates some probability based on experience or information provided

Step two: Determine the expected monetary value of each option

Step three: Select the option with the highest expected monetary value

Example

The sales manager is looking up to select the best price his company can use to sell its products.

So the decision to be made will be determined by the best of the worse pay-off identified. Such that if given the following pay-off matrix;

Costs were as follows;

Variable cost $5

Salaries         $25,000

The probability for the three conditions are 0.33 each

Required, using the Laplace Criterion rule, show the correct alternative.

Solution

 

Remember that our decision is on price to use in the market. Therefore,

For 10.00= 24,750+8,250+18,150=$51,150

For 10.30=23,232+20,608.50+12,738=$56,578.50

For 10.50=23697.50+20,790+9,900=$54.578.50

Decision-select price $10.30