Summary of Expected Monetary Value and Value of Perfect Information
Expected Monetary Value (EMV)
- Expected value is calculated as the sum of each outcome's value multiplied by its probability: EMV = \Sigma (value \space of \space outcome \space x \space probability \space of \space outcome)
- EMV represents the average outcome if an event is repeated many times.
Choice of Job Example
- Compare EMVs of different options to make decisions.
- Choose the option with the higher EMV for better long-term gains.
Illegal Parking Example
- Calculate EMV considering both potential fines and probabilities.
- Compare the EMV of not buying a ticket versus the cost of buying one to decide the best course of action.
- Profitability depends on market demand which could be Poor, Modest, or Excellent.
New Product Launch
- Calculate EMV for investment decisions considering possible market demands (Poor, Modest, Excellent) and their probabilities.
- Assess whether to invest based on the overall EMV.
- If sales were to be poor, we would not invest.
- EVPI = EMV \space with \space advance \space knowledge - EMV \space with \space no \space advance \space knowledge
- EVPI indicates how much better off one would be with perfect knowledge of the future.
- In practice, companies improve forecasting through surveys, market research, and pilot trials to move towards 'perfect' information.