What is Decision Theory?

Decision theory is an interdisciplinary approach to arrive at the decisions that are the most advantageous given an uncertain environment.

Key Takeaways

  • Decision theory is an interdisciplinary approach to arrive at the decisions that are the most advantageous given an uncertain environment.
  • Decision theory brings together psychology, statistics, philosophy, and mathematics to analyze the decision-making process.
  • Descriptive, prescriptive, and normative are three main areas of decision theory and each studies a different type of decision making.

Understanding Decision Theory

Decision theory brings together psychology, statistics, philosophy, and mathematics to analyze the decision-making process. Decision theory is closely related to game theory and is studied within the context of understanding the activities and decisions underpinning activities such as auctions, evolution, and marketing.

There are three main areas of decision theory. Each studies a different type of decision making.

  1. Descriptive decision theory: examines how irrational beings make decisions.
  2. Prescriptive decision theory: tries to provide guidelines for agents to make the best possible decisions given an uncertain decision-making framework.
  3. Normative decision theory: provides guidance for making decisions given a set of values.

Decision theory framework generally identifies three types of decision classes:

  1. Decisions under certainty: an abundance of information leads to an obvious decision
  2. Decisions under uncertainty: analysis of known and unknown variables lead to the best probabilistic decision.
  3. Decisions under conflict: a reactive approach that involves anticipating potential consequences to the decision, prior to making a decision.

Decision Under Uncertainty: Prisoner's Dilemma

A common example of decision theory stems from the prisoner's dilemma in which two individuals are faced with an uncertain decision where the outcome is not only based on their personal decision, but also on that of the other individual. Since both parties do not know what actions the other person will take, this results in an uncertain decision framework. While mathematics and statistical models determine what the optimal decision should be, psychology and philosophy introduce factors of human behaviors to suggest the most likely outcome.