DEFINITION of 'Decision Theory '

Decision theory is an interdisciplinary approach to determine how decisions are made given unknown variables and an uncertain decision environment framework. 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.

BREAKING DOWN 'Decision Theory '

There are three main areas of decision theory. Each studies a different type of decision making. Descriptive decision theory examines how irrational beings make decisions. Prescriptive decision theory tries to provide guidelines for agents to make the best possible decisions given an uncertain decision-making framework. Normative decision theory provides guidance for making decisions given a set of values.

Example of Decision Theory

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.

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