Risk and uncertainty is a topic on which you have been examined previously, but is deemed knowledge and it therefore repeated here as revision.
Decision making involves making decisions now which will affect future outcomes which are unlikely to be known with certainty.
Risk exists where a decision maker has knowledge that several possible outcomes are possible – usually due to past experience. This past experience enables the decision maker to estimate the probability or the likely occurence of each potential future outcome.
Uncertainty exists where the future is unknown and where the decision maker has no past experience on which to base predictions.
Whatever the reasons for the uncertainty, the fact that it exists means that there is no ‚rule‘ as to how to make decisions. For the examination you are expected to be aware of, and to apply, several different approaches that might be useful.
As will be illustrated by an example, the approach taken to make the decision will depend on the decision-makers attitude to risk.
A risk seeker will be interested in the best possible outcome, no matter how small the change that they may occur.
Someone who is risk neutral will be concerned with the most likely or ‘average’ outcome.
A risk avoider makes decisions on the basis of the worst possible outcomes that may occur.