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MBA201a: The Value of Information

MBA201a: The Value of Information. Understanding probabilities. A probability reflects a set of information. Collecting information can change the best estimate of a probability. A probability can be conditional on the outcomes of previous events or it can be independent of previous events.

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MBA201a: The Value of Information

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  1. MBA201a: The Value of Information

  2. Understanding probabilities • A probability reflects a set of information. • Collecting information can change the best estimate of a probability. • A probability can be conditional on the outcomes of previous events or it can be independent of previous events. • After the fact (ex post), the probability of an event is either 0 or 1. MBA201a - Fall 2009

  3. Movie is a hit [p=0.8] $2.5m Develop new product -$1m Movie flops [p= ] $.1m Drop the new product 0 Another decision tree… Developing a new product to cobrand with a soon-to-be released movie. MBA201a - Fall 2009

  4. Develop product -$1m + $2.5m Movie will be a hit [p=0.8] Don’t develop product 0 Develop product -$1m + $.1m Movie will be a flop [p= ] Don’t develop product 0 Would it be valuable to get information about the success of the movie before developing the product? MBA201a - Fall 2009

  5. Obtaining information first changes your decision • The information helps you avoid developing the product if the movie flops. • This happens with 0.2 probability. • In the event the movie flops, you save $.9. The expected value of this is $.18, which is the difference in the value of the two trees: $1.2-$1.02. MBA201a - Fall 2009

  6. The value of information • Information is valuable only if it may affect your choices. • Valuation of information is from an ex ante (before the fact) position. • In other words, don’t confuse a good outcome with a good decision. MBA201a - Fall 2009

  7. Takeaways • Remember: decision trees are a tool to formalize the decision process. • Decision-makers do not always maximize expected value. • Probabilities reflect a set of information. • Decision trees can help you think about the value of obtaining new information. • Ask yourself: What, if anything, would I do differently with new information? • Would new information be worth more than the cost, if any, of acquiring it? MBA201a - Fall 2009

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