Decision-making Environment (Choice): Audio Transcript

This file transcribes the audio recording http://web.pdx.edu/~woodsj/Teaching/podcasts/InvestmentCriteria/ChoiceEnvironments.mp3 which is linked on the page http://ec314-pdx-edu.wikidot.com/the-basic-environments


Let's talk a little bit more about some decision making environments and in order to get there we have to start off with how we are going to define our choices.

Our choices, it's probably best to think of them as elements on a menu. And the environments will go ahead and give you a kind of restrictions that you're going to have on this menu of choices. So let's start with the most general of all environments, which is going to be referred to as unconstrained choice.

With unconstrained choice what you can visualize is that you have a list of projects that you have available to you. You can have things like replace the roof, replace the windows, add wall insulation, add ceiling insulation, get a new air conditioner; and those are the menu items that are available to each of you.

Now for unconstrained choice what you are able to do is choose as many of those individual items you wish, but not two of any one item. And that’s a crucial restriction. So you can't find something that’s really really really good, like, adding in some ceiling insulation and then just quadruple it or say infinity it and say here are the investments we are going to make. It’s just not something that’s in the cards for us. So for unconstrained choice it is: choose as many of the menu items as you wish, but no more than one of any given item.

Now the second environment we are gong to use (and there are going to be several more that come after this) are going to be something called the exclusive choice criteria. And what you do with exclusive choice is you're trying to choose the one best option from the menu that’s available to you. A nice way of thinking about this is, if you have your choices of this particular model of air conditioner or this other model of air conditioner, or this other model, or this other model. What you are doing is picking the best model to fit in that spot, and that’s what we mean by exclusive choice.

Now one of the ways you can think about using exclusive choice is you can also use it for count. So for example option A could be get 1, option B could be get 2, option C could be get 3 and so on down the line. And you can use the exclusive choice criteria in order to say, "Clearly we should get 5 of them, that’s going to be our best choice."

So that’s the first couple of environments we are going to use. Later on we'll expand the environment to things that are slightly more complicated and we'll start talking about what happens when we put restrictions on the amount of dollars that you can invest because we haven’t done it in either one of these two cases. It all has to do with the count of investments available. And we'll also have another environment where we have our funds are not all priced at the same amount. And that will be the increasing cost of funds environment. That’s something we will handle later, but for the introduction to our choice criteria we are going to stick with these two basic environments: unconstrained choice, choose as many assets as you wish but no more than one of any given asset and exclusive choice where you pick just one of those choices there, at most one.

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