Decision theory is a mathematical theory about how to best reach a decision. This is done using probability theory, statistics and logical reasoning. A decision can be made in different ways. Decision theory usually picks the best decision by looking at the consequences each way to decide might have.
In most cases, decision theory is normative and prescriptive. Most of the time, it assumes the decision maker has perfect knowledge. Decision makers know all the consequences, and case take the best pick.
There are three branches of decision theory:
- Normative decision theory: The decision makers take rational choices. There is also a set of axioms that describe the decision process. This allows to reach a decision through the use of logic. This describes how to reach a decision.
- Prescriptive decision theory: This tries to help people reach better decisions, through the use of models to follow. Humans have only limited capabilities to reach a decision. This is taken into account.
- Descriptive decision theory looks at the way decisions are taken in real life, and tries to improve the process.
Decision theory can also be classified as follows:
- Choice under certainty: The decision maker knows all possible alternatives, and can exactly say at what probability each occurs. The decision maker chooses the action that will result in the most desirable outcome.
- Choice under uncertainty: There are several outcomes for each action, depending on the state of nature. The outcome corresponding to the chosen action are uncertain, but the probabilities associated with each outcome is known.