Page 186 - BA2 Integrated Workbook - Student 2017

Chapter 12

2.3 Probability trees

A way of showing the probability of all of the different options is by using a probability
tree (or decision tree). This uses the expected value technique but shows the
information in a more graphical way. All possible outcomes are shown along with
their associated probabilities. Expected values can then be calculated.

Probability trees should be used where a problem involves a series of decisions
being made and several outcomes arise during the decision-making process.
Probability trees force the decision maker to consider the logical sequence of events.
A complex problem can be broken down into smaller, easier to handle sections.

To draw the trees:

 they use lines called branches

 squares depict decision points

 circles depict chance outcome points

 the probabilities of the outcomes are shown on the branches. (remember,
probabilities should add up to 1)

 the financial outcomes are shown at the end of the branches, and the expected
values are calculated by working back, right to left, along the branches.

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