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Step 3: Calculation of Gains and Losses. Add the gains and
losses for each outcome to indicate the net result.
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Step 4: Determination of the Probability of Outcomes. Estimate
(possibly by intelligent guesswork) the probability that each outcome will
occur.
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Step 5: Calculation of Expected Value. Use these probabilities to
work out the expected value of the each option. The expected value of an
outcome is the probability of an outcome multiplied by the net value of the
outcome. The expected value of a decision is the sum of the expected values
of all possible outcomes when the decision is made.
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Step 6: Highest Net Value. To decide which outcome is best we
see which has the higher or highest expected value. A net benefit will have a
positive measure and a net cost a negative measure.
Illustration
We can illustrate these steps. For this we will use as an example a decision to
litigate.
Step 1: Choices
Work out the choices that the person faces. Here the choice is to litigate or not
to litigate.
Step 2: Identification of Gains and Losses
Calculate the gains and losses from each choice:
(1)
Plaintiff does not litigate. Assume that if the plaintiff does not litigate the
plaintiff can use the time that would otherwise be spent in fighting the case in
doing work which yields $15,000.
(2)
Plaintiff does litigate. Assume that if the plaintiff does litigate the
possibilities are as follows:
(i)
If the plaintiff wins the plaintiff gains a verdict of $22,000,
receives costs of $3,000 and has expenses of $5,000.
(ii)
If the plaintiff loses the plaintiff pays her own costs of $6,000 and
the defendant’s costs of $4,000.
In this example, for the sake of simplicity we concentrate only on financial
gains and losses. Although these are typically the main types in litigation they
are not the only ones. There can also be symbolic and libertarian costs and
benefits.
Step 3: Calculation of Gains and Losses
Having adjusted all figures to a common standard, add the gains and losses for
each outcome to determine the net result. To illustrate this we assume, for
simplicity, that the figures given have already been adjusted to allow for
changes over time in the purchasing power of money:
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