Decision Model

1. The director of social services of a county has learned that the state has mandated additional
information requirements. This will place an additional burden on the agency. The director
has identified three acceptable alternatives to handle the increased workload. One alternative
is to reassign present staff members, the second is to hire and train two new workers, and the
third is to redesign current practice so that workers can readily collect the information with
little additional effort. An unknown factor is the caseload for the coming year when the new
data will be collected on a trial basis. The estimated costs for various options and caseloads
are shown in the following table:

Caseload
Moderate High Very High
Reassign staff $50* 60 85
New staff 60 60 60
Redesign collection 40 50 90
* Cost in $ thousands.

Assuming that past experience has shown the probabilities of various caseloads to be unreliable,
what decision would be appropriate using each of the following criteria?
a. Maximin.
b. Maximax.
c. Minimax regret.
d. Laplace.

2. The information for a decision is often summarized in a payoff table, which shows the
expected payoffs for each alternative under the various possible states of nature. These tables
are helpful in choosing among alternatives because they facilitate comparison of alternatives.
Consider the following payoff table, which illustrates a capacity planning problem.

POSSIBLE FUTURE DEMAND

Using the expected monetary value criterion, identify the best alternative for the payoff table for
these probabilities: low = 0.30, moderate = 0.50, and high = 0.20.
3. The lease of Theme Park, Inc., is about to expire. Management must decide whether to renew the lease for
another 10 years or to relocate near the site of a proposed motel. The town plan-ning board is currently
debating the merits of granting approval to the motel. A consultant has estimated the net present value of
Theme Park’s two alternatives under each state of nature as shown on the following page.

Options Motel Approved Motel Rejected

What course of action would you recommend using?

4. A logistics provider plans to have a new warehouse built to handle increasing demands for its services.
Although the company is unsure of how much demand there will be, it must decide now on the size (large or
small) of the warehouse. Preliminary estimates are that if a small warehouse is built and demand is low, the
monthly income will be $700,000. If demand is high, it will have to either expand the facility or lease
additional space. Leasing will result in a monthly income of$100,000 while expanding will result in a
monthly income of $500,000.
If a large warehouse is built and demand is low, monthly income will only be $40,000, while if demand is
high, monthly income will be $2 million.
Construct a tree diagram for this decision.
Using your tree diagram, identify the choice that would be made using each of the four approaches for
decision making under uncertainty.

1. Fiber Synthetics’ manager must decide whether to process a chemical order or to contract it out at a cost of
$20,000. The final product batch will be sold for $40,000. In-house processing involves direct costs for
raw materials of $4,000. The first step, costing $2,000, is chlorosulfanation, for which there is an 80%
chance of getting a satisfactory intermediate chemical base. If the base is unsatisfactory, there will not be
sufficient time to start a new batch, but there will still be a choice of turning down the order or contracting
out the production. In the latter case, there is a 60% chance of being too late and having to dump the final
product. The last stage of in-house processing may be a low-temperature one costing $10,000 or a high-
temperature one costing $16,000. There is a 30% chance that the low-temperature process will fail, so that
the resulting chemicals must be dumped; it would then be too late to go outside. The high-temperature
procedure is certain to work. (a) Using net cash flow (revenue minus costs) as the payoff measure, diagram
the manager’s decision tree. (b) What action maximizes expected payoff?

2. A government official wants to determine the most effective way to control tree damage from the gypsy
moth. There are three methods for attacking the pest: (1) spray with DDT; (2) use a scent to lure and trap
males, so that the remaining males must compete for mating with a much larger number of males that have
been sterilized in a laboratory and then released; and (3) spray with a juvenile hormone that prevents the
larvae from developing into adult moths.
The net improvement in current and future tree losses using DDT is lowest, because it assumed that DDT
will never completely eradicate the moth.
If the scent-lure program is instituted, the probability that it will leave a low number of native males is .5,
with a .5 chance that it will leave a high number. Once the scent-lure results are known, a later choice must
be made either to spray with DDT or to release sterile males. The cost of the scent lures is $5 million and
the cost of sterilization is an additional $5 million. But if this two-phase program is successful, the worth of
present and future trees saved will be $30 million. If scent lures leave a small native male population, there
is a 90% chance for success using sterile males; otherwise, there is only a 10% chance for success using
sterile males. A failure results in no savings.
The juvenile hormone must be synthesized at a cost of $3 million. There is only a .20 probability that the
resulting product will work. If it does, the worth of trees saved would be $50 million, because the gypsy
moth would become extinct. If the hormone does not work, savings would be zero.
Should one of the esoteric eradication procedures be chosen and then fail, the official’s contingency plan is
to spray with DDT. The savings from successful implementation of the sterile male or juvenile hormone
procedures reflect the value of environmental damage and other costs avoided by not having to use DDT.
To compare outcomes, the official proposes to use the net advantage (crop and environmental savings minus
cost) relative to where she would be were she forced to spray with DDT.

Questions
1. Under the official’s proposal, the selection of DDT without even trying to other procedures would lead to
an outcome with zero payoff. Discuss the benefits of her proposed payoff measure.
2. Construct the official’s decision tree diagram, using the proposed payoff measure.
3. What action will maximize the decision maker’s expected payoff?