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    Decision Theory

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    pillaiwarm
    The document discusses decision theory and provides examples of solving decision problems under uncertainty. It defines decision making as choosing the best alternative among multiple options. Common decision making structures and problems are outlined. Methods for solving problems under uncertainty include Laplace criterion, maximin, minimax, and Hurwitz criterion. An example problem about determining the optimal daily order size for a perishable item is provided and solved using each method. The Laplace criterion solution is 225 kg, maximin is 150 kg, minimax is 225 kg, and Hurwitz criterion is also 225 kg.

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    Decision Theory

    Uploaded by

    pillaiwarm
    123 views16 pages
    The document discusses decision theory and provides examples of solving decision problems under uncertainty. It defines decision making as choosing the best alternative among multiple options. Common decision making structures and problems are outlined. Methods for solving problems under uncertainty include Laplace criterion, maximin, minimax, and Hurwitz criterion. An example problem about determining the optimal daily order size for a perishable item is provided and solved using each method. The Laplace criterion solution is 225 kg, maximin is 150 kg, minimax is 225 kg, and Hurwitz criterion is also 225 kg.

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    The document discusses decision theory and provides examples of solving decision problems under uncertainty. It defines decision making as choosing the best alternative among multiple options. Common decision making structures and problems are outlined. Methods for solving problems under uncertainty include Laplace criterion, maximin, minimax, and Hurwitz criterion. An example problem about determining the optimal daily order size for a perishable item is provided and solved using each method. The Laplace criterion solution is 225 kg, maximin is 150 kg, minimax is 225 kg, and Hurwitz criterion is also 225 kg.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    123 views16 pages

    Decision Theory

    Uploaded by

    pillaiwarm
    The document discusses decision theory and provides examples of solving decision problems under uncertainty. It defines decision making as choosing the best alternative among multiple options. Common decision making structures and problems are outlined. Methods for solving problems under uncertainty include Laplace criterion, maximin, minimax, and Hurwitz criterion. An example problem about determining the optimal daily order size for a perishable item is provided and solved using each method. The Laplace criterion solution is 225 kg, maximin is 150 kg, minimax is 225 kg, and Hurwitz criterion is also 225 kg.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 16

    Decision Theory

    Kshitij Pillai

    Definition
    According to the functional cycles of management, the managerial activity as a whole includes 5 phase or life processes which are planning, organization, direction, supervision & control. In performing all these activities the management has to face several such situations where they have to make a choice of the best among a no. of alternative courses of action. The choice making is technically termed as decision making

    Steps
    Clearly identify and define the problem at hand Specify objectives and decision criteria. Identify and evaluate the possible alternatives. Formulate one of the mathematical decision theory moddels. Apply the model and select the best alternative. Conduct a sensitivity analysis of the solution. Communication and implementation of decision. Follow up and feedback of results of decision.

    Structure of Decision Making


    The Decision Maker. Objectives. Environment. Payoff. Alternative coarse of action.

    Problems in Decision Making


    Deterministic Problems
    Those problems in which each coarse of action results in only one outcome. For such outcomes, the probability of each outcome is known to be believed as either 1 or 0. Complete and accurate knowledge of the outcome of each alternative as there is only one outcome.

    Stochastic Problems
    Those problems in which each coarse of action can result in alternative outcomes, the probabilities of which are known or can be estimated. A probability of occurrence can be attached to each.

    Problems Under Uncertainty


    Probabilities of which cannot be assigned as the decision maker does not know which outcomes can or will occur. This means that decision maker has to act with imperfect information in such a situation. Such situations arise when a new product is introduced in the market or a new plant is set up.

    Methods for Solving Uncertainity


    Hurwitz criterion or the Maximax Decision
    The maximax looks at the best that could happen under each action and then chooses the action with the largest value. They assume that they will get the most possible and then they take the action with the best best case scenario. The maximum of the maximums or the "best of the best". This is the lotto player; they see large payoffs and ignore the probabilities.

    Maximin Decision
    The maximin person looks at the worst that could happen under each action and then choose the action with the largest payoff. They assume that the worst that can happen will, and then they take the action with the best worst case scenario. The maximum of the minimums or the "best of the worst". This is the person who puts their money into a savings account because they could lose money at the stock market.

    Minimax Decision
    Minimax decision making is based on opportunistic loss. They are the kind that look back after the state of nature has occurred and say "Now that I know what happened, if I had only picked this other action instead of the one I actually did, I could have done better". So, to make their decision (before the event occurs), they create an opportunistic loss (or regret) table. Then they take the minimum of the maximum. That sounds backwards, but remember, this is a loss table. This similar to the maximin principle in theory; they want the best of the worst losses.

    Laplace Criterion
    It assumes that all the states of nature are equally likely to occur. Thus if there are n states of nature , probability of occurrence of each state of nature will ne 1/n. Using these equal probabilities, the expected payoff for each strategy is computed and the strategy with maximum expected value is regarded as optimal.

    Problem
    A retail store desires to determine the optimal daily order size for a perishable item. The store buys the perishable item at the rate of Rs. 80 per kg and sells at the rate of Rs. 100 per kg. If the order size is more than the demand, the excess quantity can be sold at Rs. 70 per kg in a secondary market; otherwise, the opportunity cost of the store is Rs. 15 per kg for the unsatisfied portion of the demand. Based on the past experience, it is found that the demand varies from Rs 50 kg to 250 kg in steps of 50 kg. the possible values of the order size are from 75 kg to 300 kg in steps of 75 kg. Determine the optimal order size which will maximize the daily profit of the store.

    Solution
    Purchase price of the perishable item= Rs 80/ kg Selling price of the perishable item in the primary market= Rs. 100/ kg Profit in the primary market P1= 100-80= Rs 20/ kg Selling price in the secondary market= Rs 70/ kg Profit in the secondary market P2= 70-80= Rs -10/ kg Opportunity Cost of not meeting the demand oc= Rs. 15/ kg Net Profit= Dj * p1 (Qi-Dj) * p2 if Qi Dj Net Profit= Qi * p1 (Dj-Qi) * oc if Dj Qi Qi is the ith order Size and Dj is the demand jth future state.

    Demand (Dj) 50 100 150 200 250

    Order Size (Qi)

    75 150 225 300

    50* 20 25 * 10= 750

    75* 20 25 * 15= 1125 100* 20 50 * 10= 1500 100* 20 125 * 10= 750 100* 20 200 * 10= 0

    75* 20 75 * 15= 750

    75* 20 125 * 15= -375

    75* 20 175 * 15= 1125 150* 20 100* 15= 1500 225* 20 25 * 15= 4125 250* 20 50 * 10= 4500

    50* 20 100 * 10= 0

    150* 20 = 3000

    150* 20 50 * 15= 2250 200* 20 25 * 10= 3750 200* 20 100 * 10= 3000

    50* 20 175 * 10= 750 50* 20 250 * 10= 1500

    150* 20 75 * 10= 2250 150* 20 150 * 10= 1500

    Laplace Criterion
    Based on the principle of insufficient reasoning, the probablity of occurrence of each future state according to laplace is 1/n. Therefore,
    The expected outcome of the action i=
    =1 1/

    Solving the above problem with Laplace we have,


    E(Q1)= 1/5 (750 + 1125 + 375 - 375 1125)= 150 E(Q2)= 1/5 (0 + 1500 + 3000 - 2250 1500)= 1650 E(Q3)= 1/5 (- 750 + 750 + 2250 - 3750 4125)= 2025 E(Q4)= 1/5 (- 1500 + 0 + 1500 - 3000 4500)= 1500

    Thus the Expected daily net profit is maximum when the order size is Q3.

    Maximin Criterion
    Demand (Dj)
    50 100
    1125 1500 750

    150
    375 3000 2250

    200
    -375 2250 3750

    250
    -1125 1500 4125

    Minimum
    -1125 0* -750

    Order Size (Qi)

    75 150 225

    750 0 -750

    300

    -1500

    1500

    3000

    4500

    -1500

    * Maximin value. This means that the optimal daily order size of the perishable item should be 150 kg.

    Minimax Criterion
    Demand (Dj)
    50 100
    1125 1500

    150
    375 3000

    200
    -375 2250

    250
    -1125 1500

    Maximum
    1125 3000*

    Order Size (Qi)

    75

    750

    150 0

    225 -750
    300 -1500

    750
    0

    2250
    1500

    3750
    3000

    4125
    4500

    4125
    4500

    * Minimax Value. This means that the optimal daily order size of the perishable item should be 750 kg.

    Hurwicz Criterion or Maximax Criterion


    Huwicz Criterion aims to stike a balance between the extreme optimism and the extreme pessimism by assigning a weight of to the optimism and 1 for the pessimism. In the absence of any bias either towards optimism or pessimism, assume = 0.5. The formula for weighted outcome for each row would be
    WOi = =1,2,.. , + 1 =1,2,.., (, )

    Demand (Dj) Order Size (Qi)


    50
    75
    750

    100
    1125 1500 750

    150
    375 3000 2250 1500

    200
    -375 2250 3750 3000

    250
    -1125 1500 4125 4500

    Maximum Minimum Weighted Outcome


    1125 3000 4125 4500 -1125 0 -750 -1500 0 1500 1687.50* 1500

    150 0 225 -750

    300 -1500 0

    * Maximin Weighted Average Value. Since this is a maximization problem, the rrow with the maximum weighted outcome should be selected as the best action. Hence the action of the row 3 is the best action. This means that the optimal daily order size of the perishable item should be 225 kg.

    Thank You

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