Quantitative Methods For Decision Making: Dr. Tanvir Abir
Quantitative Methods For Decision Making: Dr. Tanvir Abir
Quantitative Methods For Decision Making: Dr. Tanvir Abir
Decision Making
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►
Outline
The Decision Process in Operations
► Fundamentals of Decision Making
► Decision Tables
► Types of Decision-Making Environments
► Decision Trees
Learning Objectives
When you complete this chapter you should be
able to:
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Decision-Making Environments
Decision making under uncertainty
Complete uncertainty as to which state of nature
may occur
Decision making under risk
Several states of nature may occur
Each has a probability of occurring
Decision making under certainty
State of nature is known
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The Decision Process in
Operations
1. Clearly define the problem and the
factors that influence it
2. Develop specific and measurable
objectives
3. Develop a model
4. Evaluate each alternative solution
5. Select the best alternative
6. Implement the decision and set a
timetable for completion
Fundamentals of
Decision Making
1. Terms:
a. Alternative – a course of action or
strategy that may be chosen by the
decision maker
b. State of nature – an occurrence or a
situation over which the decision
maker has little or no control
Fundamentals of
Decision Making
2. Symbols used in a decision tree:
a. – Decision node from which one of
several alternatives may be selected
b. – A state-of-nature node out of
which one state of nature will occur
Decision Tree Example
A decision node A state of nature node
Favorable market
1
t ruct t Unfavorable market
o ns plan
C ge
lar Favorable market
Construct
small plant
2
Do Unfavorable market
no
thi
ng
Figure A.1
Decision Table Example
TABLE A.1 Decision Table with Conditional Values for Getz Products
STATES OF NATURE
ALTERNATIVES FAVORABLE MARKET UNFAVORABLE MARKET
Construct large plant $200,000 –$180,000
Construct small plant $100,000 –$ 20,000
Do nothing $ 0 $ 0
Uncertainty
1. Maximax
Find the alternative that maximizes the maximum
outcome for every alternative
Pick the outcome with the maximum number
Highest possible gain
This is viewed as an optimistic decision criteria
Uncertainty
2. Maximin
Find the alternative that maximizes the minimum
outcome for every alternative
Pick the outcome with the minimum number
Least possible loss
This is viewed as a pessimistic decision criteria
Uncertainty
3. Equally likely
Find the alternative with the highest average
outcome
Pick the outcome with the maximum number
Assumes each state of nature is equally likely to
occur
Decision making under uncertainty
1. Optimistic (maximax)
2. Pessimistic (maximin)
3. Criterion of realism (Hurwicz)
4. Equally likely (Laplace)
5. Minimax regret
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Uncertainty Example
TABLE A.2 Decision Table for Decision Making Under Uncertainty
STATES OF NATURE
Construct large
plant $200,000 –$180,000 $200,000 –$180,000 $10,000
Construct small
plant $100,000 –$ 20,000 $100,000 –$ 20,000 $40,000
Do nothing $ 0 $ 0 $ 0 $ 0 $ 0
Maximax Maximin Equally
likely
For example, let’s say that you have $1,000 to invest for a 1-
year period. One alternative is to open a savings account
paying 4% interest and another is to invest in a
government Treasury bond paying 6% interest. If both
investments are secure and guaranteed, there is a certainty
that the Treasury bond will pay a higher return. The return
after 1 year will be $60 in interest.
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Decision Making Under Certainty
Is the cost of perfect information worth it?
Determine the expected value of perfect
information (EVPI)
Expected Value of
Perfect Information
EVPI is the difference between the payoff
under certainty and the payoff under risk
Expected value Maximum
EVPI = with perfect – EMV
information
Expected value with = (Best outcome or consequence for 1st state
perfect information of nature) x (Probability of 1st state of
(EVwPI) nature)
+ Best outcome for 2nd state of nature)
x (Probability of 2nd state of nature)
+ … + Best outcome for last state of nature)
x (Probability of last state of nature)
EVPI Example
1. The best outcome for the state of nature
“favorable market” is “build a large facility”
with a payoff of $200,000. The best outcome
for “unfavorable” is “do nothing” with a payoff
of $0.
Expected value
with perfect = ($200,000)(.6) + ($0)(.4) = $120,000
information
EVPI Example
2. The maximum EMV is $52,000, which is the
expected outcome without perfect
information. Thus:
Payoffs
Favorable market (.6)
$200,000
nt 1
e pla Unfavorable market (.4)
l arg
t
–$180,000
s t ruc Favorable market (.6)
n
Co $100,000
Construct
small plant 2
Unfavorable market (.4)
Do –$20,000
no
th
in EMV for node 2
g = (.6)($100,000) + (.4)(–$20,000)
= $52,000
$0
Complex
Decision
Tree
Example
Figure A.3
Complex Example
1. Given favorable survey results
Recommended Book:
Quantitative Analysis for Management twelfth
edition Barry Render • Ralph M. Stair, Jr. • Michael
E. Hanna • Trevor S. Hale
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