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OU SCM 3523 - Chapter 5S

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Slide 1Supplement 5: Learning ObjectivesDecision TheoryCharacteristics of Suitable ProblemsProcess for Using Decision Theory ApproachProcess for Using Decision Theory ApproachDecision ProcessCauses of Poor DecisionsCauses of Poor DecisionsCauses of Poor DecisionsDecision EnvironmentsDecision Making Under certaintyDecision Making Under certainty Example 5s-1 (page 222 & 223)Decision Making Under UncertaintyDecision Making Under Uncertainty Example 5s-2 (page 223 & 224)Example – Maximin Criterion (A)Example – Maximax Criterion (b)Example – Laplace Criterion (C)Example – Minimax RegretExample – Minimax Regret (cont.)Decision Making Under RiskDecision Making Under Risk Example 5s-4 (page 225)Expected Value of Perfect InformationExpected Value of Perfect Information Example 5S-6 (Page 228)Expected Value of Perfect Information Example 5S-6 (Page 228)Expected Value of Perfect Information Example 5S-6 (Page 228)Expected Value of Perfect Information Example 5S-7 (Page 228)Expected Value of Perfect Information Example 5S-7 (Page 228)Expected Value of Perfect Information Example 5S-7 (Page 228)DECISION THEORYCHAPTER 5 SUPPLEMENTSUPPLEMENT 5: LEARNING OBJECTIVESYou should be able to:LO 5s.1 Outline the steps in the decision processLO 5s.2 Name some causes of poor decisions LO 5s.3 Describe and use techniques that apply to decision making under uncertaintyLO 5s.4 Describe and use the expected-value approachLO 5s.5 Construct a decision tree and use it to analyze a problemLO 5s.6 Compute the expected value of perfect informationLO 5s.7 Conduct sensitivity analysis on a simple decision problemDECISION THEORYDecision Theory - a general approach to decision making Decision Theory is suitable to a wide range of operations management decisionsExamples:Capacity planningProduct and service designEquipment selectionLocation planningCHARACTERISTICS OF SUITABLE PROBLEMSCharacteristics of decisions that are suitable for using decision theory:1. A set of possible future conditions that will have a bearing on the results of the decision2. A list of alternatives from which to choose3. A known payoff for each alternative under each possible future condition1. Identify the possible future states of nature2. Develop a list of possible alternatives3. Estimate the payof for each alternative for each possible future state of nature4. If possible, estimate the likelihood of each possible future state of nature5. Evaluate alternatives according to some decision criterion and select the best alternativePROCESS FOR USING DECISION THEORY APPROACHPROCESS FOR USING DECISION THEORY APPROACHPayoff Table - A table showing the expected payoffs for each alternative in every possible state of natureA decision is being made concerning which size facility should be constructedThe present value (in millions) for each alternative under each state of nature is expressed in the body of the above payoff tablePossible Future DemandAlternatives Low ModerateHighSmall facility $10 $10 $10Medium facility 7 12 12Large Facility (4) 2 16Steps in the Decision Process:1. Identify the problem2. Specify objectives and criteria for a solution3. Develop suitable alternatives4. Analyze and compare alternatives5. Select the best alternative6. Implement the solution7. Monitor to see that the desired result is achievedDECISION PROCESSCAUSES OF POOR DECISIONSDecisions occasionally turn out poorly due to unforeseeable circumstancesnot the normMore frequently poor decisions are the result of a combination ofMistakes in the decision processBounded rationalitySuboptimizationCAUSES OF POOR DECISIONSErrors or Mistakes in the Decision Process:Failure to recognize the importance of each stepSkipping a stepFailure to complete a step before jumping to the next stepFailure to admit mistakesInability to make a decisionCAUSES OF POOR DECISIONSBounded RationalityThe limitations on decision making caused by costs, human abilities, time, technology, and availability of informationSuboptimizationThe results of different departments each attempting to reach a solution that is optimum for that departmentDECISION ENVIRONMENTSThere are three general environment categories for the degree of uncertainty:CertaintyEnvironment in which relevant parameters have known valuesRiskEnvironment in which certain future events have probabilistic outcomesUncertaintyEnvironment in which it is impossible to assess the likelihood of various possible future eventsDECISION MAKING UNDER CERTAINTYDecisions are sometimes made under complete certainty.Know what possible future conditions will occurDecision criteria:StraightforwardChoose the alternative that has the best payoff under that state of natureDECISION MAKING UNDER CERTAINTY EXAMPLE 5S-1 (PAGE 222 & 223)Determine the best alternative in the payoff table when it is known with certainty that demand will be:A. LowB. ModerateC. HighPossible Future DemandAlternatives Low ModerateHighSmall facility $10 $10 $10Medium facility 7 12 12Large Facility (4) 2 16DECISION MAKING UNDER UNCERTAINTYDecisions are sometimes made under complete uncertainty. No information is available on how likely the various states of nature are.Decision criteria:MaximinChoose the alternative with the best of the worst possible payoffsMaximaxChoose the alternative with the best possible payoffLaplaceChoose the alternative with the best average payoff Minimax regretChoose the alternative that has the least of the worst regretsDECISION MAKING UNDER UNCERTAINTYEXAMPLE 5S-2 (PAGE 223 & 224)Possible Future DemandAlternatives Low Moderate HighSmall facility $10 $10 $10Medium facility 7 12 12Large Facility (4) 2 16Determine which alternative would be chosen under each strategy:A. MaximinB. MaximaxC. LaplaceEXAMPLE – MAXIMIN CRITERION (A)Possible Future DemandAlternatives Low Moderate HighSmall Facility $10 $10 $10Medium Facility 7 12 12Large Facility (4) 2 16A. Maximin Criterion:Choose the “best of the worst”EXAMPLE – MAXIMAX CRITERION (B)Possible Future DemandAlternatives Low Moderate HighSmall Facility $10 $10 $10Medium Facility 7 12 12Large Facility (4) 2 16B. Maximax Criterion:Choose the best possible payoffEXAMPLE – LAPLACE CRITERION (C)Possible Future DemandAlternatives Low Moderate HighSmall Facility $10 $10 $10Medium Facility 7 12 12Large Facility (4) 2 16C. Maximax


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