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 processLO 5s.2 Name some causes of poor decisions LO 5s.3 Describe and use techniques that apply to decision making under uncertaintyLO 5s.4 Describe and use the expected-value approachLO 5s.5 Construct a decision tree and use it to analyze a problemLO 5s.6 Compute the expected value of perfect informationLO 5s.7 Conduct sensitivity analysis on a simple decision problemDECISION THEORYDecision Theory - a general approach to decision making Decision Theory is suitable to a wide range of operations management decisionsExamples:Capacity planningProduct and service designEquipment selectionLocation planningCHARACTERISTICS OF SUITABLE PROBLEMSCharacteristics 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 APPROACHPayoff Table - A table showing the expected payoffs for each alternative in every possible state of natureA decision is being made concerning which size facility should be constructedThe 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 DECISIONSDecisions occasionally turn out poorly due to unforeseeable circumstancesnot the normMore frequently poor decisions are the result of a combination ofMistakes in the decision processBounded rationalitySuboptimizationCAUSES OF POOR DECISIONSErrors or Mistakes in the Decision Process:Failure to recognize the importance of each stepSkipping a stepFailure to complete a step before jumping to the next stepFailure to admit mistakesInability to make a decisionCAUSES OF POOR DECISIONSBounded RationalityThe limitations on decision making caused by costs, human abilities, time, technology, and availability of informationSuboptimizationThe results of different departments each attempting to reach a solution that is optimum for that departmentDECISION ENVIRONMENTSThere are three general environment categories for the degree of uncertainty:CertaintyEnvironment in which relevant parameters have known valuesRiskEnvironment in which certain future events have probabilistic outcomesUncertaintyEnvironment in which it is impossible to assess the likelihood of various possible future eventsDECISION MAKING UNDER CERTAINTYDecisions are sometimes made under complete certainty.Know what possible future conditions will occurDecision criteria:StraightforwardChoose 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 UNCERTAINTYDecisions are sometimes made under complete uncertainty. No information is available on how likely the various states of nature are.Decision criteria:MaximinChoose the alternative with the best of the worst possible payoffsMaximaxChoose the alternative with the best possible payoffLaplaceChoose the alternative with the best average payoff Minimax regretChoose 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 16Determine 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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