Post on 10-May-2017
5s-1 Decision Theory
William J. Stevenson
Operations Management
6th edition
5s-2 Decision Theory
CHAPTER2s
Decision Making
McGraw-Hill/IrwinOperations Management, Eighth Edition, by William J. StevensonCopyright © 2005 by The McGraw-Hill Companies, Inc. All rights
reserved.
5s-3 Decision Theory
Decision Theory represents a general approach to decision making which is suitable for a wide range of operations management decisions, including:
product andservice design
equipment selection
location planning
Decision TheoryDecision Theory
Capacityplanning
5s-4 Decision Theory
A set of possible future conditions exists that will have a bearing on the results of the decision
A list of alternatives for the manager to choose from
A known payoff for each alternative under each possible future condition
Decision Theory ElementsDecision Theory Elements
5s-5 Decision Theory
Identify possible future conditions called states of nature
Develop a list of possible alternatives, one of which may be to do nothing
Determine the payoff associated with each alternative for every future condition
Decision Theory ProcessDecision Theory Process
5s-6 Decision Theory
If possible, determine the likelihood of each possible future condition
Evaluate alternatives according to some decision criterion and select the best alternative
Decision Theory Process (Cont’d)Decision Theory Process (Cont’d)
5s-7 Decision Theory
Bounded Rationality The limitations on decision making caused by costs, human abilities, time, technology, and availability of information
Causes of Poor DecisionsCauses of Poor Decisions
5s-8 Decision Theory
Suboptimization
The result of different departments each attempting to reach a solution that is optimum for that department
Causes of Poor Decisions (Cont’d)Causes of Poor Decisions (Cont’d)
5s-9 Decision Theory
Certainty - Environment in which relevant parameters have known values
Risk - Environment in which certain future events have probable outcomes
Uncertainty - Environment in which it is impossible to assess the likelihood of various future events
Decision EnvironmentsDecision Environments
5s-10 Decision Theory
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 of any of the alternatives
Minimax Regret - Choose the alternative that has the least of the worst regrets
Decision Making under UncertaintyDecision Making under Uncertainty
5s-11 Decision Theory
Payoff TablePayoff Table
Alternatives Low Moderate HighSmall facility $10 $10 $10
Medium facility 7 12 12
Large facility (4) 2 16
Possible future demand*
*Present value in $ millions
5s-12 Decision Theory
Format of a Decision TreeFormat of a Decision Tree
State of nature 1
B
Payoff 1
State of nature 2
Payoff 2
Payoff 3
2
Choose A’1
Choose A’2
Payoff 6State of nature 2
2
Payoff 4
Payoff 5
Choose A’3
Choose A’4
State of nature 1
Choose A’
Choose A’2
1
Decision PointChance Event
Figure 5S.1
5s-13 Decision Theory
A manager must decide on the size of a video arcade to construct. The A manager must decide on the size of a video arcade to construct. The manager has narrowed the choices to two: large or small. Information has manager has narrowed the choices to two: large or small. Information has been collected on payoffs, and a decision tree has been constructed. Analyze been collected on payoffs, and a decision tree has been constructed. Analyze the decision tree and determine which initial alternative (build small or build the decision tree and determine which initial alternative (build small or build large) should be chosen in order to maximize expected monetary value. large) should be chosen in order to maximize expected monetary value.
5s-14 Decision Theory
Expected Value of Perfect InformationExpected Value of Perfect InformationApproach I : Expected value of perfect information: the difference between the expected payoff under certainty and the expected payoff under risk
Expected value ofperfect information
Expected payoffunder certainty
Expected payoffunder risk= -
5s-15 Decision Theory
5s-16 Decision Theory
5s-17 Decision Theory
5s-18 Decision Theory
5s-19 Decision Theory
Sensitivity AnalysisSensitivity Analysis
16141210 86420
16141210 86420
A
B
C
A bestC bestB best
#1 Payoff #2 Payoff
Sensitivity analysis: determine the range of probability for which an alternative has the best expected payoff
Example S-8