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**Decisions Under Uncertainty
**

ENME 808s Product & System Cost Analysis End of Semester Class Project Authors: Brian Reynolds, Brian Schaeffer Professor: Dr. Peter Sandborn

1. Purpose: Explains the purpose and use of this tutorial. 2. Introduction: An introduction to "decisions under uncertainty". 3. Decision Rules: Defines and explains the different decision rules commonly used for decisions under uncertainty and illustrates their use in a hypothetical decision problem. 4. References: References to information used in this tutorial. 5. Related Links: WWW links relevant to this topic. 6. Bibliography: Extended bibliography of sources relevant to this topic. 1. Purpose: The purpose of this project is to give a tutorial level

summary of "decisions under uncertainty" and its application to product and system cost analysis. Included will be the summary of the topic, a list of relevant sources with links, and an extended bibliography. The depth and breadth of coverage should be equivalent to one class lecture.

2. Introduction:

Typically, personal and professional decisions can be made with little difficulty. Either the best course of action is clear or the ramifications of the decision are not significant enough to require a great amount of attention. On occasion, decisions arise where the path is not clear and it is necessary to take substantial time and effort in devising a systematic method of analyzing the various courses of action. [2,3] When a decision maker must choose one among a number of possible actions, the ultimate consequences of some if not all of these actions will generally depend on uncertain events and future actions extending indefinitely far into the future. With decisions under uncertainty, the decision maker must: 1. Take an inventory of all viable options available for gathering information, for experimentation, and for action; 2. List all events that may occur;

i.25) 20 20 20 Table 1: General Payoff Matrix style from Chankong [4]. Arrange all pertinent information and choices/assumptions made. Maximax criterion. utility. This approach attempts to strike a balance between the maximax and maximin criteria. (However.3.25) 20 0 50 S2 (P=. and 4 different possible. The A's stand for the alternative actions available to the decision maker. Decision rules prescribe how an individual faced with a decision under uncertainty should go about choosing a course of action consistent with the individual‟s basic judgments and preferences. Each S has an associated probability of its occurance. Savage minimax regret criterion. [2. the decision maker must synthesize the information set before him/her using the most appropriate decision rules. Laplace insufficient reason criterion. This generic/hypothetical example illustrates 3 different actions that can be taken. 3. 5. It suggests that the minimum and maximum of each strategy should be . or both. judgments. This type of table will be used to illustrate each type of decision rule. This numerical value can represent monetary value.25) 60 20 -20 S3 (P=. the only decsion rule that makes use of the probabilities is the Laplace criterion. This website will describe five such decision rules commonly used in industry [2. The uncertain events or states of nature are represented by the S's. The table shown below is an example of a payoff matrix. Maximin criterion. These actions represent the controllable variables in the system. uncertain states of nature with their respective payoffs.3]: Hurwicz criterion. Actions\States A1 A2 A3 S1 (P=.25) -60 -20 -80 S4 (P=. Determine the probability of an uncertain event occurring. Decision Rules: A tool commonly used to display information needed for the decision process is a payoff matrix or decision table. Rank the consequences resulting from the various courses of action. 4.) The payoff is the numerical value associated with an action and a particular state of nature. and preferences. Hurwicz criterion.3] Upon systematically describing the problem and recording all necessary data. denoted P.

See the table below for an illustration of this criterion. Maximax criterion. The maximax criterion is an optimistic approach. This approach may also appeal to a decision maker who likes to gamble and who is in the position to withstand any losses without substantial inconvenience. Therefore. results in a tie between the first two alternatives. iii. An adventurous decision maker will set a = 0 which reduces the Hurwicz criterion to the maximax criterion. A table illustrates this criterion below. It suggests that the decision maker examine the maximum payoffs of alternatives and choose the alternative whose outcome is the best. it is reasonable to assume that they are equally likely.a as weights. The use of expected values distinguishes this approach from the criteria that use only extreme payoffs. [1] A decision table illustrating the application of this criterion (with a = .5 Table 3: Laplace insufficiency illustration.5 0 0 -15 Table 2: Hurwicz criterion illustration (a = .5). This characteristic makes the approach similar to decision making under risk. The Laplace insufficient reason criterion postulates that if no information is available about the probabilities of the various outcomes. [1] .5) to a decision situation is shown below. Second alternative wins when expected payoff is calculated between equiprobable states. A cautious decision maker will set a = 1 which reduces the Hurwicz criterion to the maximin criterion. This approach also suggests that the decision maker calculate the expected payoff for each alternative and select the alternative with the largest value. Laplace insufficient reason criterion. Actions\States A1 A2 A3 S1 20 0 50 S2 60 20 -20 S3 -60 -20 -80 S4 20 20 20 a = .25) Expected Payoff: A1 A2 A3 20 0 50 60 20 -20 -60 -20 -80 20 20 20 0 5 -7. Here the probability of each state is not considered.25) S4 (P=.averaged using a and 1 .25) S3 (P=. This criterion appeals to the adventurous decision maker who is attracted by high payoffs.25) S2 (P=. if there are n outcomes. The index a reflects the decision maker‟s attitude towards risk taking. ii. [1] Actions\States S1 (P=. the probability of each is 1/n. a represents the index of pessimism and the alternative with the highest average is selected.

[1] Actions\States A1 A2 A3 S1 20 0 50 S2 60 20 -20 S3 -60 -20 -80 S4 20 20 20 Min payoff -60 -20 -80 Table 5: Maximin illustration. This criterion is applied to the same decision situation and transforms the payoff matrix into a regret matrix. This criterion is illustrated in the table below. Second alternative wins. This definition of regret allows the decision maker to transform the payoff matrix into a regret matrix. The regret corresponding to a particular payoff Xij is defined as Rij = Xj(max) – Xij where Xj(max) is the maximum payoff attainable under the situation Sj. It is particularly attractive to a decision maker who knows that several competitors face identical or similar circumstances and who is aware that the decision maker‟s performance will be evaluated in relation to the competitors. This approach may be justified because the minimum payoffs may have a higher probability of occurrence or the lowest payoff may lead to an extremely unfavorable outcome. This is shown below. First alternative wins. It suggests that the decision maker examine only the minimum payoffs of alternatives and choose the alternative whose outcome is the least bad. opportunity cost or loss resulting when a particular situation occurs and the payoff of the selected alternative is smaller than the payoff that could have been attained with that particular situation. The Savage minimax regret criterion examines the regret. The minimax criterion suggests that the decision maker look at the maximum regret of each strategy and select the one with the smallest value.Actions\States A1 A2 A3 S1 20 0 50 S2 60 20 -20 S3 -60 -20 -80 S4 20 20 20 Max Payoff 60 20 50 Table 4: Maximax illustration. there is at least a known minimum payoff. Maximin criterion. Savage minimax regret criterion. This criterion appeals to the cautious decision maker who seeks to ensure that in the event of an unfavorable outcome. This approach appeals to cautious decision makers who want to ensure that the selected alternative does well when compared to other alternatives regardless of what situation arises. iv. v. [1] . The maximin criterion is a pessimistic approach.

uottawa.htm -.mil/~me/calvano/asnesem/sld098. http://vislab-www.html -. http://web. 7-9.edu/aae705/notes/a06prisk. http://www. p.bus. and A.au/~ronm/syseng/SLIDES/06_ALTMO/index.introduction to production decisions under risk.no/iok_html/users/sww/sto-pro. Addison-Wesley Publishing .com/~horvitz/reflect.htm -.ed.navy.html 5. ix. England.ac.iot.uk/inst/cee/hey. p.htm -.edu/aae705/notes/a06prisk.aae. Addresses Decisions under uncertainty in the context of systems engineering.ca/ordal/papers/fishburn/node8. http://www. Kmietowicz."Decision Under Risk and Uncertainty": webpage giving an introduction to the topic (mathematical basis)."A Survey of Systems Engineering in a Ship Design Environment".htm http://www.ac.ntnu.nps. Pearman.htm -"Alternative models in decision making" slide show. Decision Theory and Incomplete Knowledge.ca/ordal/papers/fishburn/node8.uts.W.eng.htm http://www. Related Links: http://www.nps.Slide on decisions under uncertainty. 1981.Actions\States A1 A2 A3 R1 30 50 0 R2 0 40 80 R3 40 0 60 R4 0 0 0 Max Regret 40 50 80 Table 5: Minimax illustration. http://www.html http://www.htm -.navy.uottawa. 4.wisc. Hampshire. http://www.research.html -.uk/courses/honours/dmu.html http://www. Gower Publishing Company Limited: Aldershot.microsoft.D.htm http://informs.palisade.org/Conf/NO95/TALKS/WA17. [2] Raiffa.csi.aae.Stochastic Programming.edu. Decision Analysis: Introductory Lectures on Choices Under Uncertainty.york. Howard.a recent book covering the subject Decision making under uncertainty.4. First alternative wins.wisc.csi. Other Links: http://www.com/html/decision_making. References: [1] Z.mil/~me/calvano/asnesem/index.

New York. Helps in the representation of the sequential multistage logic of a decision problem. Is a very simple technique. c. The pay off matrix helps the decision maker a lot as it provides him with the quantitative measures of the pay off for each of the possible consequences and also each for the alternatives. With the help of the probability.V). (North Holland series in system science and engineering. The decision maker is forced by the pay off matrix to make a firm judgment about what he thinks may happen and the worth to him to those outcomes. the pay off matrix can be prepared. g. which are assigned by the Decision Maker to each of them. Very commonly used method. Yacov Y. Decision Tree a. Haimes. 6568. 8).Company: Reading. NY. Multiobjective Decision Making: Theory and methodology. h. Inc.umd.. But the pay off matrix also has some weaknesses and these can be summarized as the follows – a. f.html#purpose 1. c. e. Robert. [4] Vira Chankong. b. Helps in summarizing the various interactions of the various alternative actions and the various events. Robert E. Analysis of Decisions Under Uncertainty. 2. The main concept of the technique is actually based on the extension of the probability theory. Shows the various decision paths that may be taken in – to account rather than the criteria used for the selection of a given path. Krieger Publishing Company: Huntington. Massachusetts. c. b. Explains about the probability in a very good manner. http://terpconnect. The probability is expressed in terms of the percentages. 1978. . The pay off matrix is very largely dependent on the decision maker‟s judgment about the possible outcomes for each of the alternative and also the values. p.edu/~sandborn/courses/808S_projects/reynolds. 1983. p. 32-38. Elsevier Science Publishing Co. which are under the consideration this is generally referred to as the Expected Value (E. e. d. The probability can also be expressed in terms of the number of the times the particular event is appropriate to occur in a hundred trials. This technique is also referred to as the Decision Tables. Acts as a very good quantitative technique. The pay off matrix doesnot make a decision but instead it forces the Decision maker to be more realistic about the various outcomes that are possible. 1970. Pay Off Matrix :– The main characteristics of the pay off matrix can be summarized as the follows – a. d. b. New York. [3] Schlaifer.

h. Then after this movement takes place on to the various options emanating points and this is referred to as the Chance Nodes. Helps in the presentation of the analysis. Decision Table – a. conditions. the branches are to be added mainly for the external states of the events. d. But this technique can only be used in the conjunction with the other techniques. The various steps that are to be followed in the process of this technique can be summarized as the follows – A. The “THEN” listings offer the actions that are needed to be taken if the suitable conditions are present. Helps the decision maker in working out the various options and along with this also helps a lot in taking care of the different types of the odds and further helps in making a reasonably precise comparison among the various alternative courses of the action. i. k. D. Decision Tree technique generally mathematically factors the degree of the risk into a business decision. Then one has to work in the backward direction as this step helps a great deal in analyzing the various consequences at each node of the tree.mbaofficial. e. Very helpful in representing the various probabilities for the outcomes. b. Decision Tables are in the form of “IF” LISTINGS and “THEN” LISTINGS. variables and the alternatives. The “IF” listings stipulate the required conditions. With the help of the Decision Rules. 3.com/mba-courses/principles-of-management/explain-various-decision-makingtools/ . Is very much precise and also very compact in the nature. c. d. The decision rules and the decision tables find their use together in the process of the decision – making. B. http://www. Are generally used for the programmable or the routine / operating decisions. which have the possibility of occurring. g. The decision rules are documented in the nature. when the decision maker has to make a sequence of the decisions and this is referred to as the Decision Node. C. h. Is very critical for the analyst as it helps the analyst to take in to account the various options. c. e. j. the tree has to be made with the help of the various types of the decision points.f. Documents the rules that are used for the selection of one or more actions based on one or more conditions from a set of the various conditions that are possible. g. Can include both the qualitative and the quantitative bases for the decision making. i. The “IF” LISTINGS form the „CONDITION STUB‟ and the “THEN” LISTINGS form the „ACTION STUB‟. Then the probability of each of the state has to be included and then followed by the assignment of a value for each of the unique branches. one is able to make the various decisions very economically and also in a very much efficient manner. Decision Rules – a. f. b. First of all. Also the decisions taken are more accurate and also faster in the nature. After this. 4.

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