2022-2023

Operation Research

Lecture Six
- Decision Making

Asst. Lect. Hiba Dhaher

Electrical Engineering Depart.
1- Introduction
Decision-making is a process of taking action in a particular environment. In the
process of decision-making, a decision-maker makes a choice of action among the
number of alternative actions available in a particular environment. This theory helps
the decision-maker in identifying the alternative with the highest expected value
(probability of obtaining a possible value). The decision-making process relies on the
information available about the alternatives. The reliability of information in any
decision situation can run the whole gamut from scientifically derived hard data to
subjective interpretations and from certainty about decision outcomes (deterministic
information) to uncertain outcomes represented by probabilities and fuzzy numbers.
This diversity in the type and quality of information about a decision problem calls
for methods and techniques that can assist in information processing. A decision-
making system consists of a set of goals and objectives, a system of priorities, an
enumeration of the alternatives of feasible and viable actions, a projection of the
consequences associated with different alternatives and a system of choice criteria by
which the most preferred course of action is taken. It provides an analytical and
systematic approach to depict the expected result of a situation when alternative
managerial actions and outcomes are compared.

2- Course of action and state of nature

Course of action is the decision taken by the decision makers. A state of nature is a
future condition, which is not under the control of the decision maker and it may be
linked to various courses of action. It can be probabilistic or conditional, such as a
state of the economy, a weather condition, a political development…etc. the states of
nature are usually not determined by the action of an individual or an organization.
These are the result of an ‘act of God’ or the result of many situations pushing in
various directions.

3- Pay-off
An outcome (numerical value) resulting from each possible combination of
alternatives and states of nature is called pay-off. The pay-off values are always
conditional values because of unknown states of nature. Pay-off is measured within a
specified period, which is called the decision horizon. Pay-off can also be measured
in terms of money market share, or other measures. Pay-offs considered in most
decisions Are monetary.

4- Decision-Making Environments
There are three types of decision-making environments: certainty, uncertainty and
risk

4-1 Decision-Making under Certainty

In this case, the decision-maker has the perfect information of the consequences of
every decision choice with certainty. Obviously, an alternative should be selected that
yields the largest return (pay-off) for the known future (state of nature).

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Example 1
The following table represents the returns corresponding to three strategies, and it is
required to choose the strategy that it achieves the highest returns.

Solution:
Strategy The Return
S1 100
S2 225
S3 265

Through observation, we find that the highest return is achieved by the third strategy
Hence the best alternative (‫ )بدائل‬returning 265.

Example 2
ABC Company wants to launch one of its mega campaigns to promote a special
product. The promotion budgets not yet finalized, but they know that some 5500000$
is available for advertising and promotion. Management wants to know how much
they should spend for television spots, which is the most appropriate medium for
their product. They have created five ‘T.V. campaign strategies’ with their projected
outcome in terms of increase in sales. Find which one they have to select to yield
maximum utility. The data required is given below.

Increased in
Strategy Cost in $.
sales in $.
S1 1.8 1.78
S2 2 2.02
S3 2.25 2.42
S4 2.75 2.68
S5 3.20 3.24

Solution:

Increased in
Strategy Cost in $.
sales in $. Payoffs
S1 1.8 1.78 1.78 / 1.80 = 0.988
S2 2 2.02 2.02 / 2.00 = 1.010
S3 2.25 2.42 2.42 / 2.25 = 1.075 maximum utility
S4 2.75 2.68 2.68 / 2.75 = 0.974
S5 3.20 3.24 3.24 / 3.20 = 1.012

The company will select the third strategy, C, which yields highest utility.

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5-2 Decision-Making under Uncertainty
In this case, the decision-maker cannot to specify probabilities with which the various
states of nature (futures) will occur. However, this is not the case of decision-making
under ignorance because possible states of nature are known. For example, the
probability that the share of a company will grow 10 times after 5 years is not known.
Thus, if the decision-maker does not know with certainty which state of nature will
occur, then he/she is said to be making a decision under uncertainty. the three
commonly used criteria for decision-making under uncertainty are as follows:

1- Optimistic approach (Maxi max) :In this approach, a decision-maker has an

optimistic view about the output. The decision with the largest possible pay-off is
chosen. If the pay-off table was in terms of costs, the decision with the lowest cost
or maximum profit would be chosen.
2- Conservative/pessimistic approach (Maxi min): In this approach, a decision-
maker has a pessimistic view about the outcome. For each decision, the minimum
pay-off is listed and then the decision corresponding to the maximum of these
minimum pay-offs is selected. Therefore, it is also known as maxi min approach.
The minimum possible pay-off is maximized. If the pay-off was in terms of costs,
the maximum costs would be determined for each decision and then the decision
corresponding to the minimum of these maximum costs is selected. Hence, the
maximum possible cost is minimized.
3- Equally likely (Laplace criterion): Equally likely criterion, also called Laplace
criterion, finds the decision alternative with the highest average pay-off. In this
approach, first the average pay-off for every alternative is calculated. Then the
alternative with maximum average pay-off is chosen.

Example 3
A company XYZ is thinking about the three decision alternatives: introduction of a
new product by replacing the existing product at a much higher price (S1) or effecting
a moderate change in the composition of the existing product at a small increase in
price (S2) or bringing a minor change in the composition of the existing product with
a negligible increase in price (S3). The three possible states of nature or events are:
high increase in sales (N1), no change in sales (N2) and decrease in sales (N3). The
marketing department of the company has worked out the pay-offs in terms of yearly
net profits for the strategies of each of the three events (expected sales). The profits
(pay-offs) for different courses of action under various states of nature are shown in
the table below.

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Which strategy should the company choose on the basis of :
a- Optimistic approach.
b- Conservative approach.
c- Equally likely (Laplace) criterion.

Solution:

a- Optimistic approach

The maximum among maximum pay-offs is 750,000$. Thus strategy S1 should be

chosen.

b- Conservative or pessimistic approach

The maximum among minimum pay-offs is 350,000 $. Thus, strategy S3 should be

chosen.

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 c- Equally likely (Laplace) criterion

The maximum pay-off is 365,000 $. Thus, strategy S1 should be selected.

4-3 Decision-making under Risk

In this case, the decision-maker has less than complete knowledge of the
consequence of every decision choice because it is not definitely known which
outcome will occur. This means there is more than one state of nature and he makes
an assumption of the probability with which each state of nature will occur.
Decision-making under risk is a probabilistic decision situation in which more than
one state of nature exists and the decision-maker has sufficient information to assign
probability values to the likely occurrence of each of these states. Knowing the
probability distribution of the states of nature, the best decision is to select that course
of action which has the largest expected pay-off value. the expected (average) pay-off
of course of action is the sum of all possible pay-offs of the states of nature weighted
by the probabilities of those pay-offs occurring.
4-3-1 Expected monetary value (EMV): The EMV for a given course of action is
the weighted sum of possible pay-offs for states of nature. It is obtained by summing
the pay-offs for each course of action multiplied by the probabilities associated with
each state of nature. The expected (or mean) value is the long-run average value that
would result if the decision were repeated a large number of times. Mathematically,
EMV is expressed as follows:

EMV (di) = ∑

Where N is the number of possible states of nature; pj is a probability of

occurrence of the state of nature, Nj; Pij is the pay-off associated with the state of
nature Nj and course of action Si.

4-3-2 Decision Matrix

It has been customary to depict the steps of the decision-making process in the form
of a table (decision matrix). N1, N2, N3, Nm it is a table showing the expected return for
each alternative under each of the expected cases of nature. Where they represent: ...
all future events that can occur (normal states) and S1, S2, S3, Sn possible solutions
(alternatives), where ... i = 1, 2…, n and j = 1, 2 …., m.
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 N
N1 N2 N3 …… Nm
S
S1 r11 r12 r13 r1j
S2 r21 r22 r23 r2j
S3
.
.
.
Sn rn1 rn2 rn3 rnm

Where (rij) the return resulting from the selection of the alternative (i) in when the
natural condition in ( j) The previous table is known as the decision matrix, and it is a
system that contains a number and the columns, where the rows represent the
alternatives, while the columns represent the different states of nature, and all Matrix
cells represent the achieved return or cost when adopting a particular strategy certain
states of nature.

Example 4
A marketing manager of an insurance company has kept complete records of the
sales effort of the sales personnel. These records contain data regarding the number
of insurance policies sold and net revenues received by the company as a function of
four different sales strategies. The manager has constructed the conditional payoff
matrix given below, based on his records. (The state of nature refers to the number of
policies sold). The number within the table represents utilities. Suppose you are a
new salesperson and that you have access to the original records as well as the payoff
matrix. Which strategy would you follow?

State of nature N1 N2 N3
Probability 0.2 0.5 0.3
Strategy
S1 4 6 10
S2 6 5 9
S3 2 10 8
S4 10 3 7

Solution:

State of nature N1 N2 N3 Expected payoffs

Probability 0.2 0.5 0.3
Strategy
S1 4 6 10 0.2 × 4 + 0.5 × 6 + 0.3 × 10 = 6.8
S2 6 5 9 0.2 × 6 + 0.5 × 5 + 0.3 × 9 = 6.4
0.2 × 2 + 0.5 × 10 + 0.3 × 8 = 7.8
S3 2 10 8
Maximum utility
S4 10 3 7 0.2 × 10 + 0.5 × 3 + 0.3 × 7 = 5.6

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Example 5
Consider a M/s XYZ company, which is developing its annual plans in terms of three
objectives:(1) Increased profits, (2) Increased market share and (3) increased sales.
M/S XYZ has formulated three different strategies for achieving the stated objectives.
The table below gives relative weightage of objectives and scores project the strategy.
Find the optimal strategy that yields maximum weighted or composite utility.

Measure of
ROI %Increase %Increase
Performance of
(Profit) (Market share) (sales growth)
Three objectives
Weights 0.2 0.5 0.3
Strategy
S1 7 4 9
S2 3 6 7
S3 5 5 10

Solution:

Measure of Performance of ROI %Increase %Increase Weighted or

Three objectives (Profit) (Market share) (sales growth) Composite Utility (CU)
Weights 0.2 0.5 0.3
Strategy
0.2 × 7 + 0.5 × 4 + 0.3
S1 7 4 9
× 9 = 6.1
0.2 × 3 + 0.5 × 6 + 0.3
S2 3 6 7
× 7 = 5.7
0.2 × 5 + 0.5 × 5 + 0.3
S3 5 5 10 × 10 = 6.6
Maximum utility