QUANTITATIVE ANALYSIS (FOMS)

Week 6 – Lecture

Shafiq Ur Rehman
Lecturer (Statistics)
Department of Mathematics & Statistics
University of Central Punjab, Lahore.
DECISION MAKING /ANALYSIS
Decision making is the process of selecting the best course of action among various alternatives.
It is the process of choosing a solution to a problem or an opportunity that has arisen.

Decision making involves several steps, including identifying the problem or opportunity,
gathering relevant information, identifying alternative solutions, evaluating the alternatives, and
choosing the best course of action. In addition, decision making may involve making trade-offs
between competing objectives, considering the uncertainties and risks associated with each
alternative, and assessing the potential consequences of each choice.

Effective decision making requires the use of a structured, systematic approach that is based on
sound analysis and objective criteria. The use of quantitative analysis techniques, such as
mathematical modeling and optimization, can help to improve the quality of decision making by
providing a rigorous framework for evaluating alternatives and selecting the best course of
action.
SIX-STEPS OF DECISION MAKING
1. Problem Identification: The first step in decision making is to identify the problem or
opportunity that requires a decision. This may involve identifying a gap between the desired
state and the current state, or recognizing a new opportunity that could be pursued.
2. Information Gathering: Once the problem or opportunity has been identified, the next step is
to gather relevant information that can help to inform the decision. This may involve collecting
data, conducting research, or seeking input from experts or stakeholders.
3. Alternative Generation: With the relevant information at hand, the next step is to generate
alternative solutions or courses of action. This may involve brainstorming, conducting a
feasibility analysis, or considering different scenarios.
4. Evaluation of Alternatives: The next step is to evaluate the potential advantages and
disadvantages of each alternative solution or course of action. This may involve assessing the
risks and benefits, weighing the trade-offs, and considering the feasibility and affordability of
each option.
(Cont.) SIX-STEPS OF DECISION MAKING
5. Alternative Selection: Based on the evaluation of alternatives, the next step is to select the
best course of action or solution. This may involve making a choice based on objective criteria,
such as cost-benefit analysis or risk analysis, or it may involve making a subjective judgment
based on intuition or experience.
6. Implementation: The final step in the decision-making process is to implement the chosen
course of action. This may involve developing a plan, allocating resources, and communicating
the decision to stakeholders. It may also involve monitoring progress and making adjustments
as necessary.
OPTIMIZATION
Optimization is the process of finding the best solution (to a problem) among a set of all possible
solutions. Optimization involves the use of mathematical techniques to identify the optimal values
of decision variables that will maximize or minimize an objective function, subject to constraints.
USE OF OPTIMIZATION
Optimization problems arise in a variety of contexts, such as in production planning, inventory
management, transportation, and financial management. In each of these contexts, there are
typically multiple decision variables that must be determined in order to achieve the desired
outcomes. For example, in production planning, the decision variables might include the quantities
of different products to produce, the amount of raw materials to purchase, and the number of
workers to hire.
The objective of optimization is to find the combination of decision variables that will maximize or
minimize a particular objective function. For example, the objective function might be to
maximize profit, minimize costs, or maximize efficiency. In addition, there may be constraints on
the decision variables, such as limited resources or capacity constraints, that must be taken into
account when finding the optimal solution.
(Cont.) OPTIMIZATION
Optimization techniques can be used to solve problems with a few decision variables, as well as
problems with thousands or even millions of variables. These techniques include linear
programming, nonlinear programming, integer programming, and dynamic programming. By
finding the optimal solution to a problem, optimization can help to improve decision making and
achieve better outcomes in a variety of contexts.
Decision Making under uncertainty Optimistic(Maximax)
Limitation
The optimistic criterion is a simple and intuitive approach to decision making under uncertainty,
but it does not take into account the likelihood of lower payoffs or the potential downside risk of
each alternative. As a result, it may not be the best approach in all situations.
DECISION MAKING UNDER UNCERTAINTY:
OPTIMISTIC(MAXIMAX)
The optimistic criterion is based on the assumption that the decision maker is optimistic and seeks to
maximize the best possible outcome. This approach involves identifying the maximum payoff for each
alternative, and then selecting the alternative that has the highest maximum payoff.
To apply the optimistic criterion, the decision maker must first identify the possible outcomes of each
alternative, and assign probabilities to each outcome. The decision maker then calculates the maximum
payoff for each alternative based on these probabilities, and selects the alternative that has the highest
maximum payoff.
For example, suppose a company is considering two possible strategies for launching a new product.
Strategy A has a 70% chance of generating $500,000 in profit, and a 30% chance of generating $200,000
in profit. Strategy B has a 60% chance of generating $400,000 in profit, and a 40% chance of generating
$300,000 in profit.
Using the optimistic criterion, the decision maker would select Strategy A, because it has the highest
maximum payoff of $500,000, even though the expected value of Strategy B is slightly higher ($380,000
vs $390,000).
1- OPTIMISTIC (MAXIMAX) MANUAL STEPS
To apply the optimistic (Maximax) criterion for decision making under uncertainty, the following
manual steps can be followed:
1. Identify the decision alternatives: List all of the possible alternatives that are available to the
decision maker.
2. Identify the possible outcomes for each alternative: For each alternative, identify all of the
possible outcomes that could occur.
3. Assign probabilities to each outcome: Estimate the probability of each outcome occurring for
each alternative. This can be based on historical data, expert opinion, or other sources of
information.
4. Determine the maximum payoff for each alternative: For each alternative, determine the
maximum payoff that could be obtained based on the probabilities assigned to each outcome.
This can be done by multiplying the probability of each outcome by the corresponding payoff,
and then selecting the highest value.
(Cont.) OPTIMISTIC (MAXIMAX) MANUAL STEPS
5. Select the alternative with the highest maximum payoff: Choose the alternative that has the
highest maximum payoff as the optimal decision.
6. Evaluate the decision: Once the decision has been made, evaluate the potential risks and
benefits of the chosen alternative, and consider whether it is consistent with the decision
maker's objectives and preferences.

It is important to note that the optimistic criterion assumes that the decision maker is optimistic
and seeks to maximize the best possible outcome, without considering the likelihood or potential
downside risk of lower payoffs. As a result, it may not always be the most appropriate approach for
decision making under uncertainty.
EXAMPLE: OPTIMISTIC (MAXIMAX) MANUAL STEPS
Suppose a farmer is deciding between two possible crops to plant in a particular field: wheat or
corn. The farmer estimates that the probability of a good growing season is 0.6, and the probability
of a poor growing season is 0.4. The farmer also estimates the potential profits for each crop based
on the season.
• Wheat has a potential profit of $40,000 in a good season and $10,000 in a poor season.
• Corn has a potential profit of $30,000 in a good season and $20,000 in a poor season.
Steps For The Optimistic (Maximax) Criterion:
1. Identify the decision alternatives: Wheat or Corn.
2. Identify the possible outcomes for each alternative: Good season or Poor season.
3. Assign probabilities to each outcome: Good season has a probability of 0.6, and Poor season
has a probability of 0.4.
4. Determine the maximum payoff for each alternative:
• For Wheat, the maximum payoff is $40,000 in a good season.
• For Corn, the maximum payoff is $30,000 in a good season.
(Cont.) EXAMPLE: OPTIMISTIC (MAXIMAX)
1. Identify the decision alternatives: Wheat or Corn.
2. Identify the possible outcomes for each alternative: Good season or Poor season.
3. Assign probabilities to each outcome: Good season has a probability of 0.6, and Poor season has a
probability of 0.4.
4. Determine the maximum payoff for each alternative:
• For Wheat, the maximum payoff is $40,000 in a good season.
• For Corn, the maximum payoff is $30,000 in a good season.
5. Select the alternative with the highest maximum payoff: Choose Wheat as the optimal decision,
because it has the highest maximum payoff of $40,000.
6. Evaluate the decision: The farmer should consider the potential risks and benefits of planting wheat, and
whether it is consistent with their objectives and preferences.

Based on the optimistic (Maximax) criterion, the farmer would choose to plant wheat, because it has the
highest maximum payoff in the best-case scenario. However, this approach does not take into account the
downside risk of a poor growing season, and the farmer should consider other decision criteria as well.
2- DECISION MAKING UNDER UNCERTAINTY: PESSIMISTIC
(MAXIMIN)
"Pessimistic (Maximin)" is another approach to decision making under uncertainty, which is based on
the assumption that the decision maker is pessimistic and seeks to minimize the worst possible outcome.
This approach involves identifying the minimum payoff for each alternative, and then selecting the
alternative that has the highest minimum payoff.
FOR APPLICATION:
To apply the pessimistic (maximin) criterion, the decision maker must first identify the possible
outcomes of each alternative, and assign probabilities to each outcome. The decision maker then
calculates the minimum payoff for each alternative based on these probabilities, and selects the
alternative that has the highest minimum payoff.
For example, consider a company that is considering two possible advertising campaigns for a new
product launch. Campaign A has a 60% chance of generating $1 million in sales, and a 40% chance of
generating $500,000 in sales. Campaign B has a 70% chance of generating $800,000 in sales, and a 30%
chance of generating $200,000 in sales.
(Cont.) DECISION MAKING UNDER UNCERTAINTY:
PESSIMISTIC (MAXIMIN)
Using the pessimistic (maximin) criterion, the decision maker would select Campaign B, because it has
the highest minimum payoff of $200,000, even though the expected value of Campaign A is higher
($700,000 vs $580,000).

The pessimistic criterion is a conservative approach to decision making under uncertainty, because it
focuses on minimizing the potential downside risk of each alternative. However, it may not always be
the best approach, because it ignores the likelihood of higher payoffs or the potential upside benefits of
each alternative. As a result, the decision maker should carefully consider the potential risks and benefits
of each alternative, and choose the approach that is most consistent with their objectives and preferences.
DIFFERENCE BETWEEN OPTIMISTIC (MAXIMAX)
& PESSIMISTIC (MAXIMIN)
The steps for applying the optimistic (Maximax) and pessimistic (Maximin) criteria are similar, but
with some important differences.
The main difference between these two criteria is in Step 4. For the optimistic (Maximax)
criterion, the decision maker identifies the highest payoff for each alternative, while for the
pessimistic (Maximin) criterion, the decision maker identifies the lowest payoff for each
alternative.
The optimistic criterion is more focused on the best-case scenario and maximizing potential gains,
while the pessimistic criterion is more focused on the worst-case scenario and minimizing potential
losses. The choice of criterion will depend on the decision maker's risk preferences and objectives.
3- CRITERIA FOR “REALISM”
In the context of decision making under uncertainty, realism refers to an approach that seeks to
balance the potential benefits and risks of each decision alternative. The realistic approach involves
considering both the best-case and worst-case scenarios, and selecting the alternative that provides
the highest expected value, or utility, based on the decision maker's preferences.
To apply the realistic approach, the decision maker must first identify the possible outcomes of
each alternative, and assign probabilities to each outcome. The decision maker then calculates the
expected value of each alternative, based on the probabilities and payoffs associated with each
outcome.
For example, suppose a company is considering two possible manufacturing processes for a new
product. Process A has a 70% chance of producing 100 units per hour, and a 30% chance of
producing 50 units per hour. Process B has an 80% chance of producing 80 units per hour, and a
20% chance of producing 40 units per hour. The company's objective is to maximize production
while minimizing costs.
(Cont.) REALISM
Using the realistic approach, the decision maker would calculate the expected value of each
alternative as follows:
• Process A: (0.7 x 100) + (0.3 x 50) = 85 units per hour
• Process B: (0.8 x 80) + (0.2 x 40) = 72 units per hour
Based on these calculations, the decision maker would select Process A, because it has the highest
expected value of 85 units per hour.
The realistic approach takes into account both the potential benefits and risks of each alternative,
and seeks to find a balance that maximizes the decision maker's overall utility. This approach is
often used in real-world decision making, where the decision maker must consider multiple
objectives and trade-offs, and make decisions based on incomplete or uncertain information.
STEPS FOR REALISM
The criteria for realism are based on the principles of expected value, risk aversion, and decision
making under uncertainty. That can help decision makers to apply a realistic approach to their
decision making process.
The criteria for realism include the following:
1. Identify the possible outcomes of each decision alternative.
2. Assign probabilities to each outcome based on available information.
3. Calculate the expected value of each alternative based on the probabilities and payoffs
associated with each outcome.
4. Consider the decision maker's attitude towards risk and their level of risk aversion.
5. Select the alternative with the highest expected value that also aligns with the decision
maker's risk preferences.
These criteria provide a structured framework for decision makers to evaluate the potential benefits
and risks of each decision alternative, and make a decision that is aligned with their objectives and
risk preferences.
An other Example of Realism
For example, suppose a homeowner is considering purchasing insurance for their home, which is
located in a flood-prone area. The homeowner must choose between two insurance policies, A and
B. Policy A has a lower premium but provides less coverage in the event of a flood, while Policy B
has a higher premium but provides more comprehensive coverage.

Using the criteria for realism, the homeowner would evaluate each policy based on the potential
outcomes and associated probabilities, as well as their own attitude towards risk. They would then
select the policy that provides the highest expected value based on these factors.

The criteria for realism can be applied to a wide range of decision-making situations, from
personal finance and insurance to business strategy and investment decisions. By taking into
account both the potential benefits and risks of each decision alternative, decision makers can
make more informed and effective decisions that align with their objectives and risk preferences.
4- CRITERIA FOR “EQUALLY LIKELY”
The Equally Likely approach assumes that each possible outcome is equally likely to occur. The
decision maker assigns equal probabilities to each outcome and calculates the expected value of
each alternative based on the probabilities and payoffs associated with each outcome. The decision
maker then selects the alternative with the highest expected value. The Equally Likely method
assumes that all possible outcomes have the same likelihood of occurring.

5- CRITERIA FOR “MINIMAX REGRET”

The Minimax Regret approach involves identifying the possible outcomes of each decision
alternative, and determining the regret associated with each outcome. Regret is the difference
between the best possible outcome and the actual outcome that occurs. The decision maker then
selects the alternative that minimizes the maximum regret, or the worst-case regret associated with
any possible outcome. The Minimax Regret method seeks to minimize the potential regret that
could result from each decision alternative.
Cont.
These three decision-making methods provide different approaches for decision makers to evaluate
the potential benefits and risks of each decision alternative and make an informed decision based
on their objectives and risk preferences.