UNIVERSITY OF NOTTINGHAM Construction Management Processes

DEPARTMENT OF CIVIL ENGINEERING Decision Theory

DECISION MAKING UNDER UNCERTAINTY

(Notes made directly from lecture PowerPoint slides)

References:

Pilcher R, Principles of construction management, 3rd edition, chapter 15, McGraw

Hill

Benjamin & Cornell, ‘Probability, Statistics & Decision Making for Civil Engineers’.
Chapter 5. McGraw Hill

Problem:

We have a decision maker who has a set of strategies that may be followed and
an exhaustive set of mutually exclusive states of the world which may confront
the chosen strategy. We assume that we can calculate the value to the decision-
maker of the outcome of any particular strategy with any particular state of the
world.

Only one state of the world can actually occur and we sometimes assume that we
know the probability of occurrence of each.

We want to find the ‘best’ strategy to follow in the face of the uncertainty of the
problem.

We will do this by using a number of criteria to value each strategy.

For any one criterion, one strategy will be the best or several will be equally
superior to the rest.

The different criteria are likely to give different ‘best’ strategies and no criterion is
guaranteed to give the strategy that is the best choice for the state of the world
that actually occurs.

We will, however, have studied the information of the problem and have made
our decision in a rational and sensible manner.

STRATEGIES

• There must be alternative strategies or there is no problem of choice.

• All alternatives should be considered and discarded for good reason rather
than being forgotten.

• Although alternative strategies may form a continuum, it is usually simpler

to split them into discrete strategies.

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UNIVERSITY OF NOTTINGHAM Construction Management Processes
DEPARTMENT OF CIVIL ENGINEERING Decision Theory

STATES OF THE WORLD

(SOWS)

• These are future happenings over which the decision maker has no
control.

PROBABILITY ESTIMATES

Statistical Probabilities

Most non-routine decision problems are one-off and little or no experimentation is

possible. There is therefore no opportunity to build up proportions for the
occurrence of each State of the World. Consequently, there is no chance of
obtaining statistical probabilities.

Subjective Probabilities

Experience and training could lead us to believe that some SOWs are more likely
than others for the problem in hand.

This can be illustrated by use of an example.

Consider a sewer serving an industrial estate. We know the type of factory

planned for the estate but are not certain of the type of factory that will actually
exist. We know the reliability of the enforcement of environmental rules in the
area. These might therefore cause us to assess the chances of any particular
concentration of a particular chemical and express them thus:

mid-range concentration - very likely p=0.8

high concentration - highly unlikely p=0.05

low concentration - not very likely p=0.15

It is important that ∑p=1 since something must happen and the SOW list is
exhaustive. Also, only one SOW will occur in practice since the SOWs are
mutually exclusive.

Subjective probabilities are therefore treated as statistical probabilities.

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UNIVERSITY OF NOTTINGHAM Construction Management Processes
DEPARTMENT OF CIVIL ENGINEERING Decision Theory

EVALUATION OF THE STRATEGIES FOR VARIOUS STATES OF

THE WORLD

If all the strategies are evaluated for every possible state of the world, the results
can be displayed as a Pay-off Matrix. This will show the outcome of each
strategy i for each possible SOW j.

In the payoff matrix, each cell i,j represents the utility of strategy i in SOW j and
is denoted by U(i,j).

The utility is often replaced by money for convenience in examples.

EXAMPLE

The strength of an aggressive chemical in the future discharge through a pipe is

unknown. We have to choose a pipe to have a 20 year life.

From our knowledge of the effect of the chemical, we can split the possible
concentrations into classes. Say:

<0.3%

>=0.3% and <2.0%

>2.0%

There is some temptation to create classes such as ‘neutral’, ‘aggressive’ and

‘highly aggressive’ but since this will relate to the pipe material used as well as
the chemical, it may complicate the problem.

Assume that from previous work, we know that pipe type 1 costs 10 units per
installation and has a life of

20yrs for concentrations <0.3%

10yrs for concentrations >=0.3% and <2.0%

5yrs for concentrations >2.0%

Pipe 2 costs 20 per installation and has a life expectancy of 20 yrs for
concentrations <2.0% but will require heavy remedial work at a cost of 10 to
give the 20yr life for higher concentrations.

This information can be expressed as a payoff matrix with the strategies

Use pipe 1

Use pipe 2

and the states of the world

<0.3%

>=0.3% and <2.0%

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UNIVERSITY OF NOTTINGHAM Construction Management Processes
DEPARTMENT OF CIVIL ENGINEERING Decision Theory

>2.0%

CRITERIA FOR DECISION

Having used our engineering knowledge to give us the strategies and states of
the world, we then use simple ‘engineering economics’ to evaluate each cell of
the payoff matrix and thereby give the bulk information required to evaluate the
strategies.

It may be necessary to consider things other than money in this evaluation.

There is always a decision to be made and the payoff matrix acts as a basis for
this. However, the choice between the strategies is not usually straight-forward
even after the information has been produced and ordered.

Consider as an example the choice of the length of piles to order for a particular
job.

It has been estimated that the depth to set (D) of the piles will be 20m, 25m, or
30m.

Piles can be ordered in lengths of 20m, 25m or 30m.

Piles cost £1 per metre and have a scrap value of £0.5 per metre. The contractor
is paid £1.2 per metre of pile installed.

If the pile is too long, the surplus is burned off and sold for scrap. If the pile is
too short it is lengthened with a weld costing £3.

The payoff matrix can be evaluated as previously:

In general we should ask ourselves what would we like our chosen strategy to do.

A common answer is

Maximize profit

but this can be viewed in many ways. eg.

maximize profit per pile

maximize profit per metre installed

maximize profit per m. purchased

maximize profit on the project

and these may not all be coincident.

Minimax Loss / Maximin Gain Criterion

For strategy i, there will be some SOW j for which the payoff U(i,j) is as small as
or smaller than that of all the other SOWs.

Pessimistically we can value strategy i by the value of this worst outcome.

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UNIVERSITY OF NOTTINGHAM Construction Management Processes
DEPARTMENT OF CIVIL ENGINEERING Decision Theory

U(i) = min (U(i,j))

Rationally we can now choose the strategy with the best worst outcome.

• the Maximum Minimum gain

• the Minimum Maximum loss

In the pile example:

U(1) = U(2) = U(3) =

Therefore the best worst is from strategy 1 and we will choose to order 20m
piles.

Minimin Loss / Maximax Gain Criterion

For strategy i, there will be some SOW j for which the payoff U(i,j) is as large as
or larger than that of all the other SOWs.

Optimistically we can value strategy i by the value of this best outcome.

U(i) = max (U(i,j))

Rationally (??) we can now choose the strategy with the best best outcome.

• the Maximum Maximum gain

• the Minimum Minimum loss

In the pile example:

U(1) = U(2) = U(3) =

Therefore the best best is from strategy and we will choose to order m piles.

Hurwitz Optimism Criterion

This seeks to give some weight to the best outcome for a strategy as well as a
the worst one in order to give a more ‘balanced’ view of the strategy value.

Define U(i) = max (U(i,j))

Then, the Hurwitz value of the strategy is given by

U (i) = m U(i) + (1-m)U(i) with 0<=m<=1

where we can set m to suit our level of optimism or conversely, we can see what
level of optimism a decision implies.

U (1) = 4m + 2(1-m) =2m+2

U (2) = 5m + 1.5(1-m) =3.5m+1.5

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UNIVERSITY OF NOTTINGHAM Construction Management Processes
DEPARTMENT OF CIVIL ENGINEERING Decision Theory

U (3) = 6m - 1(1-m) =7m-1

It can be seen that the Hurwitz value alters linearly with the measure of optimism
and a simple way of plotting the graph can be developed from this.

Draw a vertical axis line at either end of the optimism line. The one on the left
represents utter pessimism and the other complete optimism.

For each strategy in turn, plot the worst possible outcome on the pessimistic
‘axis’ and the best on the ‘optimistic’ axis.

Join these two points with a straight line.

Minimax Regret Criterion

People often review decisions with perfect hindsight and full knowledge of what
SOW did in fact occur. (Or at least they like to think that they do).

The wrong strategy is sometimes employed for the particular SOW which existed.
In this case we can make some attempt to measure the regret which we
incurred by our choice of strategy.

This is most easily done in terms of the difference between the outcome of
strategy i in SOW j (the one we chose ) and the outcome of strategy k with SOW
j ( where strategy k is that strategy which would give the best outcome for
SOW j ).

Thus using R to denote regret,

R(i,j) = max ( U(k,j) ) - U(i,j)

This can be calculated for every combination of strategy and SOW and the result
is the regret equivalent of the payoff matrix.

The sensible decision is then to choose the strategy with the Minimax regret. i.e.
the strategy which gives the minimum maximum regret or that which is the Best
Worst option.

In the example of the choice of pile lengths, the regret matrix would be:

and the consequent best choice of strategy would be:

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UNIVERSITY OF NOTTINGHAM Construction Management Processes
DEPARTMENT OF CIVIL ENGINEERING Decision Theory

Expectation Measures

The criteria so far described are likely to be unduly affected by extreme and
unlikely states of the world and may therefore perhaps not give sensible answers
in all situations.

Such problems can be reduced by using ‘Maximum Expected Utility’ as a criterion.

This helps to exclude unlikely events by incorporating subjective probabilities
(beliefs) about the probabilities of occurrence of the possible SOWs.

These are used to value the strategies in terms of their long term average
performance if the same decision were to be made many times, independently.
This is done in spite of the fact that the decision is, in reality, usually only made
once and is rarely made a large number of times.

In the piling example, say that the probabilities of the depth of set of the piles
are believed to be:

Prob of depth of set being 20m ( p(20) ) = 0.05

Prob of depth of set being 25m ( p(25) ) = 0.90

Prob of depth of set being 30m ( p(30) ) = 0.05

The Expected Utility of strategy i ( E(i) ) is given by

E(i) = ∑ U(i) . p(j)

This gives

E(1) = 0.05*4 + 0.90*2 + 0.05*3 = 2.15

E(2) = 0.05*1.5 + 0.90*5 + 0.05*3 = 4.725

E(3) = 0.05*(-1) + 0.90*2.5 + 0.05*6 = 2.5

and we would choose strategy 2 and order 25m long piles.

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UNIVERSITY OF NOTTINGHAM Construction Management Processes
DEPARTMENT OF CIVIL ENGINEERING Decision Theory

UTILITY

People tend to react to small gains and losses of similar size with changes in
feeling of ‘well being’ which are about equal in size but of opposite sign.

People tend to be more moved to disgust for large losses than they are moved to
elation by gains of equal size.

Utility measures try to use these subjective reactions to get a more satisfactory
of an outcome and a strategy.

These are useful in transforming money values and complex non-financial

outcomes.

Basic Tools for Utility Measurement

• Principle of Indifference
When a decision-maker cannot choose between two courses of action he is
said to be indifferent between them and they are of equal value in the
current value system.

• Standard Gamble
A gamble with only win or lose outcomes, known prizes and probability of
winning can be altered at will.

We have to evaluate the utility for a particular decision-maker for the outcomes
assessed for a particular problem.

Method

1. The decision-maker chooses the best and worst outcomes and values the best
at 100 and the worst at 0.

2. Take the best and worse outcomes and construct a standard gamble with
these as win and lose prizes.

3. Take each outcome in turn and adjust the win/lose probabilities until the
decision-maker is indifferent between the outcome and the gamble.

4. If the ‘win’ indifference probability is p(n) for outcome n then the utility (u) of
outcome n is given by

u(n) = p(n)*u(best) + (i-p(n))*u(worst)

= 100p(n)

5. Repeat the process for all outcomes.

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