DECISION MODELING

Chapter 1
Introduction to Modelling
Copyright 2001 Prentice Hall

INTRODUCTION TO MODELING
Modeling Approach to Decision Making:
Involves spreadsheet based management models
Uses spreadsheet software such as Excel This approach is easy for managers to use, Results in better management decisions, Provides important insights into problem.

THE MODELING PROCESS

Managerial Approach to Decision Making
Manager analyzes situation (alternatives) Makes decision to resolve conflict Decisions are implemented Consequences of decision
These steps Use Spreadsheet Modeling

THE MODELING PROCESS

The Role of Managerial Judgment in the Modeling Process:
Analysis

Model
Symbolic World Real World

Results

Managerial Judgment

Management Situation

Decisions
Intuition

Interpretation

Abstraction

THE MODELING PROCESS

Decision Support Models force you to
1. be explicit about your objectives. 2. identify and record the types of decisions that influence 3. 4. 5. 6. 7.

those objectives. identify and record interactions and trade-offs among those decisions. think carefully about which variables to include. consider what data are pertinent and their interactions. recognize constraints or limitations on the values. Models allow communication of your ideas and understanding to facilitate teamwork.

Models allow us to use the analytical power of spreadsheets hand in hand with the data storage and computational speed of computers.

TYPES OF MODELS
Physical Model
Characteristics
Tangible Easy to Comprehend Difficult to Duplicate and Share Difficult to Modify and Manipulate Lowest Scope of Use

Examples
Model Airplane
Model House Model City

TYPES OF MODELS
(A set of relationships through a different, but analogous, medium.)

Analog Model

Characteristics
Intangible Harder to Comprehend Easier to Duplicate and Share Easier to Modify and Manipulate Wider Scope of Use

Examples
Road Map Speedometer Pie Chart

TYPES OF MODELS
Symbolic Model Characteristics
Intangible Hardest to Comprehend Easiest to Duplicate and Share Easiest to Modify and Manipulate Widest Scope of Use (Relationships are represented mathematically.)

Examples
Simulation Model Algebraic Model Spreadsheet Model

MORE ON MODELS
A model is a carefully selected abstraction of reality. Symbolic models
1. always simplify reality. 2. incorporate enough detail so that the result meets your needs, it is consistent with the data you have available, it can be quickly analyzed.

Decision models are symbolic models in which some of the variables represent decisions that must or could be made. Decision variables are variables whose values you can control, change or set.

MORE ON DECISION MODELS

Decision models typically include an explicit performance measure that gauges the attainment of that objective.

For example, the objective may be to maximize profit or minimize cost in relation to a performance measure (such as sales revenue, interest income, etc).
In summary, decision models

1. selectively describe the managerial situation.

2. designate decision variables. 3. designate performance measure(s) that reflect objective(s).

BUILDING MODELS
To model a situation, you first have to frame it (i.e., develop an organized way of thinking about the situation).

A problem statement involves possible decisions and a method for measuring their effectiveness.
Steps in modeling:
1. Study the Environment to Frame the Managerial Situation 2. Formulate a selective representation 3. Construct a symbolic (quantitative) model

BUILDING MODELS
1. Studying the Environment
Select those aspects of reality relevant to the situation at hand.

2. Formulation
Specific assumptions and simplifications are made. Decisions and objectives must be explicitly identified and defined. Identify the models major conceptual ingredients using Black Box approach.

BUILDING MODELS
3. Model Construction
The next step is to construct a symbolic model.

Mathematical relationships are developed. Graphing the variables may help define the relationship.
Var. Y

Var. X

To do this, use Modeling with Data technique.

MODELING WITH DATA

Consider the following data. Graphs are created to view any relationship(s) between the variables. This is the first step in formulating the equations in the model.

CLASSIFICATIONS OF MODELS
Decision making models are classified by the business function they address or by the discipline or industry involved. Classification
Business Function

Examples
Finance, Marketing, Cost Accounting, Operations

Discipline
Industry Time Frame Mathematics Representation Uncertainty

Science, Engineering, Economics

Military, Transportation, Telecommunications, Non-Profit One Time Period, Multiple Time Periods Linear Equations, Non-Linear Equations Spreadsheet, Custom Software, Paper and Pencil Deterministic, Probabilistic

Organizational Level Strategic, Tactical, Operational

DETERMINISTIC AND PROBABILISTIC MODELS

Deterministic Models
are models in which all relevant data are assumed to be known with certainty. can handle complex situations with many decisions and constraints. are very useful when there are few uncontrolled model inputs that are uncertain. are useful for a variety of management problems. are easy to incorporate constraints on variables. software is available to optimize constrained models. allows for managerial interpretation of results. constrained optimization provides useful way to frame situations. will help develop your ability to formulate models in general.

DETERMINISTIC AND PROBABILISTIC MODELS

Probabilistic (Stochastic) Models
are models in which some inputs to the model are not known with certainty. uncertainty is incorporated via probabilities on these random variables. very useful when there are only a few uncertain model inputs and few or no constraints. often used for strategic decision making involving an organizations relationship to its environment.

MODELING AND REAL WORLD DECISION MAKING

Four Stages of applying modeling to real world decision making:
Stage 1: Study the environment, formulate the model and construct the model. Stage 2: Analyze the model to generate results. Stage 3: Interpret and validate model results. Stage 4: Implement validated knowledge.

MODELING AND REAL WORLD DECISION MAKING

Management Modeling Term Lingo
Decision Variable Parameter Consequence Variable Lever Gauge Outcome

Formal Definition
Controllable Exogenous Input Quantity

Example
Investment Amount

Uncontrollable Exogenous Interest Rate Input Quantity Endogenous Output Variable Commissions Paid

Performance Measure

Yardstick

Endogenous Variable Used for Evaluation (Objective Function Value)

Return on Investment