Professional Documents
Culture Documents
Decision
Analysis
To accompany
Quantitative Analysis for Management, Twelfth Edition,
by Render, Stair, Hanna and Hale
Power Point slides created by Jeff Heyl Copyright ©2015 Pearson Education, Inc.
LEARNING OBJECTIVES
After completing this chapter, students will be able to:
1. List the steps of the decision-making process.
2. Describe the types of decision-making environments.
3. Make decisions under uncertainty.
4. Use probability values to make decisions under risk.
5. Develop accurate and useful decision trees.
6. Understand the importance and use of utility theory in
decision making.
STATE OF NATURE
FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($)
Construct a large plant 200,000 –180,000
Do nothing 0 0
1. Maximax (optimistic)
2. Maximin (pessimistic) (Wald)
3. Criterion of realism (Hurwicz)
4. Equally likely (Laplace)
5. Minimax regret (Savage)
STATE OF NATURE
FAVORABLE UNFAVORABLE MAXIMUM IN
ALTERNATIVE MARKET ($) MARKET ($) A ROW ($)
Construct a large plant 200,000 –180,000 200,000
Construct a small plant 100,000 –20,000 100,000
Maximax
Do nothing 0 0 0
STATE OF NATURE
Do nothing 0 0 0
STATE OF NATURE
FAVORABLE UNFAVORABLE ROW
ALTERNATIVE MARKET ($) MARKET ($) AVERAGE ($)
Construct a large plant 200,000 –180,000 10,000
STATE OF NATURE
FAVORABLE UNFAVORABLE
MARKET MARKET
($) ($)
200,000 – 0 0–0
STATE OF NATURE
FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($)
Construct a large plant 0 180,000
Do nothing 200,000 0
STATE OF NATURE
FAVORABLE UNFAVORABLE MAXIMUM IN
ALTERNATIVE MARKET ($) MARKET ($) A ROW ($)
Construct a large 0 180,000 180,000
plant
Construct a small
plant 100,000 20,000 100,000
Minimax
Do nothing 200,000 0 200,000
where
Xi = payoff for the alternative in state of nature i
P(Xi) = probability of achieving payoff Xi (i.e., probability of state of nature i)
∑ = summation symbol
Do nothing 0 0 0
STATE OF NATURE
FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($) EMV ($)
Do nothing 0 0 0
With perfect 200,000 0 100,000
information
EVwPI
Probabilities 0.5 0.5
STATE OF NATURE
FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($) EOL
Construct a large plant 0 180,000 90,000
Construct a small plant 100,000 20,000 60,000
Do nothing 200,000 0 100,000
Probabilities 0.5 0.5
Best EOL
EMV Values
$300,000
–$200,000
EMV Values
Construct a large plant Greater than 0.615
$300,000
Point 1
$100,000 EMV (small plant)
.167 .615 1
–$100,000 Values of P
–$200,000
USAGE PROBABILITY
10,000 0.40
20,000 0.30
30,000 0.30
Favorable Market
A Decision Node
1
Unfavorable Market
uct nt
s tr la
on eP
C rg
La Favorable Market
Construct
2
Small Plant Unfavorable Market
Do
No
th
ing
$0
Copyright ©2015 Pearson Education, Inc. 3 – 48
Thompson’s Complex
FIGURE 3.4 Decision Tree
First Decision Second Decision Payoffs
Point Point
Favorable Market (0.78)
$190,000
lant 2 Unfavorable Market (0.22)
g eP –$190,000
Lar Favorable Market (0.78)
$90,000
) Small
. 45 Plant 3 Unfavorable Market (0.22)
0 –$30,000
e y ( ts e
urv sul abl No Plant
–$10,000
S Re vor
a
1 Surv F Favorable Market (0.27)
e $190,000
Re y (0
ey
Ne su .5 –$190,000
ur
5) ge
ga lts Lar
tS
Plant –$30,000
M
ct
No Plant
du
–$10,000
n
Co
$106,400
g
Lar $63,600 Favorable Market (0.78)
$90,000
) Small
. 45 Plant 3 Unfavorable Market (0.22)
0 –$30,000
e y ( ts e
urv sul abl No Plant
–$10,000
S Re vor
a
1 Surv F –$87,400 Favorable Market (0.27)
e $190,000
Re y (0
ey
Ne su .5 –$190,000
ur
5) ge
ga lts Lar $2,400
tS
Plant –$30,000
M
ct
No Plant
du
–$10,000
n
Co
$49,200
• For Thompson
$2,000,000
Accept
Offer
$0
Heads
Reject (0.5)
Offer
Tails
(0.5)
EMV = $2,500,000
$5,000,000
(p)
Best Outcome
Utility = 1
1 (1 – p) Worst Outcome
tive Utility = 0
erna
Alt
Alt
e rna
tive
2
Other Outcome
Utility = ?
(1 – p) = 0.20 $0
s t in e U($0.00) = 0.0
e t
Inv Esta
e al
R
Inv
es
t in
Ba
nk
$5,000
U($5,000) = p = 0.80
U ($10,000) = 1.0
1.0 –
U ($7,000) = 0.90
0.9 –
U ($5,000) = 0.80
0.8 –
0.7 –
0.6 –
U ($3,000) = 0.50
Utility
0.5 –
0.4 –
0.3 –
0.2 –
0.1 – U ($0) = 0
| | | | | | | | | | |
$0 $1,000 $3,000 $5,000 $7,000 $10,000
Monetary Value
Copyright ©2015 Pearson Education, Inc. 3 – 66
Utility Curve
• Typical of a risk avoider
– Less utility from greater risk
– Avoids situations where high losses might occur
– As monetary value increases, utility curve
increases at a slower rate
• A risk seeker gets more utility from greater
risk
– As monetary value increases, the utility curve
increases at a faster rate
• Risk indifferent gives a linear utility curve
Risk
Avoider
ce n
re
Utility
ffe
di
In
k
is
R
Risk
Seeker
Monetary Outcome
Copyright ©2015 Pearson Education, Inc. 3 – 68
Utility as a
Decision-Making Criteria
• Once a utility curve has been developed it can
be used in making decisions
• Replaces monetary outcomes with utility
values
• Expected utility is computed instead of the
EMV
Tack Lands
1 a me Point Down (0.55)
ti ve the G –$10,000
t erna lays
Al rk P
Ma
Al t
ern
at i
ve
2
U($0) = 0.15
U($10,000) = 0.30 0.75 –
Utility 0.50 –
0.30 –
0.25 –
0.15 –
0.05 –
0 –| | | | |
FIGURE 3.12 –$20,000 –$10,000 $0 $10,000 $20,000
Monetary Outcome
Copyright ©2015 Pearson Education, Inc. 3 – 72
Utility as a
Decision-Making Criteria
Step 2 – Replace monetary values with utility
values
E(alternative 1: play the game) = (0.45)(0.30) + (0.55)(0.05)
= 0.135 + 0.027 = 0.162
E(alternative 2: don’t play the game) = 0.15
e Tack Lands
a m Point Down (0.55)
ti v e1 eG 0.05
na s th
er y
Alt rk Pla
Ma
Al t
ern
ati
ve
2
Don’t Play
0.15