Decision Modeling &

Analysis
This chapter will covers:

• 5.1 Problem Definition

• 5.2 Scope and Structure
• 5.3 Structuring Tools and Decision
• 5.4 Decision Model
• 5.5 Types of Probability
• 5.6 Forecasting Probability Technique
Defining the Problem & Its Structure

• Problem Definition
• Problem Scope
• Resources, time & cognitive limitation
• Problem Structure
• Choices, Uncertainties, Objectives
• Structuring Tools
• Decision analysis of a few alternatives using
Influence diagrams, AHP or decision trees
 Problem definition and structuring
 Structuring a decision problem by
representing the inter-relationships Define
problems

among problem elements in an

influence diagram or the
structure of a decision problem Choices Dec

represented by a decision tree or

Analytic Hierarchy Process
(AHP)
Uncertainty
events
Defining the problem and its
structure

Current state of affairs

Desired state of affairs

Statement of central objectives to

distinguish between two.
A Glass Factory

A glass factory specializing in crystal is

experiencing a substantial backlog, and the
firm's management is considering three courses
of action:

A) Arrange for subcontracting

B) Construct new facilities
C) Do nothing (no change)
A Bakery Company

 Baiduri Bakery wondered why it cost more to produce breads at

their main production plant than at any of their facilities.
 Is the plant poorly managed?
 Are employee relations weak?
 Is the equipment out of date?
 They proposed studying the problem for a duration of time.
 They should suggest the most appropriate types of solutions.
Continue..

• If the problem is high production costs, there

are several alternatives can be suggested:

• Modernizing the facilities,

• Market the product to users directly who
are willing to pay more,
• Closing the plant,
 Problem scope

• The problem may be worth solving but beyond the available

resources or time constraints.
• The scope must be reduced to a focus that allows a solution.
• Identify its breadth by asking people involved, cost and
magnitude.
Problem structure
• Design the problem structure :
• What is the final appearance,
• What are the elemental details,
• What are the relationships between those elements.

• Regardless of context, a problem structure can be described

in the of choices, uncertainties and objectives.

• Difference between choices and uncertainties is the

probability of occurrence.
• There is 100% probability of at least one alternative
being selected and there is an equal probability particular
one being selected.
Step to structuring a Decision Problem

1. Create three lists: decision, uncertain events, objectives,

2. Sort lists in decreasing order of importance,
3. Create initial influence diagram or decision tree : decisions
(objectives)
 4. Add element one at a time until initial lists are exhausted,
5. Evaluate the overall structure and revise if necessary,

Uncertain
decision objectives
events
Structuring Decision Problem
• Decision problems include three types of elements: decisions,
uncertain events and objectives.
• Decisions (Objectives)
• A choice between two or more alternatives.
• Uncertain events
• A situation outside the control of the decision maker that
could result in two or more possible outcomes
• Alternatives (Choices)
• A criterion for evaluating the desirability of a situation.
 INFLUENCE DIAGRAMS

Graphical representations of a model

for visual communication

Rectangle = a decision variable (objectives)

Circle = uncontrollable or intermediate variable (criteria)

Oval = result (outcome) variable: intermediate or final (alternatives)

Variables are connected with arrows  indicates the direction of influence

(relationship)
Influence Diagram
A simple method of graphing the components of a
decision and linking them to show the relationship
between them.

Uncertain
Event

When properly constructed, it has

no cycles.
•The arrow forms a one-way path,
• there is no backward path to the
starting point Decision
Outcome C
 Influence Diagrams

Decisions
• is a choice between two or more alternatives

Alternative A
Outcome A

Alternative B Outcome B
Decision

Outcome C
Alternative C
Influence Diagrams

Uncertain Events
 is a situation outside the control of the decision maker that
could result either two or more possible outcomes.

Price A
sales
Uncertain
Price B
event
Price C
Influence Diagrams: Example

An influence diagram for the profit model

Unit Price

~ Income
Amount used in
Advertisement Units Sold
Profit

Unit Cost Expenses

Profit = Income – Expense

Income = UnitsSold * UnitPrice
UnitsSold = 0.5 * Advertisement Expense Fixed Cost
Expenses = UnitsCost * UnitSold + FixedCost
Quiz 1:

Draw the influence diagram for this situation

1. In the situation that you are about to buy a house.

2. Ramlah is planning to pursue her degree in UTHM. She has to

decide which courses to apply to.
Analytica: The Price Submodel
Analytica: The Sales Submodel
Influence Diagrams: Software

• Analytica, Lumina Decision Systems

• Supports hierarchical (multi-level) diagrams
• DecisionPro, Vanguard Software Co.
• Supports hierarchical (tree structured) diagrams
• DATA Decision Analysis, TreeAge Software
• Includes influence diagrams, decision trees and simulation
• Definitive Scenario, Definitive Software
• Integrates influence diagrams and Excel, also supports Monte
Carlo simulations
• PrecisionTree, Palisade Co.
• Creates influence diagrams and decision trees directly in an
Excel spreadsheet
Buying a Car
Using Decision Trees

• Can be used as visual aids to structure and solve sequential

decision problems
• Especially beneficial when the complexity of the problem grows
Decision Trees

• Three types of “nodes”

• Decision nodes - represented by squares (□)
• Chance nodes - represented by circles (Ο)
• Terminal nodes - represented by triangles (optional)
• Solving the tree involves pruning all but the best
decisions at decision nodes, and finding expected
values of all possible states of nature at chance nodes
• Create the tree from left to right
• Solve the tree from right to left
Example Decision Tree

Chance
node Event 1
Decision
ion 1 Event 2
node Decis
Event 3
Dec
is ion 2
Buying second-hand Car
Structuring Tools

Decision Tree
 Another diagram that models choices and uncertainties and can
be extended to include multiple and sequential decisions.

In this diagram, only choices and

uncertainties are modeled.
• the components are connected by
lines referred as branches, Price A
•The branches extending from a
choice node represent the item Price B
contained in a choice available to the
decision maker.

Price C
Decision Analysis: A Few Alternatives

Single Goal Situations

variables

• Decision trees
• Graphical representation of
relationships
• Multiple criteria approach
• Demonstrates complex
relationships
• Cumbersome, if many
alternatives exists
Decision Analysis: A Few Alternatives

Single Goal Situations

Decision tables
 Multiple criteria decision
analysis
 Features include decision
variables (alternatives),
uncontrollable variables,
result variables
Decision Tables

 Investment example

 One goal: maximize the yield after one year

 Yield depends on the status of the economy

(the state of nature)
 Solid growth
 Stagnation
 Inflation
Investment Example:
Possible Situations

1. If solid growth in the economy, bonds yield 12%; stocks

15%; time deposits 6.5%

2. If stagnation, bonds yield 6%; stocks 3%; time deposits

6.5%

3. If inflation, bonds yield 3%; stocks lose 2%; time deposits

yield 6.5%
Investment Example:
Decision Table

 Payoff Decision variables (alternatives)

 Uncontrollable variables (states of economy)
 Result variables (projected yield)

 Tabular representation:
Canned Food from the pineapple harvest are currently being
processed at XYZ Sdn Bhd. The manager has found a case of
cans that have not been properly sealed. There are three lines
that processed cans of this type and the manager wants to
know which line is most likely to be responsible for this
mistake.
Assume the manager has the information as follow:

Line Contribution to Proportion

Total Defective
1 0.40 0.05
2 0.35 0.10
3 0.25 0.07

P(Line2/Defective)=(0.4*0.05)/0.0725 = 0.4828
Example 1: Jenny Lind

Jenny Lind is a writer of romance novels. A movie

company and a TV network both want exclusive rights
to one of her more popular works. If she signs with
the network, she will receive a single lump sum, but if
she signs with the movie company, the amount she will
receive depends on the market response to her movie.

What should she do?

#1
Payouts and Probabilities

• Movie company Payouts

• Small box office - $200,000
• Medium box office - $1,000,000
• Large box office - $3,000,000
• TV Network Payout
• Flat rate - $900,000
• Probabilities
• P(Small Box Office) = 0.3
• P(Medium Box Office) = 0.6
• P(Large Box Office) = 0.1

#2
Jenny Lind - Payoff Table

States of Nature
Small Box Medium Large Box
Decisions Office Box Office Office
Sign with
Movie $200,000 $1,000,000 $3,000,000
Company
Sign with TV
$900,000 $900,000 $900,000
Network
Prior
0.3 0.6 0.1
Probabilities

#3
Jenny Lind - How to Decide?

•What would be her decision based on:

• Maximax ?
• Maximin?
• Expected Return?

#5
Using Expected Return Criteria

EVmovie=0.3(200,000)+0.6(1,000,000)+0.1(3,000,000)
= $960,000 ( EVBest)
EVtv =0.3(900,000)+0.6(900,000)+0.1(900,000)
= $900,000
Therefore, using this criteria, Jenny should select the
movie contract.
Assumption

Jenny’s decision is only going to be made one time, and

she will earn either $200,000, $1,000,000 or $3,000,000
if she signs the movie contract, not the calculated EV of
$960,000!!

Nevertheless, this amount is useful for decision-making,

as it will maximize Jenny’s expected returns in the long
run if she continues to use this approach.

#3
 Expected Value of Perfect
Information (EVPI)

What is the most that Jenny should be

willing to pay to learn what the size of the
box office will be before she decides with
whom to sign?

#1
 EVPI Calculation

EVwPI (or EVc)

=0.3(900,000)+0.6(1,000,000)+0.1(3,000,000) = $1,170,000
EVBest (calculated to be EVMovie from the previous page)
=0.3(200,000)+0.6(1,000,000)+0.1(3,000,000) = $960,000
EVPI = $1,170,000 - $960,000 = $210,000

Therefore, Jenny would be willing to spend up to $210,000 to learn

additional information before making a decision.
Jenny Lind Decision Tree

Small Box Office

$200,000

Sign with Movie Co. Medium Box Office

$1,000,000

Large Box Office

$3,000,000

Small Box Office

$900,000

Sign with TV Network Medium Box Office

$900,000

Large Box Office

$900,000
Jenny Lind Decision Tree

Small Box Office

ER .3 $200,000
?
Sign with Movie Co. .6 Medium Box Office
$1,000,000
ER .1
? Large Box Office
$3,000,000

Small Box Office

ER .3 $900,000
?
Sign with TV Network .6 Medium Box Office
$900,000
.1
Large Box Office
$900,000
Jenny Lind Decision Tree - Solved

Small Box Office

ER .3 $200,000
960,000
Sign with Movie Co. .6 Medium Box Office
$1,000,000
ER .1
960,000 Large Box Office
$3,000,000

Small Box Office

ER .3 $900,000
900,000
Sign with TV Network .6 Medium Box Office
$900,000
.1
Large Box Office
$900,000
Example 2: Air Line Company

• Eagle Airlines has expansion plan. Currently 50% of flights are

scheduled and 50% are chartered.
• A new seneca airplane costs 85000-90000USD.
• It has seats for 5 passenger. Operating cot is 245 per hour. Annual
fixed cost is 20000 including insurances and finance charges.
• The company needs to borrow 40% of the money with 9.5%
interest rate.
• The company may be able to charge 300-350$ per hour for charter
or 100$ per person for scheduled flights. Scheduled flights on
average is half full. Company hops that the airplane fly 1000 hour
per year but 800 is more realistic.
• Other options:
• Invest in Bank with 8%
• Rent airplane with 2500-4000$

#1
Modeling the problem

• Alternatives:
• Purchasing the airplane
• Renting the airplane
• Investing in a bank
• Objectives?
• Company Growth, Greater influence in the community,
Maximizing Profit
• If the probability of various unknown such as
operating cost, amount of business ,etc is known then
an decision tree or influence diagram can be used to
structure the problem.

#2
 Initial influence diagram

Inputs

Inputs
Inputs

Intermediate
Consequence node
calculations
#3
 Variables

The base Value: Initial Guess regarding the variables

Lower and Upper Bound: Absolute extremes ( variables can not fall beyond)

#4
One Way Sensitivity Analysis

• What variables really make a difference in terms of the decision in

hand?
• Do different interest rates really matter?
• Does it matter that company can set the ticket price?
• Now that the problem is simplified, we can include
consideration about interdependencies of the chance
variables

#4
One way Sensitivity graph for hours flown

The fact that the company believes that the hours flown could be
above or below 664 suggests that this is a crucial variable.
#5
 Conclusion…..

• Describe the problem definition

• Understand the scope and structure of the problem
• Apply the decision model to problem structure
• Construct influence diagram and decision tree for structuring
problem.
 Thank you
for
your attention