Decision

theory
Theory
Decision
theory
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EMERGENCY
MEETING
 Topics
Decision Theory Decision Making
under Uncertainty

Decision Theory Four criteria used for

Decision Making under
Elements Uncertainty

Decision
Environments

Decision Making
under Certainty
Decision Theory
- Making decisions in uncertain situations is the focus of the mathematics and
philosophy study of decision theory. It helps to determine which option is optimal
based on the facts at available and the expected outcomes in a particular situation.
Several disciplines, including economics, finance, psychology, and engineering,
Involved decision theory..

- Decision Theory is a set of concepts, principles, tools and techniques that aid
the decision maker in dealing with complex decision problems under certainty

- A general approach to decision-making when the results associated with

alternatives are often unclear is Decision theory. Because decisions about process,
capacity, location, and inventory involve an uncertain future, it helps operations
managers to make these decisions.
Decision Theory Elements

A list of
ALTERNATIVES for the
manager to choose
from
A known PAYOFF for
each alternative

A set of possible
FUTURE conditions
Decision Theory Environment
Operations management decision environments are classified according to the degree of certainty
present. There are three basic categories:

1. Certainty means that relevant parameters such as costs, capacity, and demand
have known values.
2. Uncertainty is an environment where the set of alternative managerial actions is
known, but absolutely no information is available regarding the possible outcomes
of each action.
3. Risk means that certain parameters have probabilistic outcomes, An environment
where the set of alternative managerial actions is known, but where the outcome of
each action can be estimated only in terms of a probability distribution.
 Decision Making under
HEADER
EXAMPLE Certainty
- The decision is usually relatively straight
forward.

- Simply choose the alternative that has the

best payoff under that state of nature..

Example:

Determine the best alternative in the preceding payoff table for

each of the cases: It is known with certainty that demand will be:
(a) low, (b) moderate, (c) high.
28
 Decision-Making under Uncertainty

At the opposite extreme is complete uncertainty:

no information is available on how likely the
various states of nature are.

Under those conditions, four possible decision

criteria are:
a) Maximin,
b) Maximax,
c) Laplace, and
d) Minimax regret.
 A) Maximin Pessimistic
HEADER EXAMPLE Decision
The maximin approach is a pessimistic one,
because it takes into account only the worst
Since 15 is the maximum, Then possible outcome for each alternative.
choose to build the small facility
- First, determines the worst possible payoff for
each alternative.

- Then, select the maximum of these minimum

facility
15 payoffs “best worst”.

- The actual outcome may not be as bad as

that,
but this approach establishes a “guaranteed
minimum”.
B) Maximax Optimistic Decision
HEADER EXAMPLE
Since 25 is the maximum, then
choose to build the large facility
25
- The maximax approach is optimistic decision, “go
for it ” strategy. It selects the decision that results in
the maximum of the maximum payoffs.
- Decision maker assumes that the most favorable
state of nature for each decision alternative will
occur.
- If the payoff table was in terms of profits, the
decision with the highest profit would be chosen.
- If the payoff table was in terms of costs, the
decision with the lowest cost would be chosen.
 C) Laplace
HEADER EXAMPLE
- Assumes that all states of nature are equally likely
to occur.

Since 15.33 is the highest - Calculate the average payoff for each alternative
average, then choose to build the and select the alternative with the maximum
medium facility number.

- Average payoff: the sum of all payoffs divided by

the number of states of nature.

- Select the decision that gives the highest average

payoff.
15.33
6+20+20 = 26

26/3 = 15.3333
 D) Minimax Regret
- This approach seeks to make the decision on the least regret for making that
choice.

- Regret is the amount of loss due to making an incorrect decision (opportunity

cost)

1) Choose the alternative with the best payoff.

2) Establish the difference between the payoff that is given and the best payoff for
each state of nature.

3) Choose the alternative that minimizes the maximum regret associated with each
alternative by determining the maximum regret for each alternative.

4) Pick the alternative with the minimum number (lowest regret).

Minimax Regret Example
 Four criteria used for Decision
Making under Uncertainty

Maximin (Pessimistic Decision)

- Choose the alternative with the best of the worst possible payoffs.

Maximax (Optimistic Decision)

- Choose the alternative with the best possible payoff

Laplace
- Choose the alternative with the best average payoff of any of the alternatives.

Minimax regret
- Choose the alternative that has the least of the worst regrets.
 Conclusion

Decision theory is a helpful tool for making decisions in difficult

situations. considering all possible outcomes, costs, and benefits
associated with them. The best course of action could be defined.
Decision theory serves as a helpful tool for making decisions in a
variety of situations and is important for doing so systematically and
rationally.
summary
The topic of the mathematics and philosophy study
of decision theory is making decisions in uncertain
situations. Based on the facts which are already
known and the results that are envisioned in a
particular context, it helps to decide which option is
best. Decision theory was used in a variety of areas,
including economics, finance, psychology, and
engineering.
References
•https://plato.stanford.edu/entries/decision-theory/
•
https://corporatefinanceinstitute.com/resources/capital-markets/decision-the
ory/
•
https://www.oreilly.com/library/view/operations-management-processe
s/9780134741062/xhtml/fileP7001014064000000000000000000FD6.
xhtml#:~:text=Decision%20theory%20is%20a%20general,are%20abo
ut%20an%20uncertain%20future
.•
https://www.siue.edu/~evailat/decision.htm#:~:text=to%20decision%2
0theory-,There%20are%204%20basic%20elements%20in%20decision
%20theory%3A%20acts,events%2C%20outcomes%2C%20and%20pa
yoffs
.
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