•BU275: Business

Decision Models –
Lecture WK5-1

• Instructor – Dr Qiang
Li
Winter 2024
February 5/6,
2024
Midterm
Exam
Review
Review for the Midterm

• Review several points

• Practice problems
Topics Studied

• Decision under
uncertainty
• Decision under risk
• Decision tree
• Utility
• Queueing
Generate a Payoff Table
The probability distribution of weekday newspaper sales
from the vending box at the corner of a street are as follows:
Papers sold 15 20 25

Probability 0.2 0.3 0.5

• On each paper sold, the retailer makes a gain of $0.40;

• On each paper not sold, the retailer makes a loss of $0.20;
• On each lost sale, the retailer makes a loss of $0.05.
Papers in Papers sold
the box 15 20 25

15 (0.40)(15)=6 (0.40)(15)-(0.05)(20-15)=5.75
20 (0.40)(15)(0.20)(20-15)=5
25
Over stock Out of stock
Decision Making under Uncertainty

Four different decision-making

criteria:
1) Maximax (or optimistic approach,
minimin)

2) Maximin (or conservative approach,

minimax)

3) Equally likely (or Laplace approach)

Profit or Cost?

Maximax (Extreme
Optimistic)
Profit High Moderate Low Maximum
Large plant $200,000 $100,000 -$120,000 $200,000

Small plant $90,000 $50,000 -$20,000 $90,000
No $0 $0 $0 $0

Cost State of nature 1 State of nature 2 Minimum

Alternative A $600 $200 $200
Alternative B $100 $700 $100

Dominated Alternative?

Which city T&T superstore should open a store

in?
Alternatives High demand Low demand Alternatives High demand Low demand
(p1=?) (p2=?) (p1=?) (p2=?)

Halifax $30,000 -$15,000 Halifax $30,000 -$15,000

Waterloo $40,000 -$10,000 Waterloo $40,000 -$15,000

Charlottetown $6,000 -$3,000 Charlottetown $6,000 -$3,000

Waterloo Waterloo absolutely Waterloo Waterloo does not absolutely

dominates Halifax dominates Halifax dominates Halifax dominates Halifax
Two Ways to Get EVPI

EVPI = Expected value with perfect information –

max{EMV}
EVPI = Lowest EOL

EVSI=EMV of best decision with sample

information assuming no cost to get it –
max{EMV}
Need Bayesian Updating?

About applying decision tree to solve problems,

some problems may directly tell you the probabilities,
and you do not need to update probabilities.

According to historical data, when

the demand was high, the company
Need to update
correctly forecasted with probability
80%; when the demand was low, the
company correctly forecasted with
probability 90%.

The company will forecast high

demand with probability 60%... Not need to
update
Bayesian Updating (Bayes’ Theorem)

The formula to compute posterior probability is

known as Bayes’ theorem
Theory of Bayes Updating

• Prior to obtaining information, probability estimates

for the states of nature, i.e., P(states of nature), are
called prior probabilities e.g., P (demand is high) ;
P(demand is low)
• With knowledge of conditional probabilities for
indicators based on the sample/survey information
given state of natures, e.g., P(Forecast was high | demand is
high); P(Forecast was low| demand is high)
• Prior probabilities can be revised by Bayes' Theorem
• After revised, the obtained probabilities are called
posterior probabilities e.g., P(demand is high | Forecast was
Calculating Posterior Probabilities

• With knowledge of conditional probabilities, P(finding|

state), for findings (indicator) of the sample or survey,
prior probabilities, P(state), can be revised
• For each state of nature, multiply prior probability by
conditional probability  gives joint probabilities,
P(finding and state)
• Sum joint probabilities over all states  gives marginal
(prior) probability for findings (indicator)
• For each state, divide joint probability by marginal (prior)
probability for findings (indicator)  gives posterior
probabilities
Utility
Utility
• A Risk neutral decision maker has a
linear utility function. Utility
max payoff,1
• Makes choice based on expected payoff
risk avoider
• A Risk avoider has a concave utility
function (decreasing marginal value)
• Prefers a guaranteed payoff versus a risk
neutral
gamble with the same expected payoff
risk taker
• A Risk taker has a convex utility
function (increasing marginal value)
• Prefers a gamble with the same
0
expected payoff than a guaranteed Payoffs
payoff of the same amount
Utility – Given Two Points
Utility
U(X)
Suppose Y<Z<X. Tell you U(X) and U(Y). U(Z) of a risk avoider

Increasing function of payoff: U(Z) of a risk neutral

U(Y)<U(Z)<U(X) U(Z) of a risk taker
U(Y)

Example.
Alternative 1:
40% to get $6,000; 60% to get $1,000. Y Z X Payoffs
Example.
Alternative 2: sure to get $2,500
Alternative 1:
No difference.
40% to get $6,000; 60% to get $1,000.
U(6,000)=70; U(1,000)=20
U(6,000)=70; U(1,000)=20
U(2,500)? Risk avoider/neutral/taker?
If the person is a risk taker, U(2,800) is
possible to be
Solution.
A. 50 B. 45 C. 40 D.23
U(2,500)=70*0.4+20*0.6=40
EMV=6,000*0.4+1,000*0.6=3,000
Solution. EMV=6,000*0.4+1,000*0.6=3,000
Risk avoider
Risk neutral U(3,000)=70*0.4+20*0.6=40
U(2,800)<U(3,000)<40
Queueing Stable

Arrival rate (), Service rate (), Numbers of servers(s)

Utilization factor (): Proportion of time the servers are

busy
 = /(s)

A queue is stable (also called Steady-State condition) if  < 1

Namely, Total arrival rate () < Total service rate ()
Queueing Notation

M: Exponential
distribution
D: Constant time
Distribution of Calling
service times G: General
population
distribution

/ / / / Example.
M/M/1/∞/∞/FCFS

Distribution of Number Waiting

interarrival times of space Poisson Exponential
servers process distribution
Queueing

Customer: Service:
 or 1/ ?  or 1/?
In the waiting queue or in the
system?
Average number of
Average𝜆number customers in the waiting
𝐿=
of customers in queue
𝜇− 𝜆
the system
𝜆 𝜆
𝐿 𝑄= −
𝜇− 𝜆 𝜇
Probability that there are n
customers in the system

( )
𝑛
𝜆
𝑃 𝑛= 𝑃0
𝜇
M/M/1

All the
formulas

𝜆 1𝑊 = 1 1
𝜌= 𝑊 = 𝑞 −
𝜇 𝜇− 𝜆 𝜇− 𝜆 𝜇

𝜆 𝜆 𝜆
𝐿= 𝐿 𝑄= −
𝜇− 𝜆 𝜇− 𝜆 𝜇

( )𝑃
𝑛
𝜆 𝜆
𝑃 0 =1− 𝑃 𝑛 = 0
𝜇 𝜇
M/M/s


s=# of servers 𝜌 =
𝑠𝜇

𝐿𝑞 𝐿
𝑊 𝑞= 𝑊=
 

Utilization 1 − 𝑃0
rate
Exercise
You are given the following decision table of payoffs (in
thousands of dollars):
State of Nature

Alternatives S1 S2

A1 200 150

A2 -75 450

A3 175 125

a)If you are pessimistic, which decision alternative will

you choose?
b)If you want to minimize your maximum regret, which
decision alternative will you choose?
c)What is EVPI if S1 has 40% chance of occurring?
d)There exists a dominated alternative?
Exercise

The average time between arrivals of machines for repair

at a service facility has an exponential distribution with a
mean of 15 minutes. There is a single repairman who
repairs the machines. There is infinite waiting space and
the pool of potential machines that arrive for repair is
infinite. If the average number of machines at the service
facility should not exceed 8, what is the maximum average
service time that the repair facility can have? Assume that
service time has an exponential distribution, and the queue
discipline is FCFS.
A. 16.875 minutes
B. 3.56 minutes
C. 4.5 minutes
D.13.33 minutes
Exercise

Pete’s Market is a small local grocery store with

only one checkout counter. Patrons arrive
according to a Poisson process at a rate of 15
customers per hour. Service time is exponentially
distributed with a mean of 3 minutes. Service is
FCFS and there is infinite waiting room. What is the
probability that there are two or fewer customers in
the system?
Exercise
A deli has two cashiers. Customers arrive at the deli according to a
Poisson distribution with average time between arrivals of two successive
customers being 4 minutes. The service times are exponentially
distributed with a mean service time of 5 minutes. Each cashier is paid
$20 per hour and the deli incurs a cost of $0.25 per minute that a
customer is in the deli. Assume that customers want to minimize the total
time they spend in the deli. Assume that the deli wants to minimize the
Queue type information
total cost. The following λ (per hour) isµgiven
(per hour) L
to you:
M/M/1 4 5 4
M/M/1 7.5 12 1.67
M/M/1 15 24 1.67
M/M/2 4 5 0.95
M/M/2 15 12 2.05

a) If customers who come into the deli split evenly between the two
cashiers, what is the total cost per hour?
b) If customers who come into the deli form a single line and the
person at the front of the line goes to whichever cashier is free
first, what is the total cost per hour?
Exercise
MJ Logistics has decided to build a new warehouse to support its supply
chain activities. They have the option of building either a large warehouse or
a small one. The profit depends on the volume of work the company expects
to contract for in the future, which is strongly correlated with future
economic conditions. This is summarized in the following table (in millions of
dollars): Economy improves Economy deteriorates
Large warehouse 30 -6
Small warehouse 20 8

The company believes that there is a 25% chance that the economy
improves and so the volume of demand will be high. Suppose that the
company engages some economic experts to provide their opinion about the
future economic conditions. Historically, whenever there was an upside
trend in economy, they had predicted it with 75% accuracy, and whenever
there was a downside trend in economy, their prediction accuracy had been
90%.
a. If the experts predict that the economy trend is upward, what is the best
decision and what is the expected profit from that decision?
b. If the experts are hired, what is the maximum amount MJ logistic should