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Lecture 4 With Notes - PDF - 1

1. The document summarizes a lecture on decision analysis and decision making under risk and uncertainty. It includes examples of probability distributions, decision making steps, and decision criteria like EMV, EVPI, and sensitivity analysis. 2. An in-class exercise on ordering donuts for a café is presented, including the demand probabilities and payoff table. Students are asked questions about the exercise. 3. Sensitivity analysis in Excel is demonstrated to investigate how changing a parameter like probability would impact the optimal decision.

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Chan Chin Chun
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0% found this document useful (0 votes)
31 views

Lecture 4 With Notes - PDF - 1

1. The document summarizes a lecture on decision analysis and decision making under risk and uncertainty. It includes examples of probability distributions, decision making steps, and decision criteria like EMV, EVPI, and sensitivity analysis. 2. An in-class exercise on ordering donuts for a café is presented, including the demand probabilities and payoff table. Students are asked questions about the exercise. 3. Sensitivity analysis in Excel is demonstrated to investigate how changing a parameter like probability would impact the optimal decision.

Uploaded by

Chan Chin Chun
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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2 12

Recap of Last Lecture In-class Exercise: Café du Donut


• Poisson distribution à number of arrivals • Monetary Payoff (Profit) Table
▫ Relationship with binomial distribution
• Exponential distribution à time • Cost = $40, revenue = $60
▫ Relationship with Poisson distribution
D=4 D=5 D=6 D=7 D=8 D=9 D = 10 EMV
• Uniform distribution
• Normal distribution Q=6 0 60 120 120 120 120 120 105
▫ Standard normal distribution and Z table Q=7 -40 20 80 140 140 140 140 104
• Steps in decision making Prob. 0.05 0.15 0.15 0.20 0.25 0.10 0.10
▫ Define the problem
▫ List all possible alternatives, states of nature, and corresponding
payoff for each combination
• Should we reduce the order size from 6 to 5? What is the EMV of Q=5?
▫ Select a decision theory model and make the decision
• Decision making under certainty
• Decision making under risk • If we can only choose between 6 and 7, what is the EVPI?
▫ Maximize EMV & Minimize EOL
▫ EVPI = EVwPI – max EMV or EVPI = min EOL
11
In-class Exercise: Café du Donut
• The Café buys donuts each day for $40 per carton of 20 dozen
Chapter 02 donuts. Any cartons not sold are thrown away at the end of
the day. If a carton is sold, the total revenue is $60.
Decision Analysis DAILY DEMAND PROBABILITY CUMULATIVE
(CARTONS) PROBABILITY
IIMT3636 • The original plan 4 0.05 0.05
Faculty of Business and Economics is to order 6 5 0.15 0.2
The University of Hong Kong cartons per day. 6 0.15 0.35
Should the Café 7 0.20 0.55
Instructor: Dr. Yipu DENG
increase the 8 0.25 0.8
9 0.10 0.9
order size to 7?
10 0.10 1.0
Total 1.00
15 17
Decision Making under Risk Sensitivity Analysis in Excel
EMV
Point1: 0=120,000p
• Step 1: setup the payoff table (data and formulas)
$300,000 • Step 2: setup the data table
Point2: 380,000p ▫ Set a list of values in the first column for the parameter to be
$200,000 EMV (large plant) explored, except for the first row.
Point 2 380,000p-180,000
0.45 ▫ Reference the output values in the first row, starting from the
$100,000
Point 1
EMV (small plant) second column.
120,000p-20,000
• Step 3: generate the one-way data table
0 EMV (do nothing)
0 ▫ Select the entire data table.
.167 .615 1
▫ Click: DATA -> What-If Analysis -> Data Table.
–$100,000 Values of p
▫ Set the Column input cell to the parameter cell in the original
model.
–$200,000
13 16
Decision Making under Risk Results of Sensitivity Analysis
• If the estimation of probability is changed, how will John change his
decision?
• A sensitivity analysis is needed! It investigates how our decision
BEST ALTERNATIVE RANGE OF P VALUES
might change given a change in the problem data.
STATE OF NATURE Construct a large plant >0.615
FAVORABLE UNFAVORABLE EMV Construct a small plant 0.167 - 0.615
ALTERNATIVE MARKET (profit in $) MARKET (profit in $) (in $1,000) Do nothing <0.167
Construct a large plant 200,000 –180,000 380p – 180
Construct a small plant 100,000 –20,000 120p – 20
Do nothing 0 0 0
Probability p 1–p
19 4
In-Class Exercise Decision Making under Uncertainty
• Given Opportunity Loss Table What if we do not know the probabilities for all states of
State I State II nature?
Option A 5 1
Option B 0 3
Option C 6 0
• Maximax (optimistic)
Probability 0.3 0.7 • Maximin (pessimistic)
Payoff table
• How to restore the payoff table? • Criterion of realism (Hurwicz)
State I State II • Equally likely (Laplace)
Option A 1 3
EVwPI = 6(0.3) + 4(0.7) = 4.6 • Minimax regret Opportunity loss table
Option B 6 1
Option C 0 4
• What is the EVwPI?
18 3
In-Class Exercise In-class Exercises
• Assume directly measuring monetary payoff is infeasible • The Monty Hall Problem Revisited
▫ Suppose you're on a game show, and you're given the choice of three doors:
• Opportunity Loss Table Behind one door is a car; behind the others, goats. You pick a door, say No. 1, and
the host, who knows what's behind the doors, opens another door, say No. 3,
State I State II which has a goat. He then says to you, "Do you want to pick door No. 2?" Is it to
your advantage to switch your choice?
Option A 5 1
• Timeline
Option B 0 3
• Payoff table (payoff = 1 if you get a car; 0 otherwise)
Option C 6 0
Given door 1 is Car behind Car behind Car behind Expected
Probability 0.3 0.7 chosen door 1 door 2 door 3 Value
Switch 0 1 1 2/3
• Which is the option that maximizes EMV? Do not switch 1 0 0 1/3
Probability 1/3 1/3 1/3

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