Operations Management: William J. Stevenson
Uploaded by
devilturn70Operations Management: William J. Stevenson
Uploaded by
devilturn705s-1
Decision Theory
Operations Management
William J. Stevenson
6th
edition
5s-2
Decision Theory
CHAPTER
2s
Decision Making
McGraw-Hill/Irwin
Operations Management, Eighth Edition, by William J. Stevenson
Copyright 2005 by The McGraw-Hill Companies, Inc. All rights
5s-3
Decision Theory
Decision Theory
Decision Theory represents a general
approach to decision making which is suitable for a
wide range of operations management decisions,
including:
Capacity
planning
location
planning
product
product and
and
service
service design
design
equipment
selection
5s-4
Decision Theory
Decision Theory Elements
A set of possible future conditions exists that
will have a bearing on the results of the
decision
A list of alternatives for the manager to
choose from
A known payoff for each alternative under
each possible future condition
5s-5
Decision Theory
Decision Theory Process
Identify possible future conditions called
states of nature
Develop a list of possible alternatives, one
of which may be to do nothing
Determine the payoff associated with each
alternative for every future condition
5s-6
Decision Theory
Decision Theory Process (Contd)
If possible, determine the likelihood of each
possible future condition
Evaluate alternatives according to some
decision criterion and select the best
alternative
5s-7
Decision Theory
Causes of Poor Decisions
Bounded Rationality
The limitations on decision
making caused by costs,
human abilities, time, technology,
and availability of information
5s-8
Decision Theory
Causes of Poor Decisions (Contd)
Suboptimization
The result of different
departments each
attempting to reach a
solution that is
optimum for that
department
5s-9
Decision Theory
Decision Environments
Certainty - Environment in which
relevant parameters have known
values
Risk - Environment in which certain
future events have probable
outcomes
Uncertainty - Environment in which
it is impossible to assess the
likelihood of various future events
5s-10 Decision Theory
Decision Making under Uncertainty
Maximin - Choose the alternative with the best of the worst
possible payoffs
Maximax - 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
5s-11 Decision Theory
Payoff Table
Possible future demand*
Alternatives Low Moderate High
Small facility
$10
$10
$10
Medium facility
12
12
Large facility
(4)
16
*Present value in $ millions
5s-12 Decision Theory
Format of a Decision Tree
Figure 5S.1
Decision Point
Chance Event
A
e
s
o
o
h
C
State
re 1
u
t
a
of n
State
of
natur 2
e2
C
ho
os
State
1
e
r
u
t
2
of na
e
A 2
State
of n a
ture 2
Payoff 1
A1
e
s
o
o
Ch
Payoff 2
C h o o se
A2
Payoff 3
A3
e
s
o
o
Ch
Payoff 4
C h o o se
Payoff 5
A4
Payoff 6
5s-13 Decision Theory
A manager must decide on the size of a video arcade to construct. The
manager has narrowed the choices to two: large or small. Information has
been collected on payoffs, and a decision tree has been constructed. Analyze
the decision tree and determine which initial alternative (build small or build
large) should be chosen in order to maximize expected monetary value.
5s-14 Decision Theory
Expected Value of Perfect Information
Approach I : Expected value of perfect information:
the difference between the expected payoff under
certainty and the expected payoff under risk
Expected value of
Expected payoff
perfect information = under certainty
Expected payoff
under risk
5s-15 Decision Theory
5s-16 Decision Theory
5s-17 Decision Theory
5s-18 Decision Theory
5s-19 Decision Theory
Sensitivity Analysis
Example S-8
#1 Payoff
16
14
12
10
8
6
4
2
0
#2 Payoff
B best
C best
A best
Sensitivity analysis: determine the range of
probability for which an alternative has the best
expected payoff
16
14
12
10
8
6
4
2
0
