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Course: Quantitative Techniques Code: MTS-601 Mba-R/Ms Spring 2021-E-H

1. The document discusses decision analysis and outlines the six steps of decision making: define the problem, list alternatives, identify outcomes, list payoffs, select a decision model, and apply the model. 2. It provides an example of Thompson Lumber Company considering whether to develop a new product line. The alternatives are to construct a large plant, small plant, or do nothing. Possible outcomes are a favorable or unfavorable market. 3. Decision making environments are defined as certainty, uncertainty, or risk depending on what is known about outcomes and probabilities. Models like maximax, maximin, and minimax regret are presented to evaluate decisions under uncertainty.

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Waqar Ahmad
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39 views16 pages

Course: Quantitative Techniques Code: MTS-601 Mba-R/Ms Spring 2021-E-H

1. The document discusses decision analysis and outlines the six steps of decision making: define the problem, list alternatives, identify outcomes, list payoffs, select a decision model, and apply the model. 2. It provides an example of Thompson Lumber Company considering whether to develop a new product line. The alternatives are to construct a large plant, small plant, or do nothing. Possible outcomes are a favorable or unfavorable market. 3. Decision making environments are defined as certainty, uncertainty, or risk depending on what is known about outcomes and probabilities. Models like maximax, maximin, and minimax regret are presented to evaluate decisions under uncertainty.

Uploaded by

Waqar Ahmad
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Course: Quantitative Techniques

Code: MTS-601
MBA-R/MS
Spring 2021-E-H

Dr. Abdul Kabeer Kazi


Dean, FMS
[email protected]
021-34314970, Ext. 338
Chapter 3

Decision Analysis
Learning Objectives
After completing this chapter, students will be able to:

1. List the steps of the decision-making


process.
2. Describe the types of decision-making
environments.
3. Make decisions under uncertainty.
4. Use probability values to make decisions
under risk.

3-3
Introduction

 What is involved in making a good


decision?
 Decision theory is an analytic and
systematic approach to the study of
decision making.
 A good decision is one that is based
on logic, considers all available data
and possible alternatives, and the
quantitative approach described here.

3-4
The Six Steps in Decision Making

1. Clearly define the problem at hand.


2. List the possible alternatives.
3. Identify the possible outcomes or states
of nature.
4. List the payoff (typically profit) of each
combination of alternatives and
outcomes.
5. Select one of the mathematical decision
theory models.
6. Apply the model and make your
decision.
3-5
Thompson Lumber Company
Step 1 – Define the problem.
 The company is considering
expanding by manufacturing and
marketing a new product – backyard
storage sheds.
Step 2 – List alternatives.
 Construct a large new plant.
 Construct a small new plant.
 Do not develop the new product line
at all.
Step 3 – Identify possible outcomes.
 The market could be favorable or
unfavorable.
3-6
Thompson Lumber Company

Step 4 – List the payoffs.


 Identify conditional values for the
profits for large plant, small plant, and
no development for the two possible
market conditions.
Step 5 – Select the decision model.
 This depends on the environment and
amount of risk and uncertainty.
Step 6 – Apply the model to the data.
 Solution and analysis are then used to
aid in decision-making.

3-7
Thompson Lumber Company

Decision Table with Conditional Values for


Thompson Lumber

STATE OF NATURE

FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($)
Construct a large plant 200,000 –180,000

Construct a small plant 100,000 –20,000

Do nothing 0 0

Table 3.1

3-8
Types of Decision-Making
Environments

Type 1: Decision making under certainty


 The decision maker knows with
certainty the consequences of every
alternative or decision choice.
Type 2: Decision making under uncertainty
 The decision maker does not know the
probabilities of the various outcomes.
Type 3: Decision making under risk
 The decision maker knows the
probabilities of the various outcomes.

3-9
Decision Making Under
Uncertainty
There are several criteria for making decisions
under uncertainty:
1. Maximax (optimistic)
2. Maximin (pessimistic)
3. Minimax regret

3-10
Maximax
Used to find the alternative that maximizes the
maximum payoff.
 Locate the maximum payoff for each alternative.
 Select the alternative with the maximum number.

STATE OF NATURE
FAVORABLE UNFAVORABLE MAXIMUM IN
ALTERNATIVE MARKET ($) MARKET ($) A ROW ($)
Construct a large 200,000 –180,000 200,000
plant
Maximax
Construct a small 100,000 –20,000 100,000
plant
Do nothing 0 0 0
Table 3.2
3-11
Maximin
Used to find the alternative that maximizes
the minimum payoff.
 Locate the minimum payoff for each alternative.
 Select the alternative with the maximum
number.
STATE OF NATURE
FAVORABLE UNFAVORABLE MINIMUM IN
ALTERNATIVE MARKET ($) MARKET ($) A ROW ($)
Construct a large 200,000 –180,000 –180,000
plant
Construct a small 100,000 –20,000 –20,000
plant
Do nothing 0 0 0
Table 3.3 Maximin
3-12
Minimax Regret
Based on opportunity loss or regret, this is
the difference between the optimal profit and
actual payoff for a decision.
 Create an opportunity loss table by determining
the opportunity loss from not choosing the best
alternative.
 Opportunity loss is calculated by subtracting
each payoff in the column from the best payoff
in the column.
 Find the maximum opportunity loss for each
alternative and pick the alternative with the
minimum number.

3-13
Minimax Regret
Determining Opportunity Losses for Thompson Lumber
STATE OF NATURE

FAVORABLE MARKET ($) UNFAVORABLE MARKET ($)

200,000 – 200,000 0 – (–180,000)

200,000 – 100,000 0 – (–20,000)

200,000 – 0 0–0

Table 3.6

3-14
Minimax Regret
Opportunity Loss Table for Thompson Lumber

STATE OF NATURE

FAVORABLE UNFAVORABLE
ALTERNATIVE MARKET ($) MARKET ($)
Construct a large plant 0 180,000

Construct a small plant 100,000 20,000

Do nothing 200,000 0

Table 3.7

3-15
Minimax Regret

Thompson’s Minimax Decision Using Opportunity Loss

STATE OF NATURE
FAVORABLE UNFAVORABLE MAXIMUM IN
ALTERNATIVE MARKET ($) MARKET ($) A ROW ($)
Construct a large 0 180,000 180,000
plant
Construct a small
plant 100,000 20,000 100,000
Minimax
Do nothing 200,000 0 200,000

Table 3.8

3-16

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