psm decision making techniques (1)

Probability & Statistical ModellingDecision Making Techniques

CT042-3-2 Probability and Statistical ModelingDecision Making Techniques

Slide 2 (of 68)Topic & Structure of the lessonIntroductionDecision making Under UncertaintyExpected Value / Expected Opportunity LossExpected Value of perfect informationDecision TreesSequential TreesComputerised decision tree analysis


Slide 3 (of 68)Learning Outcomes At the end of this topic, You should be able to:

Understand how to calculate and use Expected ValueKnow how to value Perfect and Imperfect informationUse various decision rulesKnow what is meant by a Decision TreeBe able to describe Decision Trees and Outcomes Nodes


Slide 4 (of 68)Understand how to draw Decision Trees using the Forward PassKnow that the outcome values are calculated using the backward passBe able to incorporate Bayes Theorem into a Decision Tree.


Slide 5 (of 68)Key Terms you must be able to useIf you have mastered this topic, you should be able to use the following terms correctly in your assignments and exams:(Prepare your own list)


Slide 6 (of 68)IntroductionDecision making involves the following steps:Recognise and clearly define the problemCollect the information needed to analyse possible alternativesChoose and implement the most feasible alternative


Slide 7 (of 68)Problem formulationA decision problem is characterized by decision alternatives, states of nature, and resulting payoffs.The decision alternatives are the different possible strategies the decision maker can employ.The states of nature refer to future events, not under the control of the decision maker, which may occur. States of nature should be defined so that they are mutually exclusive and collectively exhaustive.


Slide 8 (of 68)a general approach to decision making when the outcomes associated with alternatives are often in doubtList the feasible alternativesList the eventsCalculate the payoff Estimate the likelihood of each eventSelect a decision ruleDecision Theory


Slide 9 (of 68)When a decision has to be made, there will be a range of possible actionEach action will have a certain consequences or payoff


Slide 10 (of 68)Manager knows which event will occurpick the alternative with the best payoff

What is the best choice if future demand will be low?Decision Making Under Certainty

Possible Future Demand

Alternative

Low

High

Small facility

200

270

Large facility

160

800

Do nothing

0

0


Slide 11 (of 68) Decision making without probability (no probability of occurrence are assigned)

Decision making with probabilities (probabilities can be assigned)Decision Making Under Uncertainty


Slide 12 (of 68)Decision Making Without ProbabilitiesDecision Criteria Maximax criterionMaximin criterionMinimax regret criterionHurwicz criterion


Slide 13 (of 68)Maximax Criterion maximise the maximum profitoptimistic - looks at the best possible payoffsignores the possibility of a potential loss

N/B: maximax criterion deals with profit, if the payoff table consists of costs, then minimum criterion would be used ( i.e. minimise the minimum costs)


Slide 14 (of 68)Quick Review Question Decision making without probability (no probability of occurrence are assigned)

Determine the maximax criterion for our investment.

State of Nature

Decision

(purchase)

Good Economic conditions

Poor Economic conditions

Apartment building

$50,000

$30,000

Office building

100,000

-40,000

Warehouse

30,000

10,000



The maximax criterion for our investment is to purchase office building.

Decision

(purchase)

Apartment building

$50,000

Office building

100,000

Warehouse

30,000


Slide 16 (of 68)Maximin Criterion looks at the worst possible payoffspessimistic and conservativeresults in the maximum of the minimum profit

Its equivalent is minimax (i.e. minimise the maximum cost)



Determine the maximin criterion for our investment.

State of Nature

Decision

(purchase)



Apartment building

$50,000

$30,000

Office building

100,000

-40,000

Warehouse

30,000

10,000



The maximin criterion for our investment is to purchase apartment building.

Decision

(purchase)

Apartment building

30,000

Office building

-40,000

Warehouse

10,000


Slide 19 (of 68)Minimax Regret CriterionRegret (opportunity loss) is the difference between the payoff from the best decision and all other decision payoffs in those circumstances

In this criterion decision maker attempts to avoid regret by selecting the decision alternative that minimises the maximum regret



State of Nature

Decision

(purchase)



Apartment building

$50,000

$30,000

Office building

100,000

-40,000

Warehouse

30,000

10,000



Regret Table

State of Nature

Decision

(purchase)



Apartment building

$50,000

0

Office building

0

70,000

Warehouse

70,000

20,000



Decision:

According to minimax regret criterion, the decision should be to purchase apartment building because this decision will result, at most, $50,000 in regret.

Decision (purchase)

Apartment building

$50,000

Office building

70,000

Warehouse

70,000


Slide 23 (of 68)Hurwicz Criterion a comprise between the maximax and maximin criteriaintroduce , the coefficient of optimism 0< 40, 0.4120,0002040, 0.2 40,000

psm decision making techniques (1)

Documents

decision making

statistical modelingdecision

decision alternatives

decision maker

decision treebe able

probability of occurrence

states of nature

backward passbe able