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Decision Analysis
DS 412/BUS 786
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•
This is a topic in Operations Research.
•
It provides a framework for decision
making when the future is unknown.
•
There are two approaches:
1. Using a Decision Table
2. Using a Decision Tree
Steps
•
1. Identify all possible future conditions,
called
States of Nature
. These are beyond
the control of the decisionmaker.
•
2. Develop a list of alternative decisions.
•
3. Estimate the payoff (profit/cost) for each
decision for each state of nature.
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•
4. Estimate the probability of occurrence
of each state of nature.
•
5. Compute the Expected Value (EV) of
the payoff for each decision; choose the
best decision. (Highest EV if payoffs are
profits; lowest EV if payoffs are costs).
DecisionMaking Environments
•
1. Certainty: Future state of nature is
known.
•
2. Risk: Future state of nature is unknown;
but the probabilities of occurrence can be
estimated.
•
3. Uncertainty: Future state of nature is
unknown; further, the probabilities of
occurrence cannot be estimated.
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Decision
Alternatives
States of Nature
Favorable
Market
Unfavorable
Market
Build Large
Plant
400
 280
Build Small
Plant
280
 60
Do Nothing
0
0
Certainty
•
Favorable Market:
Build Large Plant
EV = 400
•
Unfavorable Market:
Do Nothing
EV = 0
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•
Suppose Prob.(Favorable) = 0.6
Prob.(Unfavorable) = 0.4
•
EV (Large Plant) = 0.6x(400) + 0.4x(280)
= 128
•
EV (Small Plant) = 0.6x(280) + 0.4x(60)
=
144
•
EV (Do Nothing) = 0.6x(0) + 0.4x(0) = 0
•
Decision: Build a Small Plant; EV = 144
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This note was uploaded on 09/09/2011 for the course DS 412 taught by Professor Eng during the Spring '07 term at S.F. State.
 Spring '07
 Eng

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