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Decision_Analysis

# Decision_Analysis - Decision Analysis DS 412/BUS 786...

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Decision Analysis DS 412/BUS 786

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Definition 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 decision-maker. 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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Steps (cont’d) 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).
Decision-Making 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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Example 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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Risk 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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