4_DS412BUS786_DecisionAnalysis

4_DS412BUS786_DecisionAnalysis - Decision Analysis Sada...

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1 Decision Analysis Sada Soorapanth Decision Sciences
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2 Why is Decision Making Often Difficult? Example: After graduation you receive two job offers. Company A: Start-up in new, promising industry Salary lower, but generous stock options and opportunities with growth Located in Bay Area, which you find very desirable except for the high cost of living. Company B: Established Top 100 companies to work for Salary higher, but less opportunity for advancement Located in Austin, Texas, which you don’t find as desirable as the Bay Area, but you do like its lower cost of living.
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3 ….Two Primary Reasons Uncertainty Conflicting objectives
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4 Why Study Decision Analysis ? To make better decisions that improve the chance of achieving the best outcome. A good decision does not always result in a good outcome. Luck often plays a role Decision analysis provides structure and guidance for systematic thinking in difficult situations.
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5 Characteristics of Decision Problems Alternatives: Courses of action. Alternatives must be mutually exclusive. Criteria: Factors that are important to the decision maker. States of Nature: Future events that are not under the decision maker’s control. Payoff: Consequence/outcome associated with each alternative for every future condition
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6 Example: An individual has sued for damages of $450K because of an injury. The insurance company has offered to settle for $100K. What are the alternatives, criteria, and states of nature? Alternatives: Criteria: States of Nature: Payoff:
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7 Decision Environments Certainty - Environment in which relevant parameters have known values Demand = 500 units and profit = $2/unit. Risk - Environment in which certain future events have probable outcomes Demand = 500 units with probability 50%, 0 unit with probability 50%, price = $5/unit, cost = $3/unit. Uncertainty - Environment in which it is impossible to assess the likelihood of various future events Demand distribution is unknown. Price = $5/unit and cost =$3/unit.
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8 Decision Making Under Uncertainty An Inventory Example* Consider the following problem: Cost = $3/unit, Selling price = $5/unit Unsold units have no salvage value. How much should we buy? Alternatives: ___________________ States of Nature: _______________ We will consider several criteria…. Demand Alternative 0 1 2 Buy 0 0 0 0 Buy 1 -3 2 2 Buy 2 -6 -1 4 Payoff Matrix If we buy 2 and demand is 1 then our profit is (5x1)-(3x2)= -1. * Bierman, Bonini, Hausman. Quantitative Analysis for Business Decisions 8 th ed.
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Decision Making Under Uncertainty Maximax Criterion Maximax Criterion: The supreme optimist” Determine the best payoff for each alternative, then pick the best one. Demand
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4_DS412BUS786_DecisionAnalysis - Decision Analysis Sada...

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