Decision Analysis

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Lecture 2

Definitions

A decision is a choice between alternatives based on estimates of the values of those alternatives.

Supporting a decision means helping people working alone or in a group gather intelligence, generate alternatives and make choices

Supporting the choice making process involves supporting the estimation, the evaluation and/or the comparison of alternatives

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Human decision-making

H. A. Simon is considered a pioneer in the development of human decision-making models. His basic model depicts human decision-making as a three-stage process. These stages are: Intelligence: The identification of a problem (or

opportunity) that requires a decision and the collection of information relevant to the decision

Design: Creating, developing, and analyzing alternative courses of action

Choice: Selecting a course of action from those available.

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Decision-Making Phases and Steps Intelligence

Data GatheringObservation of reality and collecting of any relevant qualitative and quantitative data is done for the general situation of interest.

Problem Recognition Based on the interpretation of collected data, a well focused problem statement and general objective is defined.

Design Model Formulation

Using the well-focused problem, a predefined model is instanced with a set of courses of action, outcomes criteria, set of uncontrolled events and parameters, and the relationships between these variables. If a predefined model is unavailable, a new model must be developed.

Model AnalysisFace validity and pilot test of the model is conducted to reduce any potential source of significant error.

Choice Generation & Evaluation

With a validated model, all courses of action are evaluated (or dynamically generated) and what-if, sensitivity, and goal-seeking analysis are conducted, in terms of the outcomes criteria.

Selection Best course of action is finally suggested, using an optimization, satisfaction criteria, or other approach. H.Malekinezhad

Elements for rational decision making

Elements for rational decision making Identify the goal to be achieved by the decision Identify the options available to the decision maker Evaluate the likely outcomes if each option is chosen Decide which option is best … And then Do it!

Decision makers need support with all elements

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Why are decisions hard?

1. Because of its complexity; uncertainty surrounding the subject, to think about interests of various groups, Having limited information:

it needs a structure to keep the problem to be analyzed: decision tree and influence diagram.

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Why are decisions hard?

2. Because of inherent uncertainty: example: introducing a new product to the market.

3. A decision maker may work toward multiple objective but progress in one direction. A trade off between benefit in one area against cost in other areas.

4. Different perspectives may lead to different conclusions. More than one person is involved in decision making.

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What is a good decision?

A simple answer: it is the one that gives the best outcome.

You may make a decision after careful consideration of the available information and through deliberation about the goals and possible outcomes, however still have an unlucky outcome: such as stock market.

DSS helps you make a decision with eyes open! You can do better with structure and guidance

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Decision Analysis

Decision Analysis providers structure and guidance for thinking systematically about hard decisions.

To help a decision maker take action with confidence gained through a clear understanding of the problem.

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Subjective judgment

While management science and operational research ignore subjective judgment, decision analysis approach include it.

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Decision Analysis Process

1. Identify the decision situation (find the exact problem): minimizing cost? Maximizing profit? Minimizing risks?

2. Identify alternatives3. Decompose and model the problem: model of

problem structure, Model of uncertainty, Model of preference.

4. Choose the best alternative5. Sensitivity analysis6. Is further analysis needed? If YES repeat step 1,2

and 3 7. Implement the chosen alternative

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Decision Process

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Decision Analysis

Once a decision making problem is understood and defined it is time to analyze it.

You might wonder if the decisions you make are suitable for decision analysis. If you are looking for a way to structure your decisions to make them more organized and easier to explain to others, you definitely should consider using formal decision analysis.

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Influence Diagrams

Influence diagrams present a decision in a simple, graphical form.

Decisions, chance events and payoffs (values) are drawn as shapes (called nodes) and are connected by arrows (called arcs) which define their relationship to each other.

In this way, a complex decision may be reduced to a few shapes and lines.

Influence diagrams are excellent for showing the relationship between events and the general structure of a decision clearly and concisely.

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Influence Diagrams

The term influence refers to the dependency of a variable on the level of another variable.

The variables are connected by arrows which indicate the direction of influence.

Rectangle: Decision Variable

Circle: uncontrollable or intermediate variable

Oval: result (outcome) variable, intermediate or final

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Influence Diagrams

The shape of arrow indicate the type of relationship:

Certainty

Uncertainty

Random (Risk variable) Dereference (between outcome variables):

Amount In CDs

Interest Collected

PriceSales

~Demand Sales

A double lined arrowH.Malekinezhad

Example Consider the following profit

model: Profit = income – expenses Income = unit sold x unit price

~amount used

in advertisement

Units Sold

Units Cost

Fixed Cost

UnitPrice

Unit Sold = 0.5 x amount used in advertisement

Expenses = unit cost x units sold + fixed cost

Income

Expenses

Profit

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Example: An Influence Diagram for the Profit Model

~Amount used in advertisement

Profit

Income

Expense

Unit Price

Units Sold

Unit Cost

Fixed Cost

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Decision Trees

Decision trees are a comprehensive tool for modeling all possible decision options.

While influence diagrams produce a compact summary of a problem, decision trees can show the problem in greater detail.

Decision trees describe events in chronological order but can be much larger than influence diagrams.

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Decision Trees It utilizes a network of two types of nodes: decision

(choice) nodes, and states of nature (chance) nodes Square represents decisions to be made. Circles represents chance events. Chance nodes,

are random variables and they represent uncertain quantities that are relevant to the decision problem.

Branches from a square correspond to the choices available to the decision maker.

Branches from a circle represent the possible outcome of a chance event.

The consequence is specified at the ends of the branches.

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Example

Venture capitalist's situation in decision weather to invest in a new business.

Objective: to make money.

Do not Invest

Typical Return Earned on Less Risky Investment

Venture Succeeds

Venture Fails

Large Return On Investment

Funds LostInvest

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Interpretation of Decision Trees The options represented by branches from a

decision node must be such that the decision maker can choose only one option.

Each chance node must have branches that correspond to a set of mutually exclusive and collectively exclusive outcomes ( only one of them can happen, No other possibilities exit)

A Decision Tree must show all the possible paths that the decision maker might follow through time. Including all possible decision alternatives.

Some times the nodes might occur in a time sequence.

The sequence of decisions is shown in the tree from left to right. H.Malekinezhad

Modeling Decisions

Given a complicated problem, how should we begin?

A critical first step is to identify elements of the situation: Values and Objectives, Decisions to make, Uncertain events, Consequences

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Values and Objectives Values refer to the thing that matter to you.

What is value for a farmer? What is values for a scientist?

Objective is a specific thing that you want to achieve. An individual’s objective taken together make up his or

her values. A persons values are the reason for making decisions. Every decision situation involves a specific context and

that context determines what objectives need to be considered.

A requisite decision model includes all of the objectives that matter within the decision context at hand.

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Money Making: A special Objective Money Making is an important objective because it

allows us to do thing that we want to do: eat, afford housing and clothing, travel, live comfortably,…

For corporations money is a primary objective. However many situations may require a trade-off between making money and some other objective. Example: Consider a hospital that performs organ

transform. Wealthy people can pay more to move up in the queue. Hospital can use this extra money to buy new equipments to help needy people. But moving wealthy patient may have risks to the lives of other people. In this case hospital will probably think to forget the wealthy people money.

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Example: Selecting a Supercomputer for a Company

Objectives: Minimize Cost: Five year Cost, Cost of improved

performance. Maximize performance: Speed, Throughput, Memory size,

Disk Size, On site performance, Satisfy User needs: Installation date, Ease of use, Software

compatibility, Mean time between failure. Satisfy organizational needs: Square footage, Water

cooling, Operator Tools, Telecommunications, Vendor support.

Satisfy Management issues: Vendor Health, Commitment to supercomputer.

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Decisions to Make

Identifying the immediate decision to make is a critical step in understanding difficult decision situation.

Sequential decisions In many cases there is no single decision to make, but

several sequential decisions. Example: A manufacture may decide weather or not to

introduce a product, then whether to produce it or subcontract it, then where to market it ,…

Dynamic Decisions: A decision in future may depend on sequences of decisions taken already.

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Uncertain Events

Many important events has to be taken without knowing exactly what will happen in the future.

It is important to know at each decision exactly what information is available and what remains unknown.

The possible things that can happen in the resolution of uncertain events are called outcomes.

Many different uncertain events might be considered in a decision situation but only some are relevant!

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Consequences

After the last decision has been made and the last uncertain event has been resolved, the decision maker’s fate is finally determined.

It may be a matter of profit or loss. How far in the horizon should we consider?

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