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Operations Management

MELJUNELJUN

MELJUN CORTES,BSCS,ACS

Department of ICT

Faculty of Information

Technology

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H

APTER

5s

Decision Theory

MELJUNELJUN

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Decision Theoryrepresents a generalapproach to decision making which is suitable for a

wide range of operations management decisions,

including:

product and

service design

product and

service design

equipmentselectionlocationplanning

Decision TheoryDecision Theory

Capacity

planning

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A set of possible future conditions exists thatwill have a bearing on the results of thedecision

A list of alternatives for the manager tochoose from

A known payoff for each alternative under

each possible future condition

Decision Theory ElementsDecision Theory Elements

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Identify possible future conditions calledstates of nature

Develop a list of possible alternatives, one

of which may be to do nothing

Determine thepayoffassociated with each

alternative for every future condition

Decision Theory ProcessDecision Theory Process

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If possible, determine the likelihood of eachpossible future condition

Evaluate alternatives according to some

decision criterion and select the bestalternative

Decision Theory Process (Contd)Decision Theory Process (Contd)

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Bounded RationalityThe limitations on decision

making caused by costs,

human abilities, time, technology,and availability of information

Causes of Poor DecisionsCauses of Poor Decisions

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Suboptimization

The result of different

departments each

attempting to reach a

solution that is

optimum for that

department

Causes of Poor Decisions (Contd)Causes of Poor Decisions (Contd)

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MBA MPA BSCS ACS

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Certainty - Environment in whichrelevant parameters have knownvalues

Risk - Environment in which certainfuture events have probableoutcomes

Uncertainty - Environment in which

it is impossible to assess thelikelihood of various future events

Decision EnvironmentsDecision Environments

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Maximin - Choose the alternative with the best of the worstpossible payoffs

Maximax - Choose the alternative with the best possible payoff

Laplace - Choose the alternative with the best average payoff of

any of the alternatives

Minimax Regret- Choose the alternative that has the least of theworst regrets

Decision Making under UncertaintyDecision Making under Uncertainty

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Format of a Decision TreeFormat of a Decision Tree

Stateof

nature1

B

Payoff 1

Stateofnature2

Payoff2

Payoff 3

2

ChooseA1

ChooseA2

Payoff 6Stateofnature2

2

Payoff 4

Payoff 5

ChooseA3

ChooseA4

Stateofn

ature1

Cho

oseA

Ch

ooseA2

1

Decision Point

Chance Event

Figure 5S.1

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Expected Value of Perfect InformationExpected Value of Perfect Information

Expected value of perfect information:thedifference between the expected payoff under

certainty and the expected payoff under risk

Expected value of

perfect information

Expected payoff

under certainty

Expected payoff

under risk=-

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Sensitivity AnalysisSensitivity Analysis

16

14

12

108

6

4

20

16

14

12

108

6

4

20

A

B

C

A bestC bestB best

#1 Payoff #2 Payoff

Sensitivity analysis: determine the range ofprobability for which an alternative has the bestexpected payoff

Example S-8

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Solved Problem 5Solved Problem 5