Tuesday, August 6, 2013

THE DECISION THEORY

A decision is the act of deciding what single act among all alternatives is to be taken into account.  Successful decision making comprises a number of steps to process:

1.  Clearly define the problem.
2.  Identify the possible alternatives and their outcomes.
3.  List the profit for each combination of alternatives and outcomes.
4.  Select one mathematica; decision theory model.
5.  Apply the model and make your decision.

The success or failure that persons, companies, and management experience depends on the decision they make.  Making use of quantities in decision-making helps a great deal in minimizing mistakes and failures.  Some methods of computation should therefore be learned.

Decision theory is a general approach to decision making that is useful in many different aspects of operations management.  It provides a framework for analysis of decision.  It includes a number of different techniques that can classify according to the degree of uncertainty.

Decision under Certainty - when one knows with certainty which of the possible future conditions will actually happen, he simply chooses the alternative with the highest payoff under the state of nature.

Decision under Uncertainty - from certainty, the opposite extreme is uncertainty where there is no available information on how likely the various states of nature are.  Under this condition, there are four possible decision criterions, namely :

a) Maximin - takes into account only the worst possible outcome for each alternative.  This approach establishes a guaratee minimum.
b) Maximax - takes into account only the best possible outcome for each alternative.
c) Laplace - takes into account only the best average possible outcome for each alternative.
d) Minimax Regret - determines the worst regret for ach alternative, and chooses the alternative with the best worst.

DECISION TREES

Another useful technique for analyzing a decision situation is a decion tree.  A decision tree, like the probability tree is a graphical diagram consisting of nodes and branches.  However, rather than determining the probability of each branch as in a probability tree, in a decision tree the user computes the expected value of each outcome and makes a decision based on these expected values.  The primary benefit of a decision tree is that it provides an illustration (or picture) of the decision-making process.  This makes it easier to correctly compute the necessary expected values and to understand the process of making the decision.

The decision tree has two types of nodes: a square represents a decision point and a circle stands for a chance event.  The tree is read left to right, and analyzed from right to left (starting with the last  decision that might be made).  For each decision, choose the alternative that will yield the greatest return.  If chance events follow a decision, choose the alternative that has the highest expected value or the lowest expected loss. 

1.  T. Bone Puckett, a corporate raider, has acquired a textile company and is contemplating the future of one of its major plants located in South Carolina.  Three alternative decisions are being considered: (1) expand the plant and produce lightweight, durable materials for possible sales to the military, a market with little foreigh competition; (2) maintain the status quo at the plant, continuing production of textile goods that are subject to heavy foreign competition; or (3) sell the plant now.  If one of the first two alternatives is chosen, the plant will still be sold at the end of a year.  The amount of profit that could be earned by selling the plant in a year depends on foreign market conditions, including the status of a trade embargo bill in Congress.  The following payoff table describes this decision situation.

Decision                                                            States of Nature
                     Good Foreign Competitive Conditions               Poor Foreign Competitive Condition

Expand                            800,000                                                         500,000
Maintain status quo         1,300, 000                                                    -150, 000
Sell now                           320,000                                                         320, 000

a.  Determine the best decision using the following decision criteria.
1. Maximax
2.  Maximin
3.  Minimaz regret
4.  Hurwicz (alpha =0.3)
5.  Equal likelihood

b.  Assume that it is now possible to estimate a probability of 0.70 that good foreign competitive conditions will exist and a probability of 0.30 that poor conditions will exist.  Determine the dest decision using the expected value and expected opportunity loss.

c.  Compute the expected value of perfect information.
d.  Develop a decision tree for this decision situation, with expected values at the probability nodes.

2.  A farmer in Iowa is considering either leasing some extra land or investing in savings certificates at the local bank.  If weather conditions are good next year, the extra land will allow the farmer to have an excellent harvest.  However, if weather conditions are bad, the farmer will lose money.  The savings certificates will result in the same return regardless of the weather conditions.  The return for each investment given each type of weather condition is hown in the following payoff table.

Decision                                                Weather
                                         Good                    Bad
Lease land                        90,000               -40,000
Buy savings certificate    10,000                 10,000

Hurwicz (alpha = 0.4)

3.  The owner of the Burger Doodle Restaurant is considering two ways to expand operations: operning a drive-up windom or serving breakfast.  The increase in profits resulting from these proposed expansions depends on whether a competitor opens a franchise down the street.  The possible profits from each expansion in operations given in both future competitive situations are shown in the following payoff table.

Decision                                         Competitor
                                      Open                        Not Open
Drive-up window           -6,000                       20,000
Breakfast                         4,000                          8,000

Hurwicz (alpha = 0.10)

4.  Stevie Stone, a bellhop at the Royal Sundown Hotel in Atlanta, has been offered a management position.  Although accepting the offer would assure him a job if there were a recession, if good economic conditionsprevailed he would actually make less money as a manager than as a bellhop (because of the large tips he gets as a bellhop).  His salary during the next five years for each job given each economic condition is shown in the following payoff table.

Decision                                        Economic Conditions
                                             Good                   Recession
Bellhop                               120,000                    60,000
Manager                               85,000                     85,000


Hurwicz (alpha = 0.4)

5.  Consider the following payoff table for three alternative investments, A, B, and C, under two future states of the economy, good and bad.

Investment                                    Economic Conditions
                                             Good                   Bad
A                                           70,000               25,000
B                                           120,000            -60,000
C                                            40,000               40,000

Hurwicz (0.3)

6.  A farmer in Georgia must decide which crop to plant next year on his land: corn, peanuts, or soybeans.  The return from each crop will be determined by whether a new trade bill with the USSR passes the Senate.  The profit the farmer will realize from each crop given the two possible results on the trade bill is shown in the following payoff table.

Crop                                           Trade Bill
                                      Pass                 Fail
Corn                            35,000             8,000
Peanuts                       18,000             12,000
Soybeans                     22,000            20,000

Hurwicz (0.3)

7.  The owner of the Columbia Construction Company must decide among building a housing development, constructing a shopping center, or leasing all the company's equipment to another company.  The profit that will result from each alternative will be determined by whether material costs remain stable or increase.  The profit from each alternative given the two possibilities for material costs is shown in the following payoff table.

Decision                                  Material Costs
                                    Stable              Increase
Houses                        70,000              30,000
Shopping center        105,000              20,000
Leasing                       40,000              40,000

Hurwicz (0.2)

8.  An investor is considering investing in stocks, real estate, or bonds under uncertain economic conditions.  The payoff table of returns for the investor's decision situation is shown below.

Investment                                      Economic Conditions
                                       Good                     Stable                   Poor
Stocks                            5,000                     7,000                   3,000
Real estate                     -2,000                   10,000                  6,000
Bonds                             4,000                      4,000                  4,000

Hurwicz (0.3)

9.  A concessions manager at the Tech vs A and M football game must decide whether to have the vendors sell sun visors or umbrellas.  There is a 30% chance if rain, a 15% chance of overcast skies, and a 55% chance of sunshine, according to the weather forecast in College Junction, where the game is to be held.  The manager estimates the following profits will result from each decision given each set of weather conditions.

Decision                                           Weather Conditions
                                          Rain                 Overcast                Sunshine
                                           0.30                   0.15                        0.55
Sun visors                           -500                   -200                      1,500
Umbrellas                           2000                     0                         -900

10.  The Blitzkrieg Banking House in Berlin speculates in the money market.  The status of the U.S dollar determines the return from investments in other currencies.  The banking house will invest in the dollar, the yen, or other currencies.  The banking house will invest in the dollar, the yen, or the mark.  The return from each is shown in the following payoff table.

Currency                                   Value of the Dollar
                                         Increases (0.3)               Remains stable(0.50)           Declines(0.20)
Dollar                               210,000                                   0                                  -170,000
Yen                                    -10,000                              20,000                                 80,000
Mark                                 -40,000                              35,000                                 150,000




 

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