Rindra Rahmawati Ch 6 & Ch 8

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DECISION TREES AND INFLUENCE DIAGRAMS

Decision trees and influence diagrams is a tool to help people make any decision
while their facing complex multi-stage problem. Decision tree is designed for to
represent every possible scenario which can occur, can be counterproductive in many
circumstances. The key of this tool is simplification. While influence diagrams offer
alternative way of structuring a complex decision problem and some analysts find that
people relate to them much more easily. It can be converted to decision trees.

There are two symbols are used in decision trees. A square is used to represent a
decision node which presents an option, so the decision maker can choose which
branch to follow, and a circle is used to represent a chance node which represent the
possible circumstances. The branches with stem from this sort of node represent the
possible outcomes of a given course of action and the branch which is followed will
be determined, not by the decision maker, but by circumstances which lie beyond his
or her control. The branches emanating from a circle are therefore labeled with
probabilities which represent the decision makers estimate of the probability that a
particular branch will be followed.

Decision trees consists of a set of policies, which mean plans of action stating which
option is to be chosen at each decision node that might be reached under that policy.
The technique for determining the optimal policy in a decision tree is well known as
rollback method. To apply, we should analyze the tree from right to left by
considering the later decisions first.

Influence diagrams offer an alternative way of structuring a complex decision

problem. Some analyst find that people relate to them much more easily and the
influence diagram can be converted into decision trees. The advantage of starting with
influence diagram is that their graphic representation is more appealing to the
intuition of decision maker who may be unfamiliar with decision technologies.

In influence diagram, arrow lines between nodes indicate the influence of one node to
another. Alternatively, an arrow pointing to a decision node indicates that either the
decision is influenced by a prior decision or on the occurrence of prior events.

The steps to turning influence diagram into decision tree are: (I) identify a node with
no arrows pointing into it, (ii) if there is a choice between a decision node and an
event node, choose the decision node, (iii) place the node at the beginning of the tree
and remove the node from the influence diagram, (iv) for the now-reduced diagram,
choose another node with no arrows pointing into it, (v) place this node next in the
tree and remove it from the influence diagram, (vi) repeat above procedure until all
the nodes have been removed from the influence diagram.
Rindra Rahmawati Ch 6 & Ch 8
29115116

REVISING JUDGMENTS IN THE LIGHT OF NEW INFORMATION

Sometimes market research results are unlikely to be perfectly reliable. To
conquer this, we can use Bayes Theorm to revise our probability assessments when
new information become available. In Bayes theorem an initial probability estimate is
known as prior probability. When Bayes' theorem used to modify a prior probability
in the light of new information the result is known as a posterior probability.

The steps to apply new information are (I) construct a tree with branches
representing all the possible events which can occur and write the prior probabilities
for these events, (ii) extend the tree by attaching to each branch a new branch which
represents the new information which you have obtained. On each branch write the
conditional probability of obtaining this information given the circumstance
represented by the preceding branch, (iii) obtain the joint probabilities by multiplying
each prior probability by the conditional probability which follows it on tree, (iv) sum
the joint probabilities, and finally (v) divide the appropriate joint probability by the
sum of the joint probabilities to obtain the required posterior probability.

In the light of new imperfect information, the expected value can be calculated
by the following steps below:
1) Determine the course of action which would be chosen using only the prior
probabilities and record the expected payoff off this course of action
2) Identify the possible indications which the new information can give
3) For each indication, (a) determine the probability that this indication will
occur, (b) Use Bayes' theorem to revise the probabilities in the light of this
indication, and (c) determine the best course of action in the light of this
indication and the expected payoff of this course of action.
4) Multiply the probability of each indication occurring by the expected payoff of
the course of action which should be taken if that indication occurs and sum
the resulting products. This will give the expected payoff with imperfect
information
5) The expected value of the imperfect information is equal to the expected
payoff with imperfect information less the expected payoff of the course of
action which would be selected using the prior probabilities.