ABLAN, ARJAY I.

OTHER EXAMPLES OF QUANTITATIVE MODELS FOR DECISION MAKING

SIMULATION

Simulation is a model constructed to represent reality, on which conclusion

about real life problems can be used. It is a highly sophisticated tool by mean of

which the decision maker develop the mathematical model of the system under

consideration.

Simulation is used to model efficiently a wide variety of systems that are

important to managers. A simulation is basically an imitation, a model that imitates a

real-world process or system. In business and management, decision makers are

often concerned with the operating characteristics of a system.

How Simulations help in Project Decision –Making

Simulation modeling is useful in Project decision-making by looking at

problems as a whole and articulating the complete set of relationships, interactions,

and uncertainties. A business simulation model can predict what may happen in the

physical system and take necessary steps beforehand, so that the physical system

can maintain equilibrium despite various disturbances from both within and outside. 
 Monte Carlo Simulation

Monte Carlo simulations are used to model the probability of different

outcomes in a process that cannot easily be predicted due to the intervention

of random variables. It is a technique used to understand the impact of risk and

uncertainty in prediction and forecasting models.

Sample Problem

Imagine you are the marketing manager for a firm that is planning to introduce a

new product. You need to estimate the first year net profit from this product, which will

depend on:

 Sales volume in units

 Price per unit

 Unit cost

 Fixed costs
 Net profit will be calculated as Net Profit = Sales Volume* (Selling Price - Unit cost)

- Fixed costs.  Fixed costs (for overhead, advertising, etc.) are known to be $120,000. But

the other factors all involve some uncertainty. Sales volume (in units) can cover quite a

range, and the selling price per unit will depend on competitor actions. Unit costs will also

vary depending on vendor prices and production experience.

Uncertain Variables

To build a risk analysis model, we must first identify the uncertain variables -- also

called random variables.  While there's some uncertainty in almost all variables in a

business model, we want to focus on variables where the range of values is significant.

Sales and Price

Based on your market research, you believe that there are equal chances that the

market will be Slow, OK, or Hot.

 In the "Slow market" scenario, you expect to sell 50,000 units at an average

selling price of $11.00 per unit.

 In the "OK market" scenario, you expect to sell 75,000 units, but you'll likely

realize a lower average selling price of $10.00 per unit.

 In the "Hot market" scenario, you expect to sell 100,000 units, but this will

bring in competitors who will drive down the average selling price to $8.00 per unit.

As a result, you expect to sell 75,000 units (i.e., (50,000+75,000+100,000)/3 =

75,000) at an average selling price of $9.67 per unit (i.e.,  ($11+$10+$8)/3 = $9.67).
Unit Cost

Another uncertain variable is Unit Cost.  Your firm’s production manager advises

you that unit costs may be anywhere from $5.50 to $7.50, with a most likely cost of $6.50.

In this case, the most likely cost is also the average cost.

LINEAR PROGRAMING

Linear Programing is a quantitative technique that is used to produce an

optimum solution within the bounds imposed by constraint upon the decision.

Linear Programming is a technique for making decisions under certainty i.e.;

when all the courses of options available to an organization are known and the

objective of the firm along with its constraints are quantified. That course of action is

chosen out of all possible alternatives which yield the optimal results.

Advantages of Linear Programming

 1. Linear programming helps in attaining the optimum use of productive

resources. It also indicates how a decision-maker can employ his productive

factors effectively by selecting and distributing (allocating) these resources.

2. Linear programming techniques improve the quality of decisions. The

decision-making approach of the user of this technique becomes more

objective and less subjective.

3. Linear programming techniques provide possible and practical solutions since

there might be other constraints operating outside the problem which must be

taken into account. Just because we can produce so many units docs not

mean that they can be sold. Thus, necessary modification of its mathematical

solution is required for the sake of convenience to the decision-maker.

4. Highlighting of bottlenecks in the production processes is the most significant

advantage of this technique. For example, when a bottleneck occurs, some

machines cannot meet demand while other remains idle for some of the time.

5. Linear programming also helps in re-evaluation of a basic plan for changing

conditions. If conditions change when the plan is partly carried out, they can

be determined so as to adjust the remainder of the plan for best results.

Sample Problem

A store sells two types of toys, A and B. The store owner pays $8 and $14 for

each one unit of toy A and B respectively. One unit of toys A yields a profit of $2

while a unit of toys B yields a profit of $3. The store owner estimates that no more

than 2000 toys will be sold every month and he does not plan to invest more than
$20,000 in inventory of these toys. How many units of each type of toys should be

stocked in order to maximize his monthly total profit profit?

Solution

Let x be the total number of toys A and y the number of toys B; x and y cannot be

negative, hence 

x ≥ 0 and y ≥ 0 

The store owner estimates that no more than 2000 toys will be sold every month 

x + y ≤ 2000 

One unit of toys A yields a profit of $2 while a unit of toys B yields a profit of $3,

hence the total profit P is given by 

P = 2 x + 3 y 

The store owner pays $8 and $14 for each one unit of toy A and B respectively and

he does not plan to invest more than $20,000 in inventory of these toys 

8 x + 14 y ≤ 20,000 

What do we have to solve? 

Find x and y so that P = 2 x + 3 y is maximum under the conditions 

The solution set of the system of inequalities given above and the vertices of the

region obtained are shown.

.

Vertices of the solution set: 

A at (0 , 0) 

B at (0 , 1429) 

C at (1333 , 667) 

D at (2000 , 0) 

Calculate the total profit P at each vertex 

P(A) = 2 (0) + 3 ()) = 0 

P(B) = 2 (0) + 3 (1429) = 4287 

P(C) = 2 (1333) + 3 (667) = 4667 

P(D) = 2(2000) + 3(0) = 4000 

The maximum profit is at vertex C with x = 1333 and y = 667. 

Hence the store owner has to have 1333 toys of type A and 667 toys of type B in

order to maximize his profit.

SAMPLING THEORY

Sampling Theory is a quantitative where samples of population are

statistically determined to be used for a number of processes such as quality control

and marketing research.

A sample is not studied for its own sake. The basic objective of its study is

to draw an inference about the population. Sampling helps to know the

characteristics of the universe or population by examining only a small part of it.

The values obtained from the study of a sample such as the average and

dispersion are known as a ‘statistics’

. On the other hand, such values for the population are called

‘parameters’. Any characteristic of a sample is called statistics. To study the

population characteristic, a manager can go for either complete enumeration

(census) or a sampling study. A sample statistic is a numerical summary

measure calculated from sample data. The mean, median, mode and standard

deviation calculated for sample data are called sample statistics.

Advantages

Subjects are readily available

Large amounts of information can be gathered quickly

Disadvantages

The sample is not representative of the entire population, so results can't

speak for them

Prone to volunteer bias

STATISTICAL DECISION THEORY

Decision theory is the science of making optimal decisions in the face of

uncertainty. Statistical decision theory is concerned with the making of decisions

when in the presence of statistical knowledge (data) which sheds light on some of

the uncertainties involved in the decision problem.

The Bayesian Statistics

Bayesian statistics is a theory in the field of statistics based on the Bayesian

interpretation of probability where probability expresses a degree of belief in

an event. The degree of belief may be based on prior knowledge about the event,

such as the results of previous experiments, or on personal beliefs about the event.
This differs from a number of other interpretations of probability, such as

the frequentist interpretation that views probability as the limit of the relative

frequency of an event after many trials.

The Bayes’ theorem is expressed in the following formula:

Where:

 P(A|B) – the probability of event A occurring, given event B has occurred

 P(B|A) – the probability of event B occurring, given event A has occurred

 P(A) – the probability of event A

 P(B) – the probability of event B

 P(B|A–) – the probability of event B occurring given that event A– has occurred

 P(B|A+) – the probability of event B occurring given that event A + has occurred

Example of Bayes’ Theorem

 Imagine you are a financial analyst at an investment bank. According to your

research of publicly-traded companies, 60% of the companies that increased their

share price by more than 5% in the last three years replaced their advertising

method during the period.

At the same time, only 35% of the companies that did not increase their share

price by more than 5% in the same period replaced their advertising method.

Knowing that the probability that the stock prices grow by more than 5% is 4%, find

the probability that the shares of a company that replaces their advertising method

will increase by more than 5%.

Before finding the probabilities, you must first define the notation of the probabilities.

 P(A) – the probability that the stock price increases by 5%

 P(B) – the probability that the advertising method is replaced

 P(A|B) – the probability of the stock price increases by 5% given that the

advertising method has been replaced

 P(B|A) – the probability of the advertising method replacement given the

stock price has increased by 5%.

Using the Bayes’ theorem, we can find the required probability:

 
 

Thus, the probability that the shares of a company that replaces their advertising

method will grow by more than 5% is 6.67%.

REFERENCES

Challenges for the Future – Engineering Managemen by Hans-Jörg Bullinger Dieter

Spath

Engineering Management by Roberto Medina

Statistical Decision Theory by James O. Berger

https://smallbusiness.chron.com/importance-statistics-management-decision-

making-4589.html

https://www.pmi.org/learning/library/dynamic-project-management-using-

simulations-7328

https://www.analyzemath.com/linear_programming/linear_prog_applications.html