AP / ADMS 3300

DECISION ANALYSIS

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Week 2
Chapter 3

Structuring Decisions

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 What we did in Last Session

What is Decision Analysis?

Decision-Analysis Process

Elements of Decision Problems

Decision Criteria

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Session 2 - Objectives
Having identified the elements of a Decision
Problem, how should one begin the modeling
process?

Fundamental steps of creating a decision model

Fundamental and Means Objectives

Influence Diagrams

Introduction to Decision Tree

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Creating a Decision Model
Creating a decision model requires three fundamental
steps:
Filter & Operationalize the Objectives (Structuring
Objectives)
Structuring the elements of the decision situation into a
logical framework.
Influence Diagrams and Decision Trees
Refinement and precise definition of all of the elements
of the decision model.

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 STEP 1: Filter & Operationalize the
Objectives
Create a list of all the things that matter to you in the
decision context.
Organizing the list of objectives so that they describe in
detail what you want to achieve.
Classify Objectives as Means or Fundamental
Objectives
Classify how to measure Fundamental Objectives

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Techniques for Identifying Objectives
1. Develop a wish list.
2. Identify alternatives.
3. Consider problems and shortcomings.
4. Predict consequences.
5. Identify goals, constraints, and guidelines.
6. Consider different perspectives.
7. Determine strategic objectives.
8. Determine generic objectives.

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 Fundamental and Means Objectives
Classify objectives as Fundamental or Means
objectives

Fundamental Objectives reflect what we really want to

accomplish.

Means Objectives help achieve other objectives.

 Minimizing working hours vs Maximizing time with family

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Fundamental Objectives
Fundamental objectives are organized into hierarchies.
The upper level in a hierarchy represent more general
objectives, and the lower levels explain or describe
important elements of the more general levels.

e.g., In the context of defining vehicles regulations, a

higher-level fundamental objective might be “Maximize
Safety” below which one might find “Minimizing Loss of
Life,” “Minimizing Serious Injuries” etc.

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Vehicle-Safety Example
A Fundamental Objectives Hierarchy

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Means Objectives
Means objectives are organized into networks.

In the vehicle safety example, some means objectives might

be “Minimizing Accidents” and “Maximize Use of
Vehicle-Safety Features”. Beyond these tow mean
objectives there might be other means objectives.

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 Means Objectives
The objective of “Minimize accidents” is important.

It is important because it helps to “maximize safety”, so

it is a means objective

Means objectives can be connected to several objectives,

e.g., . “Have reasonable traffic laws” affects both
“Maximize driving quality” and “Maintain vehicles
properly”.

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Vehicle-Safety Example: A Means-Objectives Network

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 Fundamental and Means Objectives

To distinguish fundamental from means objectives,

and construct the respective hierarchies and networks,
ask:
“Why Is That Important?” (WITI)
WITI allows you to separate the two types of
objectives and see connections.
Hierarchies are branching structures with single
connections, whereas networks can have multiple
interconnecting lines.

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Questions to aid in classifying objectives

Fundamental Objectives Means Objectives

To Move: Downward in the Hierarchy: Away from Fundamental Objectives:

Ask: “What do you mean by that? “How could you achieve this?”

To Move: Upward in the Hierarchy: Towards Fundamental Objectives:

Ask: “Of what more general “Why is that important?”

objective is this an aspect?” (WITI)

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Getting The Decision Context Right
Enlarging Decision Context may increase the
number of objectives and alternatives that are
relevant.

Decreasing the Decision Context may cause

current relevant objectives or alternatives to
become irrelevant.

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 The Right Decision Context
Getting the decision context right is critical. If context
is set at the wrong level, means and objectives will also
be off.
Three criteria for determining the right context
1. Scope: Are you addressing the right problem? Does
the context really capture the problem at hand?
2. Decision ownership: Do you have the authority to
make decisions within the specified context?
3. Feasibility: Will you be able to do the needed analysis
with the time and resources available?

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Objective Hierarchy

Note that further Mean objectives can be gathered and

these mean objectives may be linked together and
organized as networks.
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STEP 2: STRUCTURE THE
ELEMENTS IN A LOGICAL
FRAMEWORK

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Influence Diagrams

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 Influence Diagram
The four basic shapes are referred to as Nodes.
Decision nodes, chance nodes, Payoff nodes,
Consequence nodes, calculation nodes
Nodes are connected by directed Arcs.

A node at the beginning of an arc is called a

Predecessor.

A node at the end of an arc is called a Successor.

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Influence Diagrams (cont…)

1. Elements are

represented by:

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Influence Diagrams

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Influence Diagrams

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Influence Diagrams

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Influence Diagrams
2. Logical relationships are represented by arrows:

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Influence Diagrams

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 Influence Diagram – Example

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Consider a venture capitalist’s situation in
Deciding whether to invest in a new
business Venture
Succeeds of
Fails

Invest?
Return on
Investment

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Some Basic Influence Diagrams

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The Basic Risky Decision
For example, you have $2000 to invest, with the
objective of earning as high a return on your
investment as possible. Two opportunities exist,
investing in a friend’s business or keeping the
money in a savings account with a fixed interest
rate.
If you invest in business and if business is
successful your returns will be $3000 beyond
your initial investment or a total flop, in which
case you will lose all your money. In the saving
account you can earn $200 in interest.

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The Basic Risky Decision

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 Business Outcomes
Results
Wild Success
Flop
Investment
Choice
Return

Business Final Cash

Alternatives Choice
Result Position($)
Savings Savings Success 2200
Business Flop 2200
Business Success 5000
Flop 0

Involves one decision and one uncertain event

Note, that the names given to each node is your choice, just be sensible
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The Basic Risky Decision

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Comments on Influence Diagrams:
Influence diagram captures current state of knowledge
An influence diagram should NEVER contain cycles
Interpreting an influence diagram is generally easy
Creating influence diagrams is difficult

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Some Basic Influence Diagrams

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Imperfect Information – Hurricane Example
Suppose you live in Miami. A hurricane near the Bahama Islands
threatens to cause severe damage; as a result, the authorities
(forecasters) recommend that every one evacuate, that is the
chances of the hurricane hitting Miami is high. Although
evacuation is costly, you would be safe. On the other hand,
staying is risky. You could be injured or even killed if the storm
comes ashore within 10 miles of your home. If the hurricane’s
path changes, however, you would be safe without having
incurred the cost of evacuating.

Objectives? Alternatives? Uncertainties? Consequences?

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 Possible Forecast Outcomes
Hurricane
Forecasts Path Hits Miami
“Will Hit Miami” Misses Miami
“Will Miss Miami”

Decision Consequen
ce

Choices
Choice Outcome Consequence
Evacuate
Stay Evacuate Hits Miami Safety, High Cost
Misses Miami

Stay Hits Miami Danger, Low Cost

Involves one decision and two uncertain events at the
time of the Decision Safety, Low Cost
Analysis. One uncertain event is known at the time that Misses Miami
the decision is made. 38
Imperfect Information – Hurricane Example

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Imperfect Information – Hurricane Example

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Sequential Decisions – Hurricane Example
Suppose you are waiting anxiously for the
forecast as the hurricane is bearing down. Do
you wait for the forecast or leave immediately?
If you wait for the forecast, what you decide to
do may depend on that forecast. In this
situation, you face a sequential decision
situation.

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Sequential Decisions – Hurricane Example

Forecast Hurricane
Path

Wait for
Forecast? Evacuate?

Consequence

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Sequential Decisions – Hurricane Example
The order of the events is implied by the arcs.
Because there is no arc from “Forecast” to “Wait for
Forecast” but there is one to “Evacuate,” it is clear
that the sequence is first to decide whether to wait
or leave immediately. If you wait, the forecast is
revealed, and finally you decide, based on the
forecast, whether to evacuate.

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Intermediate Calculations for Additional Clarity
New Product Design Example
A firm is considering introducing a new product. The
firm’s fundamental objective is the profit level of
the enterprise, and so we label the consequence
node “profit”. At a very basic level, both cost and
revenue may be uncertain, and so a first version of
the influence diagram might look like the one
shown,

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Intermediate Calculations for Additional Clarity
New Product Design Example

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Intermediate Calculations for Additional Clarity
New Product Design Example

On reflection, the firm’s CEO realizes that substantial uncertainty

exists for both variable and fixed costs. On the revenue side, there
is uncertainty about the number of units sold, and a pricing
decision will have to be made. These considerations leads CEO to
consider a somewhat more complicated influence diagram.

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Intermediate Calculations for Additional Clarity
New Product Design Example

Units
Sold Fixed
Cost

Variable
Price Cost

Profit
Introduce
Product?

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Intermediate Calculations for Additional Clarity
New Product Design Example

We can include intermediate nodes to calculate cost on one hand

and revenue on the other ;we will call these calculation nodes,
because they calculate cost and revenue given the predecessors.

Whenever a node has a lot of predecessors, it may be

appropriate to include one or more intermediate calculations to
define the relationships among the predecessors more precisely.

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 Intermediate Calculations for Additional Clarity
New Product Design Example
Intermediate Units
Fixed
nodes added for Sold
Cost
additional clarity
Variable
Price Cost

Revenue Cost

Introduce Profit
Product?

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Building an influence Diagram:

1. List all the decisions.

2. Draw sequence relationships between decisions.
3. Identify the consequence node.
4. Breakdown the consequence node.
5. Draw relationships from decision nodes to the
intermediate calculation nodes.

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Building an influence Diagram (Cont’d)
6. List all the uncertainty nodes.
7. Draw the relevance arcs between uncertainty
nodes.
8. Draw the sequence relationships from uncertainty
nodes to the decision nodes.
9. Draw the relevance arcs from the decision nodes
to the uncertainty nodes.
10. Draw the relevance arcs from the uncertainty
nodes to the intermediate calculation nodes.
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 Building an influence Diagram
Example : Toxic Chemicals and the EPA

The Environmental Protection Agency often must decide whether to

permit the use of an economically beneficial chemical that may be
carcinogenic (cancer-causing). Furthermore, the decision often must be
made without perfect information about either the long-term benefits or
health hazards. Alternative courses of action are to permit the use of the
chemical, restrict its use, or to ban it al together.

Tests can be run to learn something about the carcinogenic potential, and
survey data can give an indication of the extent to which people are
exposed when they do use the chemical. These pieces of information are
both important in making the decision. For example, if the chemical is
only mildly toxic and the exposure rate is minimal, then restricted use
may be reasonable. On the other hand, if the chemical is only mildly toxic
but the exposure rate is high, then banning its use may be imperative.
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Building an influence Diagram
Example : Toxic Chemicals and the EPA

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Building an influence Diagram
Example : Toxic Chemicals and the EPA

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Building an influence Diagram
Example : Toxic Chemicals and the EPA

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Building an influence Diagram

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Building an influence Diagram
Common Mistakes :

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Decision Trees
To display more of the details, we can use a
decision tree
As with influence diagram,
 squares represent decisions to be made, branches
form a square represent the possible alternatives
 circles represent chances available to the decision
maker, and the branches from a circle represent the
possible outcomes of a chance event.
 consequence, is specified at the ends of the
branches.

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Elements are represented by:

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 Decision Trees
Can display more details than influence diagrams
Branches from circle =
possible outcomes of a
chance event
Phrases at end of
Square = the branches =
decision to consequences
be made

Branches from square =

choices available to
decision maker

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Interpreting Decision Trees
1. Options shown by branches from a decision node
indicate that the decision maker can choose only one
option
2. Branches from each chance node form a set that is:
Mutually exclusive – only one outcome can happen
And collectively exhaustive – no other possible
outcomes exist.

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Interpreting Decision Trees
3. The decision tree shows all of the possible paths that
the decision maker might follow.
 All possible decision alternatives
 All possible chance outcomes
4. Often helpful to view the nodes as occurring
chronologically
 Beginning on the left side of the tree: this is the first
thing to happen, usually a decision
 Moving to the right: consequent decisions or chance
events happen

© 2014 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Venture Capitalist Investment Example:

Venture Succeeds Large Returns on Investment

Venture Fails
Funds Lost
Invest

Do not invest “Typical” Returns Earned

On Less Risky Investment

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 The Investor’s Basic Risky Decision Example:
Final Cash
Position

Wild Success $5000

Invest in Business
Flop
Invest 0

Savings $2200

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Decision Trees
1. Decision Trees are evaluated from left to right
2. Only one alternative can be chosen after each
decision node
3. Outcome from a chance event need to be
complete, i.e. not more than one outcome can
happen at the same time and one outcome will
happen.
4. Decision Trees represent all possible future
scenarios
5. Think of nodes as occurring in time sequence
6. If for chance nodes the order is not important
then use the easiest interpretation.

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Decision tree representation of the hurricane example

Safety Cost

Evacuate Safe High

Forecast Danger Low

Storm Hits Miami

Stay Safe
Storm Misses Miami Low

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Double Risk Dilemma

A variation of the basic risky decision might be called

the double-risk decision dilemma. Here the problem is
deciding between two risky prospects. On one hand,
you are “ damned if you do and damned if you don’t’ in
the sense that you could loss either way. On the other
hand, you could win either way.

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Double Risk Dilemma

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Range-of-Risk Dilemma

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Imperfect Information:

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Sequential Decisions

Wait

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Consequence Matrix
In the previous example, we have multiple
objectives. To include multiple objectives in a
decision tree, we use a Consequence Matrix like
the previous slide or as follows
Safety Cost
Safe High
Danger Low
Safe Low
Safe High
Danger Low
Safe Low
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Decision Trees and Influence Diagram compared:
When DP is complex decision trees, may get too
large for presentation.
For presentating a DP influence diagram are
superior.
Decision trees show more detail, hence are more
useful for in-depth understanding.
Influence diagrams are better in the structuring
phase.
For sensitivity analysis decision trees may be better.
Influence diagram present the relevance between
uncertainty nodes, decision trees do not.

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Use Influence Diagrams Or Decision Trees?
Each technique has its strength and weakness.
Using both may work complementary.
Influence Diagrams and Decision Trees must pass
the Clarity Test
No misunderstanding should be possible about the
basic key elements in the Decision Problem.

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Clarity Test
Clarity test can be applied to all elements of the
decision model. Once the problem is structured
and the decision tree or influence diagram built,
consider each node.
 Is the definition of each chance event clear enough so
that an outside observer would know exactly what
happened?
 Are the decision alternatives clear enough so that
someone else would know exactly what each one
entails?
 Are consequences clearly defined and measurable?

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STEP 3: FILL IN THE DETAILS
1. Define the elements in the decision model
clearly
Consider EPA Example:
Objective: Minimize the social cost of cancer
Definition?
Incremental Lives Lost
Incremental cases of cancer
Incremental cases of treatable cancer
Uncertain Event: Rate of Exposure
Definition?
Number of people exposed to the chemical per day
Ingesting a critical quantity
Skin contact
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3. Defining Measurement Scales for Fundamental Objectives

Objectives are measured in attributes:

Dollars
Hours
Percentage

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1. Objectives with Natural Attribute Scale

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2. Objectives With No Natural Attribute Scale

Example: Measuring Quality?

Solutions: Define an attribute scale:
BEST, BETTER, SATISFACTORY, WORSE,
WORST.
Each category needs to pass the CLARITY TEST.
Attribute Scale passes the CLARITY TEST if an
outside candidate using your definition can
allocate specimens to the identified categories.

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Practice Questions
Problem 3.4
Problem 3.9
Problem 3.11
Problem 3.18

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