LOG 307 - Optimisation and

Simulation for Decision-Making

January 2024

Zahraei and Ghosh, 2023

Zahraei and Ghosh, 2023
Study Unit 6 - Decision Analysis and Case
Studies

Simulation Decision Making under Uncertainty

Solving Supply Chain Problems using Simulation

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Zahraei and Ghosh, 2023
Study Unit Learning Outcomes

• Illustrate different elements of the decision-making process

• Examine a decision-making process under uncertainty.

• Formulate an optimisation model for a case study.

• Construct a simulation model for a case study.

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Chapter 11
Decision Making under
Uncertainty

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 Decision Analysis

✓ Managers always need to make decisions about future actions.

✓ But decision making can be a complicated task as the future can be uncertain
and objectives can be conflicting.
✓ Managers need to choose between several alternatives and decide which will
result in the maximum return.
✓ The aim of decision analysis is to help managers to make good decisions.

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 Decision Analysis - Elements
✓ Identification –the problem the managers need to solve.
✓ Decisions – possible decisions for the identified problems. Also called alternatives.
✓ Outcome – possible outcome of the decision taken.
✓ Probabilities – all of these possible outcomes have some probability of happening.
✓ Payoffs – each decision & outcome have different consequences.
✓ Decision Criterion – after identifying the problem, possible decisions, outcomes &
associated payoffs, managers need to use some criterion to choose the best decision based
on the probabilities of payoffs.
Commitment to action

Logic and Modeling

Decision Payoffs
criterion

Outcomes
(uncertain) Zahraei and Ghosh, 2023 6
 Types of uncertainty

❑Variation – it is given what will happen, but their range is not provided,
e.g., the completion time of a project

❑Foreseen uncertainty – the range of possible outcomes are known, but it is

not known which outcome will happen,
e.g., will get project approved or not

❑Unforeseen uncertainty – the possible range of uncertainty is so broad; it

cannot be effectively planned,
e.g., the impact of covid pandemic

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 Decision under foreseen uncertainty

✓ Foreseen uncertainty happens when all the possible outcomes are known.
✓ We may know the probabilities of these outcomes, or we may not.

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 Example 6.1. Investment Decision
➢ Joshua got $1,000 from his relatives during CNY. He is planning to invest this
money for one year to have some experience in investing, which can be helpful in
the future. He contacted a broker, suggesting three possible alternatives –
investing in a mutual fund, a growth stock, and a fixed deposit. The returns of
these investments vary and depend on the economic condition.

Alternatives Scenario (Economic Condition)

Up Down ✓ Which investment should Joshua pick?
Mutual Fund $350 -$250
Stock $600 -$800
Fixed Deposit $80 $80

✓ This decision problem can be solved differently based on the information available.
✓ First, consider the case when the probabilities of possible outcomes are not known
➔ We can employ a scenario approach for this problem.
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 Decision under Foreseen Uncertainty
Scenario Approach

✓ When probability information about the possible outcomes or scenarios, i.e., the
likelihood of that outcome happening, is unavailable, three common approaches
are generally used:
i. The optimistic approach
ii. The conservative approach
iii. The minimax regret approach

Determine the payoffs

Identify Define the uncertain resulting from
alternatives outcomes each decision and
the uncertain outcomes

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 Example 6.1. Investment Decision
Scenario Approach: The Optimistic Approach

▪ An optimistic decision maker feels that luck is always shining and whatever
decision is made, the best possible outcome corresponding to that decision will
occur.

Scenario (Economic Condition)

Alternatives
Up Down
Mutual Fund $350 -$250
Stock $600 -$800
Fixed Deposit $80 $80

Alternatives Maximum Return

Mutual Fund $350
Stock $600 Maximum Return
Fixed Deposit $80
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 Example 6.1. Investment Decision
Scenario Approach: The Conservative Approach

▪ A conservative decision maker wishes to ensure a guaranteed minimum

possible payoff, regardless of which outcome occurs.

Scenario (Economic Condition)

Alternatives
Up Down
Mutual Fund $350 -$250
Stock $600 -$800
Fixed Deposit $80 $80

Alternatives Maximum Return

Mutual Fund -$250
Stock -$800
Fixed Deposit $80 Maximum Return

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 Example 6.1. Investment Decision
Scenario Approach: The Minimax Regret Approach
✓ Another criterion that pessimistic or conservative decision makers frequently use is
the minimax regret criterion - minimizing the biggest possible “regret value” or “loss
of opportunity”.

❑ Construct a regret table or an opportunity loss table:

➢ Determine the best value among all possible decision alternatives for each
scenario. (Best value can be the maximum payoff or minimum cost based on the problem.)

➢ Compute the regret value for each decision alternative ➔ The best value minus the
payoff value of that alternative.

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 Example 6.1. Investment Decision
Scenario Approach: The Minimax Regret Approach

▪ A conservative decision maker wishes to ensure a guaranteed minimum

possible payoff, regardless of which outcome occurs.

Scenario (Economic Condition)

Alternatives
Up Down
Mutual Fund $350 -$250
Stock $600 -$800
Fixed Deposit $80 $80
Regret Table
Scenario (Economic Condition)
The best value minus the Alternatives
payoff value of that alternative.
Up Down
Mutual Fund $250 $330
Stock $0 $880
Fixed Deposit $520 $0
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 Example 6.1. Investment Decision
Scenario Approach: The Minimax Regret Approach
The minimax approach is as follows:

i. Find the maximum regret for each alternative from the regret table.

ii. Choose the decision alternative that has the minimum of the maximum regret.

Regret Table
Scenario
Alternatives (Economic Condition)
Up Down
Mutual Fund $250 $330 Investing in Mutual Fund for the
Stock $0 $880 minimax regret approach.
Fixed Deposit $520 $0

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 Decision under Foreseen Uncertainty
Expected Value Approach

If the probability of each scenario is available, an expected value approach can be

used.

i. Determine the expected payoff for each decision alternative ➔ The expected
payoff can be computed by multiplying the probability of each scenario with the
associated return and then by adding these products.

ii. Choose the decision alternative that the maximum expected payoff.

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Example 6.1. Investment Decision
Expected Value Approach

✓ Suppose, MAS has predicted that the economy will go up with a probability of
30% and will go down with a probability of 70%.

✓ How does Joshua use this information to decide about his investment?

Scenario (Economic Condition)

Alternatives Up Down
Expected Value (EV)
(30%) (70%)
Mutual Fund $350 -$250 = ($350×0.3) + (-$250×0.7) = -$70
Stock $600 -$800 = ($600×0.3) + (-$800×0.7) = - $380
Fixed Deposit $80 $80 = ($80×0.3) + ($80×0.7) = $80

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Chapter 12
Application of Optimisation and
Simulation in Practice

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 Problem 6.1 Putting the Link in Supply Chain
• Rick Eldridge is the new Vice President for operations at the The Golfer’s Link (TGL), a company specializing in
the production of quality, discount sets of golf clubs. TGL produces three different lines of golf clubs for men,
women, and junior golfers at manufacturing plants in Daytona Beach, Memphis, and Tempe. The plant in Tempe
produces all three lines of clubs while the one in Daytona only produces Men’s and Women’s lines, and
the plant in Memphis only produces the Women’s and Junior’s lines.

• Each line of clubs requires varying amounts of three raw materials that are sometimes in short supply: titanium,
aluminum, and a distinctive rock maple wood that TGL uses in all of its drivers. The manufacturing process for
each line of clubs at each plant is identical. Thus, the amount of each of these materials required in each set of
the different lines of clubs is summarized in the following table:

Table 1: Resources required per Club Set (in lbs)

Men's Women's Junior's
Titanium 2.9 2.7 2.5
Aluminum 4.5 4 5
Wood 5.4 5 4.8

Table 2: Estimated resource Availability (in lbs)

• The estimated amount of each of these key resources
Daytona Memphis Tempe
available at each plant during the coming month is given as: Titanium 4500 8500 14500
Aluminum 6000 12000 19000
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Wood 9500 16000 18000
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 Problem 6.1 Putting the Link in Supply Chain Cont’d
Table 3: Price of Club Sets
• Revenue per each item regardless of where they are produced is as follows: Men's Women's Junior's
$ 225.00 $ 195.00 $ 165.00
• Club sets are shipped from the production plants to distribution centers Table 4: Number of Club Sets Ordered
in Sacramento, Denver, and Pittsburgh. TGL’s contract with this To \ From Men's Women's Junior's
distributor requires the company to fill at least 90% of all distributor Sacramento 700 900 900
Denver 550 1000 1500
orders. Assume demand for the following month is: Pittsburgh 900 1200 1100

Table 5: Shipping Costs

Men's Women's Junior's
To \ From Daytona Tempe Daytona Memphis Tempe Memphis Tempe
• Shipping cost are as follows: Sacramento $51 $10 $49 $33 $9 $31 $8
Denver $28 $43 $27 $22 $42 $21 $40
Pittsburgh $36 $56 $34 $13 $54 $12 $52

a. Formulate an LP model for this problem.

b. Create a spreadsheet model for this problem and solve it using Solver. What is the
optimal solution?
c. If Rick wanted to improve this solution, what additional resources would be needed and
where would they be needed? Explain.

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 Problem 6.2 Putting the Link in Supply Chain

• Use the optimal solution derived for

Problem 6.1 and formulate a simulation
% of increase in Shipping Costs
model by including the new information. to Tempe from Production facilities
Probability
0% 0.5
• Then, examine how the optimal profit 15% 0.3
changes with the uncertainty in shipping 25% 0.2
charges between the production facilities
and Tempe distribution centre.

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Summary
• Managers take decisions and most of the time there is uncertainty present.
• Managers use various approaches to take their decisions and these approaches are
generally based on the attitude of the decision-makers, when probabilities of different
possible outcomes are not known.
• When the probabilities of different possible outcomes are known, they can use the
expected value approach to determine the best alternative.
• The modelling techniques learned in this course can be useful to solve real life
problem.
• We solve a problem where all the parameters are deterministic.
• Then, we extend the problem to include uncertainty and use simulation to address
the problem.

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THANK YOU!

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Zahraei and Ghosh, 2023