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Decision Mak
Decision Mak
Decision Theory
Operations Management
William J. Stevenson
6th
edition
5s-2
Decision Theory
CHAPTER
2s
Decision Making
McGraw-Hill/Irwin
Operations Management, Eighth Edition, by William J. Stevenson Copyright 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
5s-3
Decision Theory
Decision Theory
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Decision Theory
A set of possible future conditions exists that will have a bearing on the results of the decision
A list of alternatives for the manager to choose from A known payoff for each alternative under each possible future condition
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Decision Theory
Identify possible future conditions called states of nature Develop a list of possible alternatives, one of which may be to do nothing Determine the payoff associated with each alternative for every future condition
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Decision Theory
Evaluate alternatives according to some decision criterion and select the best alternative
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Decision Theory
Bounded Rationality The limitations on decision making caused by costs, human abilities, time, technology, and availability of information
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Decision Theory
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Decision Theory
Decision Environments
Certainty - Environment in which relevant parameters have known values Risk - Environment in which certain future events have probable outcomes Uncertainty - Environment in which it is impossible to assess the likelihood of various future events
Payoff Table
Possible future demand* Alternatives Low Moderate High
Small facility Medium facility Large facility $10 7 (4) $10 12 2 $10 12 16
Figure 5S.1
Decision Point Chance Event
Payoff 3
1
B
Payoff 4
2
Payoff 5 Payoff 6
A manager must decide on the size of a video arcade to construct. The manager has narrowed the choices to two: large or small. Information has been collected on payoffs, and a decision tree has been constructed. Analyze the decision tree and determine which initial alternative (build small or build large) should be chosen in order to maximize expected monetary value.
Approach I : Expected value of perfect information: the difference between the expected payoff under certainty and the expected payoff under risk
Sensitivity Analysis
#2 Payoff
Example S-8
#1 Payoff
B A C
16 14 12 10 8 6 4 2 0
B best
C best
A best
16 14 12 10 8 6 4 2 0
Sensitivity analysis: determine the range of probability for which an alternative has the best expected payoff