General Modeling

Introduction
THE MODELING PROCESS
Managerial Approach to Decision Making
Manager analyzes
situation (alternatives) These steps
Use
Makes decision to Spreadsheet
Modeling
resolve conflict

Decisions are
implemented

Consequences
of decision
A Detailed View of the Modeling Process
1. Diagnose the problem
2. Select relevant aspects of reality
3. Organize the facts; identify the assumptions,
objectives, and decisions to be made
4. Select the methodology
5. Construct the model
6. Solve the model (generate alternatives)
7. Interpret results (in “lay” terms!)
8. Validate the model (does it work correctly?)
9. Do sensitivity analysis (does the solution change?)
10. Implement the solution
11. Monitor results
THE MODELING PROCESS

Analysis
Model Results

Interpretation
Abstraction

Symbolic
World

Real
World

Management Intuition
Decisions
Situation
 The Modeling Process
Analysis

Model Results

Interpretation
Abstraction

Symbolic
World Managerial
Real Judgment
World

Management
Decisions
Situation
Intuition
Reasons for Using Models
 Models force you to:
 Be explicit about your objectives
 Think carefully about variables to include and
their definitions in terms that are quantifiable
 Identify and record the decisions that
influence those objectives
 Identify and record interactions and trade-offs
among those decisions
Reasons (cont.)
 Consider what data are pertinent for
quantification of those variables and
determining their interactions
 Recognize constraints (limitations) on the
values that those quantified variables may
assume
 Allow communication of your ideas and
understanding to facilitate teamwork
Types of Models
Building Models

The “Black Box” View of a Model

Decisions Performance
(Controllable) Measure(s)
Model
Parameters Consequence
(Uncontrollable) Variables
MODELING VARIABLES
Management
Modeling Term Lingo Formal Definition Example
Decision Variable Lever Controllable Exogenous Investment
Input Quantity Amount

Parameter Gauge Uncontrollable Exogenous Interest Rate

Input Quantity

Consequence Outcome Endogenous Output Commissions

Variable Variable Paid

Performance Yardstick Endogenous Variable Return on

Measure Used for Evaluation Investment
(Objective Function Value)
Examples of Decision Model
Assumptions - Profit Models
 If it is beyond your control, do not consider
it!
 Overhead costs - a convenient fiction - we
ignore
 Sunk costs - we ignore
 Depreciation - only include if we can use to
shield future taxes
 Costs are linear in the short term
 DETERMINISTIC AND
PROBABILISTIC MODELS

Deterministic Models

are models in which all relevant data are assumed to be known

with certainty.
can handle complex situations with many decisions and constraints.
are very useful when there are few uncontrolled model inputs
that are uncertain.
are useful for a variety of management problems.
allow for managerial interpretation of results.
will help develop your ability to formulate models in general.
 DETERMINISTIC AND
PROBABILISTIC MODELS
Probabilistic (Stochastic) Models

are models in which some inputs to the model are not known
with certainty.
uncertainty is incorporated via probabilities on these “random”
variables.
very useful when there are only a few uncertain model inputs and
few or no constraints.
often used for strategic decision making involving an organization’s
relationship to its environment.
 ITERATIVE MODEL BUILDING
Deductive Modeling
focuses on the variables themselves before data are collected.
variables are interrelated based on assumptions about algebraic
relationships and values of the parameters.
places importance on modeler’s prior knowledge and judgments of
both mathematical relationships and data values.
tends to be “data poor” initially.

Inferential Modeling
focuses on the variables as reflected in existing data collections.
variables are interrelated based on an analysis of data to
determine relationships and to estimate values of parameters.
available data need to be accurate and readily available.
tends to be “data rich” initially.
 ITERATIVE MODEL BUILDING
DEDUCTIVE MODELING

Models Models

Model Building
PROBABILISTIC DETERMINISTIC
MODELS Process MODELS
Models Models

INFERENTIAL MODELING
Philosophy of Modeling
 Realism
 A model is valuable if you make better
decisions when you use it than when you
don’t.
 Intuition
 A manager’s intuition arbitrates the content of
the abstraction, resulting model, analysis, and
the relevance and interpretation of the results.