SUMMARY MATERI

DECISION ANALYSIS
2020
 Linear Programming: An Overview
■ Objectives of business decisions frequently involve maximizing
profit or minimizing costs.
■ Linear programming uses linear algebraic relationships to
represent a firm’s decisions, given a business objective, and
resource constraints.
■ Steps in application:
1. Identify problem as solvable by linear programming.
2. Formulate a mathematical model of the unstructured
problem.
3. Solve the model.
4. Implementation
 Model Components
• Decision variables - mathematical symbols representing levels of
activity by the firm.
• Objective function - a linear mathematical relationship describing an
objective of the firm, in terms of decision variables - this function is to
be maximized or minimized.
• Constraints – requirements or restrictions placed on the firm by the
operating environment, stated in linear relationships of the decision
variables.
• Parameters - numerical coefficients and constants used in the
objective function and constraints.
Model Formulation Steps

Step 1 : Define the decision variables

Step 2 : Define the objective function

Step 3 : Define the constraints

TERMINOLOGY MIN COST FLOW
PROBLEM
• The model for any minimum cost flow problem is represented by a
network with flow passing through it
• Elements:
• Nodes
• Supply Node
• Demand Node
• Transshipment node
• Arcs

9.5
APPLICATION OF BINARY
VARIABLES
• Since binary variables only provide two choices, they are
ideally suited to be the decision variables when dealing with
yes-or-no-questions

9.6
DECISION ANALYSIS
TERMINOLOGY
• The decision maker is the individual or group responsible for making the decision.
• The alternatives are the options for the decision to be made.
• The outcome is affected by random factors outside the control of the decision
maker. These random factors determine the situation that will be found when the
decision is executed. Each of these possible situations is referred to as a possible
state of nature.
• The decision maker generally will have some information about the relative
likelihood of the possible states of nature. These are referred to as the prior
probabilities.
• The payoff is a quantitative measure of the value to the decision maker of the
outcome. It is often the monetary value.
9.7
THE MAXIMAX CRITERION
• The maximax criterion is the decision criterion for the
eternal optimist.
• It focuses only on the best that can happen.
• Procedure:
– Identify the maximum payoff from any state of nature for each alternative.
– Find the maximum of these maximum payoffs and choose this alternative.
THE MAXIMIN CRITERION

• The maximin criterion is the decision criterion for the total

pessimist.
• It focuses only on the worst that can happen.
• Procedure:
– Identify the minimum payoff from any state of nature for each alternative.
– Find the maximum of these minimum payoffs and choose this alternative.
 THE MAXIMUM LIKELIHOOD
CRITERION
• The maximum likelihood criterion focuses on the most likely
state of nature.
• Procedure:
– Identify the state of nature with the largest prior probability
– Choose the decision alternative that has the largest payoff for this state of nature.
BAYES’ DECISION RULE

• Bayes’ decision rule directly uses the prior probabilities.

• Procedure:
– For each decision alternative, calculate the weighted average of its payoff by multiplying
each payoff by the prior probability and summing these products. This is the expected
payoff (EP).
– Choose the decision alternative that has the largest expected payoff.
DECISION TREES
• A decision tree can apply Bayes’ decision rule while displaying
and analyzing the problem graphically.
• A decision tree consists of nodes and branches.
– A decision node, represented by a square, indicates a
decision to be made. The branches represent the possible
decisions.
– An event node, represented by a circle, indicates a random
event. The branches represent the possible outcomes of the
random event.