Decision Making Under Certainty and Uncertainty: Learning Objectives

MODULE 3
Decision making under Certainty and Uncertainty
Learning Objectives:
OVERVIEW: • Understand and use techniques that apply to

decision making under different decision
Decision making is an integral part of operations environments
management. There are different approach and tools • Construct a decision tree and use it to analyze
that may aid managers in decision making. These may a problem.
include the use of payoff tables and probabilities, • Compute the expected value of perfect
decision trees and sensitivity analysis. information.
• Conduct sensitivity analysis on a simple
decision problem.
3.1 Decision Environments

Operations manager always faces decision making in the management of operations. The decision environment can be
categorized according to the degree of certainty present. Certainty environment in which relevant parameters have
known values, Risk Environment in which certain future events have probable outcome, and Uncertainty Environment in
which it is impossible to assess the likelihood of various future events.
DECISION MAKING UNDER CERTAINTY

When it is known for certain which of the possible future conditions will actually happen, the decision is usually
relatively straightforward: Simply choose the alternative that has the best payoff under that state of nature.
DECISION MAKING UNDER UNCERTAINTY

Under uncertainty, no information is available on how likely the various states of nature are. Decision approaches that
can bus used are:
▪ Maximin—in this approach you will choose the alternative with the best of the worst possible pay-offs
▪ Maximax—here you will choose the alternative with the best possible payoff
▪ Laplace—choose the alternative with the best average payoff of any of the alternatives.
▪ Minimax regret—in this you choose the alternative that has the least of the worst regrets
DECISION MAKING UNDER RISK

Between the two extremes of certainty and uncertainty lies the case of risk: The probability of occurrence for each state
of nature is known. A decision approach that can be used in this environment is what we call the Expected Monetary
Value (EMV) criterion. Under this, determination of expected value is computed for each alternative and the one with
the best expected value is selected.
(See Example 5S-1 to 5S-4, Chapter 5 of Operations Management by William Stevenson for the illustrations of the
decision environments and the decision approaches)
3.2 Decision Trees
A decision tree is a schematic representation of the alternatives available to a decision maker and their possible
consequences. It is composed of nodes that have branches, square nodes represents decision points while the circle nodes
represent chance events, and the branches from the square nodes represent the alternatives. Decision trees are analyzed
from right to left; that is, starting with the last decision that might be made. For each decision, choose the alternative that
will yield the greatest return (or the lowest cost). If chance events follow a decision, choose the alternative that has the
highest expected monetary value (or lowest expected cost).
(See Example 5S-5, Chapter 5 of Operations Management by William Stevenson for the illustrations of the decision tree
analysis)
3.3 Expected Value of Perfect Information
When making decisions, there is always uncertainty because there are chances that the decision may turn out to be
incorrect. The expected value of perfect information (EVPI) is used to measure the cost of uncertainty as the perfect
information can remove the possibility of a wrong decision. It is the difference between the expected payoff with perfect
information and the expected payoff under risk.
There two ways to compute the EVPI, one is to to compute the expected payoff under certainty and subtract the expected
payoff under risk (EVPI=Expected Payoff under Uncertainty – Expected Payoff under risk), and the other is to use the regret
table to compute the EVPI. To do this, find the expected regret for each alternative. The minimum expected regret is equal
to the EVPI.
(See Example 5S-6, Chapter 5 of Operations Management by William Stevenson for the illustrations of computation of
EVPI)
3.4 Sensitivity Analysis
As been repeatedly said, there are different decision alternatives for the operations manager and these alternatives may
have different outcomes based on the occurrence of some condition/state of nature. Sensibility analysis helps decision
makers to determine the range of probability for which an alternative has the best expected payoff based on a given state
of nature.
(See Example 5S-8, Chapter 5 of Operations Management by William Stevenson for the illustrations of Sensitivity
Analysis)
Reference Used:
• William J. Stevenson, Production Operations Management
Exercise 1
A small building contractor has recently experienced two successive years in which work opportunities exceeded the firm’s
capacity. The contractor must now make a decision on capacity for next year. Estimated profits under each of the two
possible states of nature are as shown in the table below. Which alternative should be selected if the decision criterion is
a. Maximax? b. Maximin? c. Laplace? d. Minimax regret?
Exercise 2
Refer to Exercise 1. Suppose after a certain amount of discussion, the contractor is able to subjectively assess the
probabilities of low and high demand: P (low) .3 and P (high) .7.
a. Determine the expected profit of each alternative. Which alternative is best? Why?
b. Analyze the problem using a decision tree. Show the expected profit of each alternative on the tree.
c. Compute the expected value of perfect information. How could the contractor use this knowledge?
Exercise 3
Refer to Exercise 1 and 2. Construct a graph that will enable you to perform sensitivity analysis on the problem. Over
what range of P (high) would the alternative of doing nothing be best? Expand? Subcontract?
What am I learning from this

module?
What am I finding hard or

challenging about the topic?
What was the most important

thing I learned from this
module?

Decision Making Under Certainty and Uncertainty: Learning Objectives

Uploaded by

Copyright:

Available Formats

Decision Making Under Certainty and Uncertainty: Learning Objectives

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Decision Making Under Certainty and Uncertainty: Learning Objectives

Uploaded by

Copyright:

Available Formats

MODULE 3

Decision making under Certainty and Uncertainty

OVERVIEW: • Understand and use techniques that apply to

3.1 Decision Environments

DECISION MAKING UNDER CERTAINTY

DECISION MAKING UNDER UNCERTAINTY

DECISION MAKING UNDER RISK

3.3 Expected Value of Perfect Information

3.4 Sensitivity Analysis

What am I learning from this

What am I finding hard or

What was the most important

You might also like

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.