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Chapter 4

Comments on Shadow Price and Changes in Constraint RHS Values


Shadow prices hold only within RHS changes falling within the
values in Allowable Increase and Allowable Decrease.
Shadow prices for nonbinding constraints are always zero.
Shadow prices only indicate the changes that occur in the
objective function value as RHS values change.
Changing a RHS value for a binding constraint also changes the
feasible region and the optimal solution (see graph on following
slide).
Solvers Sensitivity Report

Answers questions about:

Amounts by which objective function coefficients can


change without changing the optimal solution.

The impact on the optimal objective function value of


changes in constrained resources.

The impact on the optimal objective function value of forced


changes in decision variables.

The impact changes in constraint coefficients will have on


the optimal solution.

Run Fig4-1.xlsm and show the sensitivity report


The Answer and Sensitivity Reports

A Warning about Degeneracy

The solution to an LP problem is degenerate if the Allowable


Increase of Decrease on any constraint is zero (0).

When the solution is degenerate:


1. The methods mentioned earlier for detecting alternate optimal
solutions cannot be relied upon.
2. The reduced costs for the changing cells may not be unique.
Also, the objective function coefficients for changing cells must
change by at least as much as (and possibly more than) their
respective reduced costs before the optimal solution would change.
3. The allowable increases and decreases for the objective function
coefficients still hold and, in fact, the coefficients may have to be
changed beyond the allowable increase and decrease limits before
the optimal solution changes.
4. The given shadow prices and their ranges may still be interpreted
in the usual way but they may not be unique. That is, a different set
of shadow prices and ranges may also apply to the problem (even if
the optimal solution is unique).
Chapter 1
A field of study that uses computers, statistics, and mathematics
to solve business problems.
Also known as: Operations research & Decision science
Benefits of Modeling
Economy - It is often less costly to analyze decision problems
using models.
Timeliness - Models often deliver needed information more
quickly than their real-world counterparts.
Feasibility - Models can be used to do things that would be
impossible.
Models give us insight & understanding that improves decision
making.

Example:
What is 1x2x3x4x5x6x7x8 ? Left group
What is 8x7x6x5x4x3x2x1 ? Right group
Anchoring Effects:
Arise when trivial factors influence initial thinking about a
problem.
Decision-makers usually under-adjust from their initial anchor.
Framing Effect

Refers to how decision-makers view a problem from a win-loss


perspective.

The way a problem is framed often influences choices in


irrational ways
Good Decisions vs. Good Outcomes
Good decisions do not always lead to good outcomes...
A structured, modeling approach to decision making helps us
make good decisions, but cant guarantee good outcomes.
Decisions & Outcomes

Concluding Thoughts
We face numerous decisions in life & business.
Math Modeling is useful
We need clear definition of the problem,
Assumptions
Variables
Objective
A variety of alternative solutions
Brute force/graphical/analytical/simulation
While brute force or graphical methods may be easy to
implement, they may not always lead to the optimal
solutions effectively
computers and spreadsheets can help todays managers.
Psychology may affect the outcome
Chapter 14
Introduction to Decision Analysis
Models help managers gain insight and understanding, but they
cant make decisions.
Decision making often remains a difficult task due to:
Uncertainty regarding the future
Conflicting values or objectives
Consider the following example...

Probabilistic Methods
At times, states of nature can be assigned probabilities
representing their likelihood of occurrence.
For decision problems that occur more than once, we can often
estimate these probabilities from historical data.
In these cases, subjective probabilities are often assigned based
on interviews with one or more domain experts.
Interviewing techniques exist for soliciting probability estimates
that are reasonably accurate and free of the unconscious biases
that may impact an experts opinions.
Decision Trees
A decision tree is a chronological representation of the decision
problem.
Each decision tree has two types of nodes; round nodes
correspond to the states of nature while square nodes
correspond to the decision alternatives.
The branches leaving each round node represent the different
states of nature while the branches leaving each square node
represent the different decision alternatives.
At the end of each limb of a tree are the payoffs attained from
the series of branches making up that limb.

Sensitivity Analysis
Sensitivity analysis can be used to determine how changes to
the following inputs affect the recommended decision
alternative:
probabilities for the states of nature
values of the payoffs
If a small change in the value of one of the inputs causes a
change in the recommended decision alternative, extra effort
and care should be taken in estimating the input value.
Utility Theory
Sometimes the decision with the highest EMV is not the most
desired or most preferred alternative.

Decision makers have different attitudes toward risk:


Some prefer A while others B.
Utility Theory incorporates risk preferences in the decision
making process
Comments
Certainty Equivalent - the amount that is equivalent in the
decision makers mind to a situation involving risk.
(e.g., $70,000 was equivalent to Alternative 2 with p = 0.8)
Risk Premium - the EMV the decision maker is willing to give up
to avoid a risky decision.
(e.g., Risk premium = $114,000-$70,000 = $44,000)
Using Utilities to Make Decisions
Replace monetary values in payoff tables with utilities.

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