DECISION ANALYSIS/ THEORY 1. The field of decision analysis provides a framework for making important decisions. 2.

Decision analysis allows us to select a decision from a set of possible decision alternatives when uncertainties regarding the future exist. 3. The goal is to optimize the resulting payoff in terms of a decision criterion. 4. Maximizing expected profit is a common criterion when probabilities can be assessed The six step in decision theory 1. 2. 3. 4. 5. 6. Clearly define the problem at hand. List the possible alternatives. Identify the possible outcomes. List the payoff or profit of each combination of alternatives and outcomes. Select one of the mathematical decision theory models. Apply the model and make your decision.

Example: Fauziah Company Define problem To introduce one of three new products 1. Keropok 2. Satay 3. Chips The market could be favorable, stable or unfavorable for the payoffs of the products List the payoff for each state of nature/decision alternative combination Decision tables and/or trees can be used to solve the problem Solutions can be obtained and a sensitivity analysis used to make a decision

List alternatives

Identify outcomes List payoffs Select a model Apply model and make decision

Payoff Tables A table showing payoffs of all combinations of decision alternatives and states of nature. Payoff can be expressed in term of profit, cost, time, distance, or any other appropriate measure. In a Payoff table: o The rows correspond to the possible decision alternatives. o The columns correspond to the possible future events. o Events (states of nature) are mutually exclusive and collectively exhaustive.

Conditional payoffs of Fauziah Company State of Nature Favorable (RM) 18,000 12,000 11,000 Stable (RM) 9,000 7,000 10,000 Unfavorable (RM) -5,000 2,000 -6,000

Alternative Keropok Satay Chips

Types of Decision-Making Environments: 1. Decision making under certainty. The future state-of-nature is assumed known. 2. Decision making under uncertainty. There is no knowledge about the probability of the states of nature occurring. 3. Decision making under risk. There is some knowledge of the probability of the states of nature occurring. Decision making under uncertainty 1. The decision criteria are based on the decision makers attitude toward life. 2. The criteria include the: o Maximax Criterion - optimistic or aggressive approach An optimistic decision maker believes that the best possible outcome will always take place regardless of the decision made. An aggressive decision maker looks for the decision with the highest payoff (when payoff is profit). o Maximin Criterion - pessimistic or conservative approach. A pessimistic decision maker believes that the worst possible result will always occur. A conservative decision maker wishes to ensure a guaranteed minimum possible payoff. o Minimax Regret Criterion - pessimistic or conservative approach. The payoff table is based on lost opportunity, or regret. The decision maker incurs regret by failing to choose the best decision. o Hurwiczs criterion of realism o Laplace s equally likely criterion

EXERCISE