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DECISION ANALYSIS:
INTRODUCTION
Nur Aini Masruroh
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Sharpening the saw

Suppose you were to come upon
someone in the woods working
feverishly to saw down a tree.
• "What are you doing?" you ask.
• "Can't you see?" comes the impatient
reply. "I'm sawing down this tree."
• "You look exhausted!" you exclaim.
"How long have you been at it?"
• "Over five hours," he returns, "and I'm
beat! This is hard work."
• "Well why don't you take a break for a
few minutes and sharpen that saw?"
you inquire. "I'm sure it would go a lot
faster."
• "I don't have time to sharpen the saw,"
the man says emphatically. "I'm too
busy sawing!“
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Decision Under
Scenario 1 Uncertainties

Roy has prostate cancer. He has three alternatives: surgery,

chemotherapy and playing a lot of golf. Prostate cancer is a very bad
disease, so he will die soon, regardless of what he does.
He likes to play golf. If he chooses golf (and has no medical
treatment), he will live on year in pain, but be able to enjoy his golf
game during that time, then he will die.
If he undergoes chemotherapy, he will suffer tremendous nausea for
six months and then he will either live for one good year or die right
away.
If he has prostate surgery he will either live two good years or die on
the operating table.
He says he wants to make his decision based on the probabilities
assigned by his doctor, who says that there is a 60% chance that the
surgery will give its better outcome and a 60% chance that
chemotherapy will give its better outcome. Which alternative should
Roy choose?
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Scenario 2
• Ms Anna, an attractive lady with graduate degree, must
decide among many suitors. Among them include:
• Mr. A is very competitive person, holds a high paying job, but not
religiously devoted.
• Mr. B loves to do community work during weekends, and holds a
reasonable job with a stable income.
• Mr. C does not have a full time job but he is very active in religion
related activities

Multiple Criteria Decision

Making
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DA Classification
• Decision Making Under Uncertainties (DMUU)
• uncertainty modeling, decision theory, making choices
• Decision Support System (DSS)
• Multiple Criteria Decision Making (MCDM)
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Why are decisions hard to make?

The decision makers are faced with the followings:
1. Complexity
• There are many alternatives or possible solutions
• There are many factors to be considered and many of these
factors are interdependent
2. Uncertainty
• The possible future outcomes are uncertain or difficult to
predict
• Information may be vague, incomplete, or unavailable
3. Multiple conflicting objectives
• The decision maker(s) may have many goals and objectives
• Many of these goals or objectives may be conflicting in nature
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Why does DA offer?

• A conceptual framework for thinking systematically
about hard and complex decision problems as to achieve
clarity of action

• DA provides a set of tools for

• Structuring and representing the dependencies among all the
alternatives and factors in the problem using decision trees
• Dealing with risks and uncertainty explicitly using probabilities
• Taking into account the risk taking attitude of the decision maker(s)
• Computing best alternatives under different future scenarios
• Managing information collection process for model enhancement
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What questions can DA answers?

• What is my best course of action?
• How risky is this project if I follow the recommended
actions?
• Which are the most important assumptions?
• What potentials are realizable in this project?
• Are there more information or data which can help me
enhance my decision and how much are these
information worth paying for?
• How much it is worth to be able to control the outcome of
an uncertain variable?
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What is a decision?
• A decision is a commitment to a specific course of action
that irrevocably allocates valuable resources (Ronald
Howard)
• Example of decision:
• To fund a research project
• To take pursue this degree
• To go on an overseas holiday
• To take an umbrella when going out
• Example of non-decision:
• Regret not buying a certain item because the price has risen
• Worry about the not able to graduate from this program
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Approaches to studies on decision

making
• Normative approach: concerned with how rational
decisions ought to be made
• Optimality
• Rationality
• Economics
• Descriptive (behavioral) approach: concerned with
understanding how humans actually make decisions
• Developing psychological models of human cognition and thinking
• Explaining human behaviors
• Predicting human behaviors
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Which approach to follow?

• Normative approach: ideal for complex decision situation
as it ensures that rational decisions are made
• However psychological experiments have found that
humans do not follow the norms prescribed by the
normative approach
• They also found that humans are not very good in
estimating probabilities
• Hence, normative approach alone is insufficient for real
world applications
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Prescriptive approach
• Prescriptive approach is normative approach taking into
account descriptive
• It subscribes fundamentally to the normative approach
and prescribe the procedures for decision modeling and
analysis that take into account the limitation of humans as
revealed by the descriptive approach
• DA is based on prescriptive approach
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Good decision versus good outcome

Good
decision

Good Bad
outcome outcome

Bad
decision

• Good decision is not guarantee good outcome – it only

enhances the chance
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Different roles in conducting DA

• Decision makers
• Stake holders or people who will make the final decision and will be
held accountable for it
• Decision analyst or consultants:
• Person or team who facilitates the decision making process
• This course will train you to be a decision analyst or consultant
• The analyst must not assume the role of the decision maker
(unless he is also the decision maker)
• Domain expert
• These are the people called in to provide expert opinion, expert
judgment, etc
The DA cycle

Confusion,
Clarity of
doubt, Formulation Evaluation Appraisal Act? action
uncertainty

Revision

Repeat steps of formulation, evaluation, and appraisal until a clear

decision is obtain
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Formulation phase
• What is the decision?
• Four questions to answer:
• Which problems will be address in ths analysis? – scope of
analysis
• What choices do we have? – the alternatives
• What make the choices difficult? – the uncertainties that affect the
outcome of the decision
• What are the criteria for making a choice? – decision maker’s
preferences
• The result is that we conceptualize and structure the
decision problem into a model which also called the
decision basis
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Decision’s elements

What you
can do
What you
know

What you
want or
value

Decision model
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Evaluation phase
• Address the question: “what is the recommended
alternative?”
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Appraisal phase
• Answer the question: “Why the recommended alternative
should be implemented?”
• Sensitivity analysis is performed to evaluate the
robustness of the recommendation
• Value of information analysis is performed
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The coin tossing game or deal

• A coin is to be tossed. If you call the outcome (e.g. picture
or number) correctly, you will be paid Rp 100.000,
otherwise nothing.
• You have to pay some money to play the game
• The game is offered to you only once regardless of the
outcome
• What is the maximum you are willing to pay for the right to
play the game?
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Personal Indifferent Buying Price

• The maximum you are willing to pay to play the game is
called your personal indifferent buying price (PIBP)
• How did you arrive at your buying price?
• Did you perform any calculation to arrive it? What is it?
• Did everybody in the class have the same buying price?
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Personal Indifferent Selling Price

• Suppose you bid for Rp X to won the right to play the
previous game. Note that Rp X should be less then or
equal to your personal indifferent buying price
• You pay Rp X and now has the right to play the game
• You can play the game immediately and resolve the
outcomes, but you also have option to sell the right to
another person and ask your friends to bid for it.
• What is the minimum amount for which you will sell the
right to play the game to another person?
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Personal Indifferent Selling Price

• The minimum you are willing to sell the game to another
person is called your personal indifferent selling price
(PISP)
• Your PISP is also called the certainty equivalent
• Is your PISP above or below Rp 50.000?
• What is so special about Rp 50.000?
• What can you say about your risk attitude?
• Is your PISP equal to your original PIBP for the deal?
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Value of information
• While you are still thinking about selling the deal and is
pondering about your uncertain future prospects on the
deal a person came along and offer to tell you the
outcome of the toss
• Suppose this person knows the outcome and will not lie to
you, what is the amount you should be willing to pay him
for the information?
• The above mount is called the value of information
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Higher stakes: does everything scale up?

• The game is now played for Rp 500.000 or nothing
• What is your personal indifferent buying price?
• Is it 5 times that of the Rp 100.000 case?
• Suppose you win the right to the game. What is now your
personal indifferent selling price?
• Is it 5 times that of the Rp 100.000 case?
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The sunk cost principle

• Review of a concept from engineering economy
• You paid Rp 50.000 for a movie and halway through,
found it pretty boring
• What should you do?
• Stay on no matter what since you have already paid Rp 50.000
• Sleep in the cinema hall and enjoy the air-con
• Walk out and do something more satisfying
• What you have already paid is called a sunk cost. It
should not be considered in choosing the best alternative
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References
• Clemen, R.T. and Reilly, T. (2001). Making Hard Decisions
with Decision Tools. California: Duxbury Thomson
Learning
• Howard, R.A, (1988). Decision Analysis: Practice and
Promise. Management Science, 34(6), pp. 679 – 695.
• Saaty, T.L. (1990). How to Make a Decision: the Analytic
Hierarchy Process. European Journal of Operation
Research, 48, pp. 9 – 26.
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