Chapter 1

Introduction to Managerial Decision

Modeling

Management Science - BMGT 555

Professor Ahmadi

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 Learning Objectives
 Define decision model and describe its importance.
 Understand two types of decision models:
deterministic and probabilistic models.
 Understand steps involved in developing decision
models in practice.
 Understand use of spreadsheets in developing
decision models.
 Discuss possible problems in developing decision
models.

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 Introduction

 Quantitative approaches to decision making are based on

the scientific method.
 Names for this body of knowledge include: Management
Science, Operations Research, and Decision Science.
 It had its early roots in World War II and is flourishing in
business and industry with the aid of computers in
general and the microcomputer in particular.
 Some of the primary applications areas of this body of
knowledge are management, marketing, production
scheduling, capital budgeting, and transportation.

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 Types of Problem Information

 Quantitative data - numeric values that

indicate how much or how many.
• Production quantity
• Rate of return
• Financial ratios
• Cash flows
 Qualitative data - labels or names used
to identify an attribute -
• Pending state or federal legislation
• New technological breakthrough

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 Role of Spreadsheets in Decision Modeling

 Computers are an integral part of decision making.

 Spreadsheet packages are capable of handling
management decision modeling techniques. Have
built-in functions and procedures, such as:

• Goal Seek
• Data Table
• Solver
• Chart Wizard, and others.

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 Models

 Models are representations of real objects or

situations.
 Three forms of models are iconic, analog, and
mathematical.
• Iconic models are physical replicas (scalar
representations) of real objects.
• Analog models are physical in form, but do not
physically resemble the object being modeled.
• Mathematical models represent real world
problems through a system of mathematical
formulas and expressions based on key
assumptions, estimates, or statistical analyses.

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 Mathematical Models
 Cost/benefit considerations must be made in selecting
an appropriate mathematical model.
 Frequently a less complicated (and perhaps less
precise) model is more appropriate than a more
complex and accurate one due to cost and ease of
solution considerations.
 Mathematical models relate decision variables with
fixed or variable parameters.
 Frequently mathematical models seek to maximize or
minimize some objective function subject to
constraints.
 The values of the decision variables that provide the
mathematically-best output are referred to as the
optimal solution for the model.

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 Types of Decision Models

Decision
Models

Deterministic Stochastic
Models Models

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 Transforming Model Inputs into Output

Uncontrollable Inputs

Controllable
Output
Inputs Mathematical
(Projected
(Decision Model
Results)
Variables)

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 Steps Involved in Decision Modeling

1. Formulation.

2. Solution.

3. Interpretation.

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 Step 1: Formulation

 Defining the problem.

• Develop clear and concise problem statement.
 Developing a model.
• Select and develop a decision model.
• Select appropriate problem variables.
• Develop relevant mathematical relation for

consideration and evaluation.

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 Step 1: Formulation (Continued )

 Acquiring input data.

• Collect accurate data for use in the model.
• Possible data sources are:

Official company reports.

Accounting, operating, and financial
information.

Views, and opinions from knowledgeable
individuals.

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 Step 2: Solution

 Developing a solution involves:

• Manipulating model to arrive at the best
(optimal) solution.
• Solution of a set of mathematical expressions.
• Alternative trial and error iterations.
• Complete enumeration of all possibilities or
utilization of an algorithm.

Series of steps repeated until best solution is
attained.

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 Step 2: Solution (Continued )

 Testing a solution involves:

• Prior to implementation of model solution,
testing the solution.
• Testing of solution is accomplished by
examining and evaluating:

Data utilized in the model and

On the model itself.

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 Step 3: Interpretation

 Interpretation and What-if Analysis.

Analyzing the results and sensitivity analysis.
1. Vary data input values and examine
differences in various optimal solutions.
2. Make changes in the model parameters and
examine differences in various optimal
solutions.

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 Example: Iron Works, Inc.
Iron Works, Inc. (IWI) manufactures two products
made from steel and just received this month's
allocation of b pounds of steel. It takes a1 pounds of
steel to make a unit of product 1 and it takes a2
pounds of steel to make a unit of product 2.
Let x1 and x2 denote this month's production level of
product 1 and product 2, respectively. Denote by p1
and p2 the unit profits for products 1 and 2,
respectively.
The manufacturer has a contract calling for at least m
units of product 1 this month. The firm's facilities are
such that at most u units of product 2 may be
produced monthly. Develop a mathematical model
for the above.

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 The Model

 Mathematical Model Summary

Max p1x1 + p2x2

s.t. a1x1 + a2x2 < b
x1 > m
x2 <
u
x1 & x2 > 0

Suppose b = 2000, a1 = 2, a2 = 3, m = 60, u = 720, p1 = 100,

p2 = 200. Rewrite the model with these specific values.

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 Transforming Model Inputs into Output

Uncontrollable Inputs:
100, 200, 2, 3, 2000, 60, 720

The
The Model:
Model:
Max
Max Z Z= = 100x
100x11 + 200x22
Controllable Inputs: 22 xx11 + Output:
+ 33 xx22 <
< 2000
xx11 , x22 Profit Z
Z
xx11 >
> 60
xx22 < 720

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 Possible Problems in Developing
Decision Models

 Defining the Problem.

 Conflicting Viewpoints.
 Impact on Other Departments.
 Beginning Assumptions.
 Solution Outdated.
 Developing a Model.
 Fitting the Textbook Models.
 Understanding the Model.

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 Possible Problems in Developing
Decision Models -continued

 Acquiring Input Data.

 Validity of Data.
 Developing a Solution.
 Hard-to-Understand Mathematics.
 Only One Answer is Limiting.
 Testing the Solution.
 Analyzing the Results.

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 Implementation – Not Just The Final Step

 Decision models assist decision maker by

providing scientific method, model, and process
which is defensible and reliable.
 Overcome sole reliance upon intuition, hunches,
and experience.
 Mathematical models are the primary forms of
models used in Management Science.

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 Summary
Decision Models and Modeling -
 The three types of models are Iconic, Analog, and
Mathematical models.
 Mathematical Decision models are classified into two
categories:
• Deterministic models.
• Stochastic (Probabilistic) models.
 Approach includes three primary steps:
• Formulation.
• Solution.
• Implementation.

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The End of Chapter 1

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