DECISION MAKING TOOLS

1

Elements of Decision Problems2

3

Elements of Decision Problems1. Objectives

2. Decisions

3. Uncertain Events

4. Consequences

4

1. Objectives

Objective:

A specific thing one wants to achieve:

To harvest successfully – Farmer.

To resolve a specific scientific problem – Scientist.

To make a lot of money – Investor.

Super ComputerObjectives

Price•Five-Year Costs•Cost of Improved performance

Performance•Speed•Throughput•Memory Size•Disk Size•On-Site performance

User Needs•Installation Date•Rollin/Roll out•Ease of Use•Software Compatibility•Mean Time to Failure

Operational Needs•Square Footage•Water Cooling•Operator Tools•Telecommunications•Vendor Support

Management Issues•Vendor Health•US Ownership•Commitment to super computer

5

6

Decision Context

DECISION CONTEXT =

The setting in which a decision occurs

Decision Context activates only subset of objectives.

7

2. Decisions (to be made)

•At least two alternatives required

•Most decisions call for: The Immediate Decision

•Look at all possible decision alternatives: Be Creative!

•Decision may be of a sequential nature:

Future decisions may need to be taken into account when making immediate decision

List of possible decisions is important, but more important is the order in which they occur.

ImmediateDecision

SecondDecision

ThirdDecision

Final Decision

NowTime Line

Resultsare

known

8

9

3. Uncertain EventsMany decisions (All?) are made

under the presence of uncertainty

Investment decision: Will stock of company go up or not?

Camping decision: Will the weather be good or not?

Mutual fund decision: Will entire stock market go up?

A decisions problem becomes more complicated when the number of

relevant uncertain events increases

The time sequence of uncertain events related to the sequence of decision is important.

Why?

• Tells you what information becomes known before a decision has to be made

• Uncertain events may be unknown at the time of the immediate decision, but may be known by subsequent decisions

ImmediateDecision

SecondDecision

ThirdDecision

Final Decision

NowTime Line

Resultsare

known

Resolved beforesecond decision

Resolved beforethird decision

Resolved beforefinal decision

Resolved beforelast decision

11

12

4. Consequences

Evaluation of outcomes:• Profit – Measured in # Dollars• Casualties – Measured in # Deaths• Environmental Damage – Measured in # Polluted Soil• Health Risk – Measured in # Infected People

Trade off between has to be madein almost any decision problem

ImmediateDecision

SecondDecision

ThirdDecision

Final Decision

NowTime Line

PlanningHorizon

Resolved beforesecond decision

Resolved beforethird decision

Resolved beforefinal decision

Resolved beforelast decision

Conse-quences

Planning Horizon = Time when decision maker finds out the results

13

Larkin Oil

15m

14

• What is the immediate decisions?

• Is this a sequential decision problem?

• What is an appropriate planning horizon for

Larkin?

• A graphical representation?

15

Structuring Decisions16

17

Steps

Suppose elements of Decision Problem (DP) are available, i.e.:

• Objectives that apply to the decision context

• Immediate Decision and subsequent decision(s)

• Alternatives for each decision

• Uncertain elements (events)

• Consequences

How does one proceed with structuring the DP?

18

STEP 1: Filter & Operationalize the Objectives

STEP 2: Structure the elements in a logical

framework

STEP 3: Fill in the Details

STEP 1: Filter & Operationalize the Objectives

Getting the Decision Context right Enlarging Decision Context may increase the

number of objectives that are relevant. Decreasing the Decision Context may cause

current relevant objectives to become irrelevant.

Classify how to measure objectives

19

STEP 2: Structure the elements in a logical framework

20

• Structure Logic and time sequence between decisions

• Structure Logic (dependence) between the uncertain events

• Structure time sequence of uncertain events related to the sequence of decisions

• Represent Logic by using Influence Diagrams or Decision Trees

STEP 3: Fill in the Details21

e.g.;

• Give precise definitions of decisions & uncertain events

• Specify probability distributions for the uncertain events

through a combination of data analysis & expert judgment.

• Specify precisely how consequences are measured and

formalize trade off between objectives

Influence Diagrams22

23

About

An influence diagram (or decision diagram) is a graphical model used to represent the structure of a decision problem and the relationships among its different elements (uncertainties, decisions, and consequences).

The diagram is built based on the decision maker’s current state of knowledge about the situation.

different elements (uncertainties, decisions, and consequences).

24

• An influence diagram captures current state of

knowledge

• An influence diagram should NEVER contain cycles

• Interpreting an influence diagram is generally easy

• Creating influence diagrams is difficult

25

Basic ElementsA node is the basic element in an influence diagram. Each node corresponds to a specific distinction or variable, including uncertainties, decisions, and consequences.

Decision Chance/ Uncertainty

Deterministic Consequence/

Value/ Objective

26

An arc is a line with an arrowhead pointing from one node to another node in an influence diagram.We refer to the sending node as a parent and the receiving node as a child.If the child node is a decision node, then the arc is informational, and indicates that the parent node’s value will be known to the decision maker at the time the decision will be chosen. Otherwise, the arc is conditional, and indicates that we will be assessing a (probability) distribution for the child conditioned on its parents.

Logical relationships

Indicates Sequence; points only to Decision Nodes

Indicates Dependence; points only to Chance Nodes& Consequence Nodes

A B

Decision A is madebefore Decision B

D

Outcome of C is knownbefore Decision D is made

C

FE

Decision E is relevantto assessing probabilitiesof outcomes of F

G H

Outcome of E is relevantto assessing probabilitiesof outcomes of F

27

28

Basic Influence DiagramsBasic Risk Decision

InvestmentChoice

BusinessResult

Return on Investment

AlternativesSavingsBusiness

OutcomesWild SuccessFlop

Choice Business Result ReturnSavings Wild Success 2200

Flop 2200Business Wild Success 5000

Flop 0

InvestmentChoice

BusinessResult

Return on Investment

AlternativesSavingsBusiness

OutcomesWild SuccessFlop

Choice Business Result ReturnSavings Wild Success 2200

Flop 2200Business Wild Success 5000

Flop 0

Imperfect Information

Decision

HurricanePath

Consequence

Forecast

AlternativesEvacuateStay

OutcomesHits MiamiMisses Miami

ConsequenceChoice Outcome Risk CostEvacuate Hits Miami Low Risk High Cost

Misses Miami Low Risk High CostStay Hits Miami High Risk High Cost

Misses Miami Low Risk Low Cost

Forecast"Hits Miami""Misses Miami"

Decision

HurricanePath

Consequence

Forecast

AlternativesEvacuateStay

OutcomesHits MiamiMisses Miami

ConsequenceChoice Outcome Risk CostEvacuate Hits Miami Low Risk High Cost

Misses Miami Low Risk High CostStay Hits Miami High Risk High Cost

Misses Miami Low Risk Low Cost

Forecast"Hits Miami""Misses Miami"

29

Sequential Decisions

Evacuate?

HurricanePath

Consequence

Forecast

Wait for Forecast?

30

31

Intermediate Calculations (deterministic nodes)

Introduce Product?

Revenue

Profit

Cost

32

33

Introduce Product?

Units Sold

Profit

Fixed CostPrice?

VariableCost

34

Introduce Product?

Units Sold

Profit

Fixed CostPrice?

VariableCost

Revenue Cost

A Lease/Buy Problem The Amiable Insurance Company needs

additional copying capacity. They are currently negotiating with

Sharp Image (SI), manufacturer of the X100 copier.

Lease or buy the X100 from SI?

35

36

Facts: effective life of three years (length of planning

horizon). SI will sell an X100 copier to Amiable for $10,000. SI will lease Amiable an X100 copier for a yearly

fee of $1,500 plus a usage fee of 7¢per copy. maintenance fees (if purchased): $800 annually. X100 will have a salvage value of $1,000 at the

end of three years. expect to make 50,000 copies on the X100 per

year. interest rate for discounting purposes is 20%.

Amiable’s objective: minimize the total discounted costs associated with the X100 copier that are generated over the three year planning horizon.

Should they lease or buy the X100?

37

38

Enriching Determination of Salvage Value Salvage value now depends upon:

the purchase price (P); the length of the planning horizon (N);

and, the usage per year (U).

Specified askP/(N × U),where k is a given constant.

39

40

41

Example: Toxic Chemicals and the EPA

15m

42

43

44