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Decision Analysis
Method Ch 14 Audio 145
Variance :
The variance is a measure of risk
Ex1: Ex 2:
General Description
1.1 Definition:
Decision Analysis is an analytic and
systematic approach to studying of decision
making
6
Certain
Prof. Maged Morcos
Quantitative Analysis - Lc 6 14/07/2014
3.1 Objective:
Decision making is used to identify, decision
in 3 cases:
1. Decision making under Certainty:
In this case the decision-maker tends to
maximize his return or minimize his cost so
s/he will choose the decision that satisfy such
criteria in a problem where s/he knows the
outcomes with certainty.
2. Decision making under Risk:
In this case the problem is probabilistic, i.e.
the decision-maker can estimate or anticipate
the probability of occurrence of the events
(outcome) that the decision maker cannot
control which is called states of nature (in
England you should have with you heavy
cloth, umbrella and shoes for ice, precautions
you take them just in case, because of the
weather) associated with each decision
alternative.
In this case the decision maker tends to
maximize his expected return minimize the
expected loss. In this method the expected
criterion is used.
3. Decision making under Uncertainty:
Problem
3 partners want to make a decision, and they have different
attitude toward risk,
Their risk cannot estimate or anticipate the probability of
occurrence of something, for the future event w (payment,
cost, profit ), how they are going to behave ?
Notes:
We will solve the problem., and the other problem.
The idea of the decision making is to change the
attitude in making the decision better next time.
It is good to share in a co., you cant decide on your
own.
We need to consult one another at least on the higher
level.
To make life easy for the company and for us
We will got the higher dividend either we took the good
or the wrong decision.
To do this, we will decide the following:
Decision-Making Procedure
There are two type of Decision-making processes:
1. Decision-making without Probabilities
This includes two types:
(a) Matrix Decision Trees or Payoff tables
1. Maximax Criterion: Optimistic
approach
2. Maximin Criterion: Pessimistic
approach
Notes:
3 decision makers want to build a mall, they thought
about the alternatives, after a feasibility study ...
They found that the first alternative d1, the 2 is
medium, and the third is large complex
A state of nature will happen : ( something that can
happen from this decision, either the market will accept
their mall or the market will be low acceptance, these
are things they do not know about it
They ask the feasibility study responsible to make
analysis, and they found that the data ( after calculating
the profit, revenue and cost ..... )
they discovered :
If they implement the Small Complex :
o will be 8m for the high acceptance
o and only 7m when the acceptance is
low
If they implement the Medium Complex :
o will be 14m for the high acceptance
o and only 5m when the acceptance is
low
If they implement the Large Complex :
o will be 20m for the high acceptance
o and only -9m when the acceptance is
low
- 9 means that they implement the large
complex and people didn't come , so they had
a loss of 9 (which happened in real life, it is
not appealing for the people, bad location,
)
Low S2 7
High S1
14
d2 = Medium
Low S2
5
High S1
20
d3 = Larger
Low S2
-9
The chance event could happen for the 3 Note,
Which Decision you are going to make from the
tree??
I should give weights to each,
To solve it without weight, I will use the intuition
(1). who will take the smaller is risk averse
(2). who will choose the higher is Risk Taker, even
if he will lose too much
(b) Decision Table:
Conservati
Optimisti
State of ve or Min
c
Nature Pessimisti Regret
approach
c
Max Max Min
S1 S2 S1 S2
Max Min Max
D1 8 7
D2 14 5
D3 20 -9
Conservati
Optimisti
State of ve or Min
c
Nature Pessimisti Regret
approach
c
S Max Min
S2 Max Min S1 S2
1 Max Max
D1 8 7 8
D2 14 5 14
2
D3 -9
0 20
Step 2 :
If I am going to take the Medium Complex, & I am
trying to Maximize the minimum of my return :
o For the Decision D1 , I will choose 7 because I
am Pessimistic
o For the Decision D2 , I will choose 5 because I
am Pessimistic
o For the Decision D1 , I will choose - 9 because I
am Pessimistic
o Comparing between the 3 alternative I will
choose the higher: 7
Conservati
Optimisti
State of ve or Min
c
Nature Pessimisti Regret
approach
c
Max Min
S1 S2 Max Min S1 S2
Max Max
D1 8 7 8
7
D2 14 5 14 5
D3 20 -9 -9
20
D3 D1
Managerial Logic:
If I will discover that I receive many clients, I begin to
regret why I didnt choose the big Mall not the small
one .
Here comes the regret Method
Step 2 :
We have to change the problem from Maximization
to minimization , because my opportunity cost has been
changed
D2 14 5 14 5 20 7
2
D3 -9 2 -9 20 7
0
0
D3 D1
These are the bad thing that can happen in the problem
D3 6
D2 ,
D3
The decision will be either D2 OR D3 ( doesnt
matter , we didnt put weights yet because it is
qualitative decision, based on my intuition )
Step 3 :
S Max Max Min
S2 S1 S2
1 Max Min Max
20 8 = 77
D1 8 7 8 7 12
12 = 0
20 14 = 75
D2 14 5 14 5 6
6 = 2
2 20 20 = 7 (- 9) =
D3 -9 2 -9 16
0 0 16
0
D3 D1 D2
- There are 3 decisions now, which one to be chosen
- We should put weights for the S1 & S2 upon Market
survey.
- Making an Elicitation of Probability
- If Probability of S1 = 0.8 & for S2 = 0.2 , and they
accept on this weight :
P 0. 0.
= 8 2
S Max Max Min
S2 S1 S2
1 Max Min Max
20 8 = 77
D1 8 7 8 7 12
12 = 0
20 14 = 75
D2 14 5 14 5 6
6 = 2
2 20 20 = 7 (- 9) =
D3 -9 2 -9 16
0 0 16
0
D3 D1 D2
Step 3 :
E ( D1 )
8 X 0.8 + 7 X 0.2 = 7.8
=
E ( D2 )
14 X 0.8 + 5 X 0.2 = 12.2
=
$
E ( D3 ) -
=
20 X 0.8 +
9
X 0.2 = 14.
2
- Expected Value without perfect information
- Expected value should be between the 2 values 7.8 s
between 7 & 8.
- The expected value means that every one gives me
different solution.
Managerial Decision :
- If 3 partners are in this business, and they want to
make a decision :
- If we want to maximize our profit, we will choose
( D3 )
EVWPI = 14.2
Decision :
The decision is D3 and the value that I am going to
get is 14.2
High S1
8
d1 = Small E ( D1 ) = 8 X 0.8 + 7 X 0.2 = 7.8
Low S2 7
High S1
14
d2 = Medium E ( D2 ) = 14 X 0.8 + 5 X 0.2 = 12.2
Low S2
5
High S1
20
d3 = Larger
E ( D3 ) = 20 X 0.8 + - 9 X 0.2 = 14.
Low S2
-9
Step 4 :
Expected Values with perfect
information
P= 0.8 0.2
S1 S2
D1 8 7
D2 14 5
D3 20 -9
$
EVPI 2 0.
0
X 0.8 + 7 X
2
= 17.
=
4
- This problem has a Maximum ceiling in its Expected
value
- If we have 7 instead of 9 , it will be perfect .
EV = $ 3.2
Is the Premium that you are going to pay if you want
a perfect information
Decision :
The decision is D1 and the value that I am going to
get is 7.8
High S1
8
d1 = Small
E ( D1 ) = 8 X 0.8 + 7 X 0.2 = 7.8
Low S2 7
High S1
14
d2 = Medium E ( D2 ) = 14 X 0.8 + 5 X 0.2 = 12.2
Low S2
5
High S1
20
d3 = Larger
E ( D3 ) = 20 X 0.8 + - 9 X 0.2 = 14.
Low S2
-9
Step 1 :
Expected Values with perfect
information
P= 0.8 0.2
S1 S2
D1 8 7
D2 14 5
D3 20 -
- Why ? , because these are
9
the lowest cost which can
happen
- Multiplied by 0.8 & 0.2
- Add them together
EVPI - 0. $
8 X 0.8 + X =
= 9 2 4.6
Expected Value Without Probability is: 4.6
- The Expected Value should be :
With Without
EVPI = $ $ 4.6 = $
33 Prof. Maged Morcos
Quantitative Analysis - Lc 6 14/07/2014
7.8 3.2
-
- Expected Values
If you have probability use
without perfect information : 7.8
- Expected
If you dont have probability you will use :
Values with perfect information : 4.6
- They are 4 different Methods, 3 for the intuition, the 4 th
when you have probability .
- If you didnt get the probability, you need to start for the
probability, then to solve the problem.
- when the market is uncertain, and you dont have the
probability, you will work with your own intuition (the
table Method), either risk take averse or risk taker or in
between.
P 0. 0.
= 8 2
S Min Max
S2 Min Min S1 S2
1 Max Min
8 8 8= (- 9) 7 =
D1 7 8 7 16
0 16
14 8 = (- 9) 5 =
D2 14 5 14 5 14
6 14
2 20 8 = (- 9) (- 9)
D3 -9 20 -
0 12 =0 -
D3 D1 D3
12
- (- 9) means a bank or loan will pay it instead of me
- If it is conservative , I will take the minimum of the
maximum , choice will be D1
- If we will take the maximum, the decision will be ( 12 )
D3
EVWPI = ( 12 )
The Sensitivity
- Who said it is 0.8 & 0.2 ?
- If we decided it is 0.7 & 0.3, the decision will remain
D3 in the maximization
- This is the sensitivity.
- I will move the probability , the decision will change
- As a decision maker , I need the chances or the
probabilities every day, like the stock market.
- Here the decision maker weight the value of the
probability in the problem
- And then the probability plays , and then the
sensitivity shows which decision I am going to do
P ( S1 ) = P P ( S2 )
=1P
- If : P (S1) = 0.8 P ( S2) = 0.2 , 0.7 &
0.3
- Lets put these values in form of probability :
P=1, P=0
-9-
1- 1-
0
P=0 -1- P=1
-2-
-3-
-4-
-5-
-6-
-7-
-8-
-9-
10 - 10 -
9- 9-
D12:
8- 8- 1,8
D1:
0,7 7- 7-
6- 6-
5- 5-
D2:
0,5 4- 4-
3- 3-
2- 2-
1- 1-
0
P=0 -1- P=1
-2-
-3-
-4-
-5-
-6-
-7-
D3 = -8-
(0,-
9) -9-
- In case of Maximization:
- If the problem is maximization, I will look to all the
highest values , till I found the intersection
- The line in red shows that its resuls is better than
what it is below it.
D3: 1 ,
20 - 20 - 20
19 - 19 -
18 - 18 -
17 - 17 -
16 - 16 -
15 - 15 -
D2: 1 ,
14 - 14 - 14
13 - 13 -
12 - 12 -
11 - 11 -
10 - 10 -
9- 9-
D12:
8- 8- 1,8
D1:
0,7 7- 7-
6- 6-
5- 5-
D2:
0,5 4- 4-
3- 3-
2- 2-
1- 1-
0
P=0 -1- P=1
-2-
-3-
-4-
-5-
-6-
-7-
-8-
D3: 0,
-9 -9-
20
19 - 19 -
18 - 18 -
17 - 17 -
16 - D3 16 -
15 - 15 -
D2: 1 ,
14 - 14 - 14
13 - 13 -
12 - 12 -
11 - 11 -
10 - D2 10 -
9- 9-
D12:
D1
8- 8- 1,8
D1:
0,7 7- 7-
6- 6-
5- 5-
D2:
0,5 4- 4-
3- 3-
2- 2-
1- 1-
0
P=0 -1- P=1
-2-
-3-
-4-
-5-
-6-
-7-
-8-
D3: 0,
-9 -9-
0.25 0.7
Conclusion:
In case of Maximization:
If the probability is 0.56 ???
I will take the Decision # 2
In case of Minimization:
- I will look to all the lowest values , till I found the
intersection
20 - 20 - D3 =
D3: 1 ,
19 - 19 - 20
18 - 18 -
17 - 17 -
16 - 16 -
15 - 15 -
D2: 1 ,
14 - 14 - 14
13 - 13 -
12 - 12 -
11 - 11 -
10 - 10 -
9- 9-
D12:
8- 8- 1,8
D1:
0,7 7- 7-
6- D1 6-
5- 5-
D2:
0,5 4- 4-
3- 3-
2- 2-
1- 1-
0
P=0 -1- P=1
D
-2- 3
-3-
-4-
-5-
-6-
-7-
-8-
D3: 0,
-9 -9-
0.6
- Here we have D3 & D1 , there is no D2
- Because the values of ( 14 , 5 ) is bad for the cost .
- Because the probability of 0.8, 0.2 killed the decision #
2
- Not always the middle decision is the best one