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Decision Theory
McGraw-Hill/Irwin
Learning Objectives
Describe the different environments under
which operations decisions are made
Describe and use techniques that apply
decision making theory under uncertainty
Describe and use the expected-value
approach
5S-2
Learning Objectives
Construct a decision tree and use it to
analyze a problem
Compute the expected value of perfect
information
Conduct sensitivity analysis on a simple
decision problem
5S-3
Decision Theory
Decision Theory represents a general
approach to decision making which is suitable for a
wide range of operations management decisions,
including:
Capacity
planning
Product and
service design
Location
planning
Equipment
selection
5S-4
5S-5
5S-6
5S-7
5S-8
Decision Process
1.
2.
3.
4.
5.
6.
7.
Decision Environments
Certainty - Environment in which
relevant parameters have
known values
Risk - Environment in which
certain future events have
probable outcomes
Uncertainty - Environment in
which it is impossible to assess
the likelihood of various future
events
5S-11
5S-12
Decision Trees
Decision tree: a Schematic representation
of the available alternatives and their
possible consequences.
Useful for analyzing situations that involve
sequential decisions
See Figure 5S.1
5S-14
Decision Point
Chance Event
Payoff 2
2
Payoff 3
1
B
Payoff 4
2
Payoff 5
Payoff 6
5S-15
Expected payoff
under risk
5S-16
Sensitivity Analysis
Sensitivity Analysis: Determining the range
of probability for which an alternative has the
best expected payoff
Useful for decision makers to have some
indication of how sensitive the choice of an
alternative is to changes in one or more of
these values
5S-17
Sensitivity Analysis
Example S-8
#1 Payoff
16
14
12
10
8
6
4
2
0
#2 Payoff
B
A
C
B best
C best
A best
16
14
12
10
8
6
4
2
0
Solved Problem 5
5S-19