Co10 Beamer

Operations Research Operations Research Operations Research Operations Research

Operations Research - Course 10
Operations Research OperationsOlariu
Research E. Operations
Florentin Research Operations Research
Operations Research Operations December
Research Operations
6, 2016 Research Operations Research
Olariu E. Florentin Operations Research - Course 10 December 6, 2016 1 / 37

Table of contents
1 Decision Analysis
Introduction
Decision
Operations making
Research without
Operations experimentation
Research Operations Research Operations Research
Operations Research
Decision making withOperations Research Operations Research Operations Research
experimentation
The Value
Operations of Experimentation
Research Operations Research Operations Research Operations Research
Operations
Decision TreesOperations Research Operations Research Operations Research
Research
UtilityResearch
Operations Functions for Money
Operations Research Operations Research Operations Research
2 Bibliography

Introduction
Operations Research
Decision analysisOperations
providesResearch Operations Research
a framework Operations Research
and methodology
for ra-
tional decision
Operations Researchmaking when
Operations the outcomes
Research are uncertain.
Operations Research Operations Research

Decision-maker:
Operations Research a personResearch
Operations or a group of persons.
Data for decision analysis:
Available
Operations Research courses
Operations
of Research Operations Research Operations Research
action (alternatives).
Payoffs for all possible outcomes. Operations Research Operations Research
Subjective
Operations probabilities
Research for all possible
Operations Research Operationsrandom
Research events.
Operations Research
Criteria used for making decisions reflect the attitude
Operations Research Operations Research Operations Research Operations towards risk,
Research
Operations
rangingResearch Operations Research
from optimism Operations Research Operations Research
to pessimism.
Decision
Operations analysis
Research is a Research
Operations powerful tool for
Operations determining
Research an optimal
Operations Research
course of action.

Introduction
A question
Operations Researchaddressed
Operationswith decision
Research analysis
Operations Researchis whether to make the
Operations Research
needed decision immediately or to first do some testing (at some
expense)
Operations to reduceOperations
Research the level of uncertainty
Research aboutOperations
Operations Research the outcome
Research of
theOperations
decision.
Operations Research
Option that can Operations Research Operations
be incorporated into Research Operations
the analysis: Research
experimenta-
tion toResearch
Operations obtain Operations
better estimates of the Research
Research Operations probabilities of Research
Operations the possible
Operations Research
states of nature. Operations Research Operations Research Operations Research
Operationsanalysis
Decision Research divides
Operationsdecision
Research making
Operations between
Research Operations
the cases
Research
of with
experimentation
Operations Research and without
Operations Researchexperimentation.
Decision trees are
Operations Research an useful
Operations visual
Research tool for
Operations analyzing
Research theResearch
Operations decision
Operations Research Operations Research Operations
process when a series of decisions needs to be made. Research Operations Research
UtilityResearch
Operations theory provides a way ofOperations
Operations Research incorporating
Research the decision
Operations makers
Research
attitude toward risk into the analysis.

Introduction
Practical application of Decision Analysis:
Operations Research More
General Motors: Operations
thanResearch
40 majorOperations Research
decision Operations
analysis Research
projects
over
5 years;

Eastman Kodak Co.:
Operations Research 378Research
Operations decisionOperations
analysis projects
Research in the
Operations 1990s
Research
contributed about $1 billion to the company; Research Operations Research

Operations
National Research
Weather Operations Research
Service: OperationsaResearch
Developed plan forOperations
respondingResearch
to flood
forecasts
Operations and warnings.

Introduction
Kinds of decision making in the face of great uncertainty:

A Operations
manufacturer
Research introducing a newOperations
Operations Research product into a Operations
Research market Research
place.

A Operations
financialResearch
firm investing in securities.

Operations Research Operations
A government contractor bidding Research Operations
on a Research Operations Research
new contract.

An agricultural Research the
firm selecting Operations
mix Research
of crops Operations Research for
and livestock
the upcoming
Operations Research season.
An oil company deciding whether to drill for oil in a particular
location.

Goferbroke Company Example
The Goferbroke Company
Operations Research (GC)
Operations owns aOperations
Research tract of land that
Research mayResearch
Operations contain
oil. A consulting geologist has reported to management that she be- Operations Research
lieves thereResearch
Operations is 1 chance in 4Research
Operations of oil. Because of this prospect,
Operations Research another oil
Operations Research
company has offered to purchase the land for $90.000. However, Research Operations Research
GC is
considering
Operations Research Operations Research Operations Research Operations Research of
holding the land in order to drill for oil itself. The cost
drilling is $100.000. If oil isResearch
found, Operations Research expected
the resulting Operations Research
revenue will
be $800.000, so the Operations
Operations Research companys expected
Research profit
Operations (afterOperations
Research deducting the cost
Research
Operations
of drilling) willResearch
be OperationsA
$700.000. Research
loss of Operations
$100.000 Research
(the Operations cost)
drilling Researchwill
be incurred if the
Operations land Operations
Research is dry (no oil). Operations Research Operations Research
Research

Goferbroke Company Example
State of nature
Operations Research Operations Research Oil
Alternatives Operations Research
Dry Operations Research
Drill for
Operations Research oil Research 700
Operations 100
Operations Research Sell
Operations
the landResearch Operations
90 Research
90 Operations Research
Operations Research Prior probability
Operations 0:25 Research
Research Operations 0:75 Operations Research

Decision making without experimentation
The Maximin
Operations Payoff Research
Research Operations Criterion Operations Research Operations Research
ForOperations Research decision
each possible Operations Research Operations
alternative, find Research
the minimumOperations Research
payoff over
allOperations
possible states of
Research nature.
Operations Next, Operations
Research find theResearch
maximum of these
Operations min-
Research
Operations Research Choose
imum payoffs. Operations Research Operations whose
the alternative Research minimum
Operations Research
payoff gives
this maximum.
ForOperations
GC the Research
optimalOperations
choiceResearch Operations
is to sell Research Operations Research
the land.
TheOperations
MaximumResearch Likelihood
Criterion
Identify
Operations Research Operations Research Operations(the
the most likely state of nature one Operations
Research with the largest
Research
prior probability). ForResearch
this stateOperations Researchfind
of nature, Operations Research alter-
the decision
native Research
Operations with theOperations
maximum payoff.
Research Choose
Operations this decision
Research alternative.
Operations Research
ForOperations
GC the Research
choiceOperations
is to sellResearch Operations Research Operations Research
the land.

Bayes Decision
Operations Research Rule
Using the best available estimates Operations
of the Research OperationsofResearch
probabilities the respec-
tive states of nature (currently the prior probabilities),
Operations Research Operations Research Operations Research Operations Research calculate
the expected value of the payoff (expected payoff) for each of the Operations Research
possible
Operationsdecision
Research alternatives. Choose
Operations Research the Research
alternative with
Research
Operations Research expected
the maximum Operations Research
payoff. Operations Research Operations Research
For GCResearch
Operations the optimal choice
Operations is toOperations
Research drill for oil because
Research Operations Research
E [PayoffOperations
Operations Research (drill )]Research
= 100 > E
90 = Research
Operations [PayoffOperations
(sell )] Research
Operations Research
Sensitivity Operations
Analysis withResearch
Bayes Operations
Decision Research
Rule Operations Research
- prior probabilities: Research Operations Research Operations Research
interval
- payoffs.

Operations
p - prior Research Operations
probability ofResearch
oil; the Operations
decisionResearch
is very Operations
sensitive Research
to p.
E
Operations[Payoff
Research (drill
Operations
)] =Research
700p Operations
100(1 Research
p ) = 800pOperations
100Research
:

E
Operations Research Operations Research (sell
[Payoff Operations
)] = 90Research Operations Research
TheOperations Research
crossover pointOperations
is p =Research
0:2375.Operations Research Operations Research
Conclusion: Sell the
Operations Research landResearch
Operations if p < 0Operations
:2375 and drill for
Research oil otherwise.
Operations Research
Operations Research Operations Research Operations Research Operations
The key question when trying to refine the true value of p is whether Research
it is smaller
Operations Researchor Operations
larger than 0:2375.

Decision making with experimentation
Posterior probabilities: Improved estimates of prior probabilities. Im-
Operations
portant Research Operations Research Operations Research Operations Research
questions:
1. Operations
How toResearch Operations
derive the Researchprobabilities?
posterior Operations Research Operations Research
2. Operations
How toResearch Operations Research
decide whether Operations Research
it is worthwhile Operations
to conduct Research
experimentation
(takingResearch
Operations into account the
Operations cost ofOperations
Research experimentation)?

Notations:

Operations
n: number Research Operations Research
of possible states ofOperations
nature Research Operations Research

Operations
P (State Research
= Si ):Operations Research Operations
prior probability Research
that true stateOperations
of nature Research
is Si , for
i = 1; n.
Finding:
Operations finding
Research from Research
Operations experimentation (a random
Operations Research variable).
Operations Research
fj : oneResearch
Operations
possibleOperations
value of the random value Finding, j = 1; m.
Operations Research j
P (State = Si Finding =Research
Operations Operations probability
fj ): posterior Research Operations
that Research
the true
state of nature
Operations Researchis SOperations
i , givenResearch
that Finding =Research
Operations = 1; n ; jResearch
fj , for i Operations = 1; m.

Basic question: given P (State = S ) and P (Finding = f jState = Si )
Operations Research Operations Research iOperations Research Operationsj Research
for i =Operations
1; n ; j = 1; m, what
Research is Research Operations Research Operations Research
Operations
P (StateResearch
Operations Research Operations = Si Finding j = fj ) =?Operations Research
Operations Research
Operations
From Bayes Research
theorem Operations Research Operations Research Operations Research
Operations Research P (Operations
State =Research jOperations
Si Finding = fResearch
j) =
Operations Research
j
X
Operations Research
P (FindingOperations
= fjResearch
State =Operations Research = Operations
Si )P (State Si ) Research
Operations=Research Operations Research Operations Research Operations Research :
n
Operations ResearchP (Finding
Operations Research j
= fj State = SResearch
Operations k )P (State = Sk Research
Operations )
Operations =
k Research
1 Operations Research Operations Research Operations Research
Example continues.
Operations Research For GC, Research
Operations possible Operations
findings of a seismic
Research survey
Operations Researchare:
USS (Unfavorable Seismic Soundings): oil is fairly unlikely; Operations Research
FSSOperations
(Favorable Seismic
Research Soundings):
Operations oil is fairly
Research Operations Researchlikely.
Operations Research

Operations
Based on past Research Operations Research
experience: Operations Research Operations Research
P (USS
Operations j = Oil )Research
StateOperations
Research )
= 0:4 Operations
P (FSS j
State =
Research Oil ) =
Operations 0:6;
Research
j
(USS State = Dry ) = 0:8
POperations ) j
P (FSS State = Dry ) = 0:2:
If the finding
Operationsof the seismic
Research survey
Operations Researchis USS thenResearch Operations Research
Operations
P (StateOperations j
= OilResearch
FindingOperations
= USS Research
) = 0:4 Operations
0:25=(0Research
Operations Research
:4 0:25 + 0:8 0:75) = 1=7
)
Operations ResearchP (Operations
State =Research j
Dry FindingOperations=Research
USS ) = Operations
6=7: Research
Operations
If the seismic Research
surveyOperations
gives FSSResearch
thenOperations Research Operations Research
P (StateOperations j
= OilResearch = FSS
FindingOperations Research
) = 0:6 Operations
0:25=(0Research
:6 0:25 +
0:2 0:75
Operations ) = 1=2
Research
) j
Operations ResearchP (Operations
State =Research
Dry FindingOperations= FSS ) =Operations
Research 1=2: Research

The probability tree diagram
Operations Research Operations in figure Operations
Research 1 showsResearch
a nice way of organizing
Operations Research
Operations
these Research inOperations
calculations Research manner.
an intuitive Operations Research Operations Research
Operations Research Operations Research Operations Research 0.15 Operations Research
Operations Research Operations Research Operations = 0.5
0.250.6 = 0.15 Research0.3 Operations Research
Operations Research Operations 0.6
Research Operations
Oil and FSS Research Operations
Oil, given FSSResearch
il
Operations Research Operations g iv en OResearch Operations Research Operations Research
,
Operations Research Operations FSS Research Operations Research 0.1 Operations Research
0.4
USOperations
Operations Research
5 S , give Research Operations Research =Operations0.14 Research
.2 n Oi 0.250.4 = 0.1 0.7
Operations Research
0
i l Operations Research l Operations
Oil and USS
Research Oil,Operations
given USS
Research
O
0.15
Operations 0Research Operations Research Operations Research Operations = 0.5 Research
.75 0.750.2 = 0.15 0.3
Operations Research
Dr Operations Research Operations Research Operations Research
Dry and FSS Dry, given FSS
Operations yResearch Operations 0.2 n DResearch
ry Operations Research Operations Research
e
Operations Research Operations , giv
FSS Research Operations Research Operations Research
Operations Research UOperations 0.8 Research Operations Research 0.6 Operations Research
SS, g = 0.86
Operations Research Operations iveResearch
n Dr Operations
0.750.8 = Research
0.6 Operations Research
0.7
y
Dry and USS Dry, given USS Research
Figure:
Operations Research The probability
Operations Research tree diagram
Operationsfor GC example.

Suppose the cost
Operations of experimentation
Research Operations Research isOperations
30. Apply
ResearchBayes decision
Operations Researchrule
withOperations
the Research Operations Research Operations Research Operations Research
posterior probabilities replacing the prior probabilities.
Ex-
pected payoffs
Operations if finding
Research is USS
Operations are:Operations Research Operations Research
Research
E[PayoffOperations j
(drillResearch = USS
FindingOperations
)] = 1=Operations
Research
7 700 + 6Research
=7 ( 100 ) 30 Research
Operations = 15:7;
E Operations(Research
[Payoff j
sell FindingOperations Research
= USS
] = Operations
1=7 90 Research
+ 6=7 90
Operations
30 =
Research
60:
Expected
Operationspayoffs
Research if Operations
finding Research
is FSS are: Operations Research Operations Research
E Operations
[Payoff (drill j
Research Operations
Finding = Research
FSS )] =Operations
1=2 700 Research
+ 1=2 Operations
( 100)Research
30 = 270;
E[Payoff
Operations(Researchj
sell Finding = Research
Operations
FSS ] = 1Operations + 1=2 90
=2 90 Research 30 =
Operations 60:
Research

Since the objective
Operations is to maximize
Research Operations the expected
Research Operations Research payoff,
Operationsthese
Researchresults
yield the optimal policy shown below: Research Operations Research Operations Research
Finding from
Operations ResearchOptimal Expected
Operations Research payoff
Operations Expected
Research Operations payoff
Research
seismicOperations
survey Research Operations
alternative Research cost
excluding Operations Research
of survey Operations
including cost Research
of survey
USS Operations Research 90Operations Research Operations
Sell the land
Operations Research 60 Research
Operations
FSS Research Operations
Drill for oil Research Operations
300 Research Operations Research
270

The Value of Experimentation
We Operations
presentResearch Operations Researchmethods
two complementary Operations Research
for Operations
evaluating theResearch
experimen-
tation potential value:

Expected
Operations Value
Research of Perfect
Operations Information
Research Operations Research (EVPI) provides an
Operations Research
Operations
upper Research
bound of theOperations Research
potential valueOperations
of the Research Operations
experiment. Research
If the upper
bound is less
Operations thanOperations
Research the costResearch
of the experiment, the Operations
Operations Research experiment may
Research
be forgone.
Expected
Operations payoff
Research with Research
Operations perfect information
Operations Research(EPPI) is Research
Operations obtained by
weighting the maximum payoff for each state of nature by Research
the prior
probability of thatOperations
Operations Research state ofResearch
nature.Operations Research Operations Research
EVPI
Operations Research Operations = EPPI
Research Operations EPWE
Research ; Operations Research
Operations
where Research
EPWE Operations Research payoff
is the expected Operationswithout
Research experimentation.
Operations Research

Example continues
Operations Research
EPPI Operations
= 0:25
Research
700 +Operations
0:75 90 Research
= 242:Operations
5;
Research

Operations ResearchEPWEOperations
= Research
0:25 700Operations
+ 0:75Research
( 100)Operations
= 100;Research
EVPI Research
= 242Operations
:5 100Research
= 142:5 Operations Research
Operations Research since
Conclusion: Operations
142:5Research Operations Research Operations Research
> 30 it may be worthwhile to proceed with
the seismic
Operations Researchsurvey. ToResearch
Operations find outOperations
for sure, we now
Research go toResearch
Operations the second
method of evaluating the potential benefit of experimentation.

Operations
Expected ResearchValue
of Experimentation (EVE) Operations
is theResearch
difference
between
Operations expected
Research payoff
Operations withOperations
Research experimentation (EPE)
Research Operations and ex-
Research
Operations
pected Research
payoff Operations
without Research Operations Research Operations Research
experimentation:
Operations Research Operations EVE = EPE
Research OperationsEPWE
Research ; Operations Research
where expected
Research payoff with experimentation is
X
Operations Operations Research Operations Research Operations Research
Operations Researchm Operations Research Operations Research Operations Research
Research= Operations
Operations EPE P (Finding E
Research =Operations
fj ) [Research j = fj ]:
Operations Research
payoff Finding
=
Operations Research
j 1 Operations Research Operations Research Operations Research

Example
Operations continues:
Research OperationsP (USS ) Operations
Research = 0:7, P (FSS ) Operations
Research = 0:3 - Research
obtained by
Operations Research
summation from dataOperations
in Research
Figure 1.Operations
FromResearch
the third Operations
column Research
of the
previous
Operationstable
Researchwe have:
E
Operations Research (Operations j
PayoffResearch
FindingOperations
= USS Research
) = 90;Operations Research
E (Payoff
Operations Research Operations j
Research = FSS
Operations
Finding ) = 300
Research Operations
: Research
Operations
Thus, Research Operations Research Operations Research Operations Research
= 0:7 90
EPE Research
Operations Operations
+ 0:3 Research
300 = 153 ; EVE
Operations = 153 Operations
Research 100 =Research
53:
Conclusion: since 53Operations
Operations Research > 30 the seismic experiment should be done.

Constructing the Decision Tree

A decision
Operations Researchnode, represented
Operations Research by a square,
Operations indicates
Research that
Operations a decision
Research
needs to be made at that point in the process. Operations Research Operations Research
AnOperations
event Research
node (orOperations
chanceResearch Operations Research
node), represented by aOperations
circle, Research
indicates
that a random
Operations Researchevent occurs
Operations at thatOperations
Research point.Research Operations Research
Branches have labels:
Operations Research numbers
Operations Research (that are Research
Operations not inserted in parenthe-
Operations Research
ses) inserted under or over the branches represent payoffs, whileOperations Research
numberResearch
Operations in parentheses represent
Operations Research prior Research
Operations or posterior probabilities,
Operations Research or
probabilities of findings. Research Operations Research Operations Research
AtOperations Research node
each terminal Operations Research the
is attached Operations
sumResearch Operations along
of all numbers Researchthe
path fromResearch
Operations the initial node.Research Operations Research Operations Research
Operations

Constructing the Decision Tree
Operations Research Operations Research Operations Research oil Operations Research
l f
Operations Research Operations Research Operations dril Research Operations Research
dry
Operations Research Operations Research e c Operations Research Operations Research
bl
Operations Research Operations Research ora Operations
sell Research Operations Research
fav
Operations Research Operationsun Research Operations Research oil Operations Research
Operations Research Operationsb Research Operations
dr i ll Research
g Operations Research
rv ic
favResearch
orable d
Operations Research dry Operations Research
su ism
Operations Research Operations Research Operations sell Research Operations Research

ey
se

do
Operations Research a Operations Research Operations Research Operations Research

l
Operations Research Operations Research Operations Research oi Operations Research
no urve
se y
s

ism
h
ll
dri Research dryOperations Research
ic

Operations Research Operations Research e Operations Research Operations Research
Operations Research Operations Research Operations sell Research Operations Research
Figure: The
Research tree (before
Researchincluding
Operationsany numbers)
Research for GC
Operations example.
Research

Performing the Analysis
Step 1.Research
Operations Start Operations
at the right
ResearchsideOperations
of the Research
decisionOperations
tree and move left
Research
oneOperations
column Research Operations
at a time. ForResearch Operations Research
each column, perform Operations Research
either Step 2 or
Step 3 depending
Operations Research upon whether
Operations Research the nodesResearch
Operations in that column are event
Operations Research
Operations
nodes or Research
decision Operations
nodes. Research Operations Research Operations Research
Step 2.Research
Operations For each event Research
Operations node, calculate
Operations its expected
Research payoff
Operations by multi-
Research
plying the expected payoff of each branch by the probability
of that
Operations
branch andResearch Operationsup
then adding Research
these Operations
products. Research
RecordOperations
this Research
expected
payoff in boldface
Operations above the
Research Operations node,Operations
Research and designate this quantity
Research Operations Research as
Operations
also beingResearch Operations Research
the expected payoff of Operations Research leading
the branch Operations
toResearch
this node.
Step 3.Research
Operations For each decision
Operations node,Operations
Research compare the expected
Research Operations payoffs
Research of its
branches and choose the alternative whose branch has
the largest
expected payoff. Operations
Operations Research Record Research
this largest expected
Operations Research payoff in Research
Operations boldface
above the decision node and record the choice on the decision
tree
Operations Research a barrier
by inserting Operationsthrough
Research each
Operations Researchbranch.
rejected Operations Research

Operations Research Operations Research Operations Research payoff Operations Research
)
Operations Research Operations Research Operations oResearch .143 670
Operations Research
il (0
Operations Research Operations Research Operations Research800 Operations Research
f
rill
Operations Research Operations Research dOperations 0
drResearch Operations Research
0 y (0.857 130
Operations Research Operations Research cOperations 10 )
90
l e 60
Operations Research Operations ora Research
b Operations
se ll Research Operations Research
fav 0.5) 670
Operations Research Operationsun Research
0 oil (
80 0
g
b
0
Research dOperations
rill 0 Research0 Operations Research
0
Operations Research OperationsfaResearch
vorable dOperations
1 Research
dry (0.5
) Operations
130 Research
su smic
90
Operations Research Operations Research seOperations Research 60 Operations Research
3 ey
ei
ll
rv
s

0
do
Operations Research
a Operations Research Operations Research Operations Research
Operations Research Operations Research Operations Research .25) Operations 700 Research
0
oil ( 0
no

0 smic
se y
80
su

h Operations Research
rv
0
e
rill
Operations Research Operations Research dOperations1 0 0 Research
dry (0.7
5) Operations Research
100
Operations Research Operations Research eOperations 90 Research Operations Research
90
Operations Research Operations Research seOperations
ll Research Operations Research
Figure: TheResearch
Operations decision Operations
tree (after addingOperations
Research the probabilities
Research Operations and payoffs).
Research


For any
Operations decision
Research tree, Research
Operations this backward
Operations induction procedure
Research Operations Researchalways
Operations
will lead toResearch Operationspolicy
the optimal Research (orOperations
policies)Research
after Operations Research
the probabilities
areOperations
computed for the
Research branches
Operations Researchemanating from a chance
Operations Research Operationsnode.
Research

The decision
Operations maker
Research now can
Operations read Operations
Research the treeResearch
from left to right
Operations to see
Research
the actual progression of events. Operations Research Operations Research
Operations
Bayes Research
decisionOperations
rule saysResearch Operations
to follow onlyResearch
the open Operations
pathsResearch
from left to
right toResearch
Operations achieveOperations
the largest possible
Research expected
Operations Research payoff.
Operations Research

Operations Research Operations Research Operations Research payoff Operations Research
)
Operations Research Operations Research Operations .143 670
15.7 oResearch
il (0 Operations Research
Operations Research Operations Research Operations Research800 Operations Research
f
Operations Research Operations Research 60 rill
dOperations
0
drResearch Operations Research
0 y (0.857 130
Operations Research Operations Research 7 ) 10
Operations Research
)
Operations Research
(0 . c 90
60
le
Operations Research Operationsavo
rab Research Operations
sell Research Operations Research
0.5) 670
123 unfResearch
Operations Research Operations 0 Operations 270 oil (
80 0
g
b
0
Research 270 Operations
ll
dri 00
Research0 Operations Research
Operations Research OperationsfavoResearch
rable (0
dOperations
1 Research
dry (0.5
) Operations
130 Research
su smic
.3) 90
Operations Research Operations Research seOperations Research 60 Operations Research
3 ey
ei
ll
rv
s

0
do
123
Operations Research
a Operations Research Operations Research Operations Research
Operations Research Operations Research Operations Research .25) Operations 700 Research
0
oil ( 0
no
Operations Research Operations Research Operations 100 Research Operations Research

0 smic
se y
80
su

h Operations Research
rv
0
e
rill
100 dOperations
Operations Research Operations Research 1 0 0 Research
dry (0.7
5) Operations Research
100
Operations Research Operations Research Operations e 90 Research Operations Research
90
Operations Research Operations Research seOperations ll Research Operations Research
Figure:
Operations The final
Research decision
Operations Research tree that
Operationsrecords
Research the analysis.
Operations Research

Example continues
Operations Research Optimal
Operations policy:
Research Do the seismic
Operations Research survey.
Operations Research
If Operations
the result is unfavorable,
Research sell theOperations
Operations Research land. Research Operations Research
If Operations
the result is favorable, drill for oil.
The expected payoffOperations
Operations Research ResearchtheOperations
(including cost ofResearch Operations
the seismic Research is 123
survey)
($123,000).

Utility Functions for Money

Risk-averse individuals
Operations Research have
Operations decreasing
Research Operationsmarginal utility for
Research Operations money
Research
(the slope of their utility function decreases as the amount of money Research
increases).
Risk-seekers
Operations Research have increasing
Operations marginal
Research Operations utility
Research for Research
Operations money (the
slope of their utility function increases as the amount of Research Operations Research
money
increases).
Risk-neutral individuals
Operations Research Operations prize
Researchmoney at their
Operations ResearchfaceOperations
value (u (M ) =
Research
Operations
M ). Such Research Operations Research
an individuals Operations
utility Research is simply
for money Operations proportional
Research
to the Research
Operations amount Operations
of money involved.
TheOperations
fact that different
Research people
Operations have different
Research utility functions
Operations Research for money
Operations Research
has an important implication for decision making in the face Research
Operations Research Operations Research Operations Research Operations of uncer-
tainty. Operations Research Operations Research Operations Research Operations Research


It Operations
is possible to exhibit
Research OperationsaResearch
mixtureOperations
of these kindsOperations
Research of behavior
Research de-
pending on the amount of money at stake. Operations Research Operations Research
Operations
Although Research
someOperations
peopleResearch
appear Operations Research Operations
to be risk-neutral whenResearch
only small
amounts
Operations of money
Research are involved,
Operations it is unusual
Research Operations Researchto be trulyResearch
Operations risk-neutral
Operations Research
with very large amounts. Operations Research Operations Research Operations Research
AnOperations Research attitude
individuals Operations Research
toward risk Operations
alsoResearch
may beOperations Research
different when
dealing with
Operations onesOperations
Research personal finances
Research thanResearch
Operations when making decisions
Operations Research
Operations
on behalf Research
of anOperations Research Operations Research Operations Research
organization.
When Operations Research function
an utility Operations Research
for money Operations Research Operations
is incorporated intoResearch
a decision
analysis approach
Operations Research toOperations
a problem, the Operations
Research utility function
Research must beResearch
Operations constructed
to fit the preferences and values of the decision maker (a single individual Operations Research
or a group of people)
Operations Research involved.

Operations Research
Fundamental Operations Research
Property: Operations Research
The decision makers Operations
utility Research
function for
money has Research
Operations the property that
Operations the decision
Research Operationsmaker
Research is indifferent between
Operations Research
Operations Research
two alternative coursesOperations Research
of actions if theOperations Research Operations
two alternatives have Research
the same
expected utility.
When the Research
Operations decision Operations
makersResearch
utility function for money
Operations Research is used
Operations to mea-
Research
sure the relative worth of the various possible monetary outcomes,
Operations
Bayes Research
decision Operations Researchmonetary
rule replaces Operations payoffs
Research by Operations Research
the corresponding
utilities.
Operations Therefore,
Research theResearch
Operations optimal actionResearch
Operations (or series of actions)
Operations Research is the
oneOperations
whichResearch
maximizesOperations
theResearch
expectedOperations
utility.Research Operations Research


Utility functions
Operations Research can sometimes
Operations Researchstill be constructed
Operations when some
Research Operations of or
Research
all the important consequences of the alternative courses of action Research
are notResearch
Operations monetary. Under
Operations these
Research circumstances,
Operations it is important
Research Operations Research to
incorporate value judgments into the decision process. Research Operations Research
OneOperations
way Research Operations
to construct u (MResearch
) is to Operations
ask the Research
decision Operations
maker to
Research
repeat-
edly makeResearch
Operations a difficult decision
Operations about
Research whichResearch
Operations probability would
Operations make
Research
him/her indifferent between two alternatives. Then using pairs of Operations Research
points Research
Operations that relate possible
Operations payoffs
Research and the
Operations corresponding
Research utilities, a
Operations Research
smooth curve can be drawn through these points. Operations Research Operations Research

Another approach
Operations ResearchforOperations Researchu (M
estimating ) is to
Operations assumeOperations
Research that the utility
Research
function has a certain mathematical form, and then adjust this form to Operations Research
fit the decision
Operations makers
Research attitude
Operations Researchtoward riskResearch
Operations as closely as possible.
Operations Research
The exponential
Operations utility
Research Operations function:
Research u (M
Operations Research 1 e M
) = R (Operations =R ), where
Research
R is the decision makers risk tolerance. This function is designed
to Operations Research Operations
fit a risk-averse Research Operations Research Operations Research
individual.
A Operations
great aversion
Research to risk corresponds
Operations to a Research
Research Operations small value of R
Operations (which
Research
gives a much more gradual bend in the curve). Research Operations Research
Operations
A drawbackResearch of Operations Research Operations
the exponential utilityResearch
functionOperations
is thatResearch
it assumes
a constant
Operations aversion
Research to Research
Operations risk (a fixed value
Operations of R),
Research regardless
Operations Researchof how
Operations
much (or Research
how little) Operations
money Research Operationsmaker
the decision Research currently
Operations has.
Research


In Operations
situations whereOperations
Research the consequences of the
Research Operations potential
Research losses
Operations are not
Research
as severe, assuming an exponential utility function may provide aOperations Research
reasonable
Operations approximation.
An easy
Operations way ofOperations
Research estimating the Operations
Research appropriate
Researchvalue of R Research
Operations is by asking
theOperations
decisionResearch
makerOperations Research
to choose Operationsthat
a number Research
wouldOperations
makeResearch
him/her
indifferent betweenOperations
Operations Research the following
Research two alternatives:
A 50:50 gamble where he/she would gain R dollars
Operations Research Operations Research Operations Research with probability
Operations Research
Operations
0.5Research
and loseOperations Research
R =2 dollars withOperations Research
probability 0:5. Operations Research
Operations
Neither Research
gain norOperations Research Operations Research Operations Research
lose anything.

Using decision trees to analyze problems with utilities
TheOperations Researchfor Operations
procedure using a Research
decision Operations
tree to Research
analyze aOperations
problem
Research
now is
identical
Operationsto that described
Research previously
Operations Research except
Operations for substituting
Research utili-
Operations Research
Operations
ties forResearch
monetary Operations
payoffs.Research Operations Research Operations Research
Operations
Therefore,Research Operations
the value Research to
obtained Operations
evaluate Research Operations
each node Research
of the
tree now
is the expected utility there rather than the expected
Operations Research Operations Research Operations Research Operations Research (monetary)
payoff.
Operations Research
Consequently, the Operations
optimalResearch
decisions Operations
selectedResearch Operations
by Bayes Researchrule
decision
maximize the expected
Operations Research utility
Operations for the
Research overall
Operations problem.

Bibliography
Operations
Hillier, F. Research
S., G. J. Operations Research Introduction
Lieberman, Operations Researchto Operations
Operations ResearchRe-
search, McGraw-Hill,
Operations 7th Research
Research Operations edition, 2001.
R. Invitation la recherche oprationnelle,Operations Research Dunod,
Operations1966.
Research
Operations
Taha, H. Research Operations Research
A., Operations Research:Operations
AnResearch OperationsPrentice
Introduction, Research Hall
International,
Operations Research 2007.

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