Homework due next Tuesday, September 22

p. 156 # 5-7, 5-8, 5-9 Please use complete sentences to answer any questions and make. Include any tables you are asked to make.

Chapter 5: Decision-making Concepts

Quantitative Decision Making with Spreadsheet Applications 7th ed.
By Lapin and Whisler Section 5-7: Decision Tree Analysis
Some slides are from Business Statistics: A Decision-Making Approach 6th Edition found at www.clt.astate.edu/asyamil/groebner6ed/ppt/ch18ppln.ppt

The Bayes Decision Rule

Takes into account all the information about the chances for various payoffs.
Act (Choice of Movement)

Probability Event (level of demand )

Gears & Levers Payoff

Spring Action

Weights & Pulleys Payoff x Prob

Payoff x Payoff Prob

Payoff x Payoff Prob

Light

.10

$25,000
400,00 0 650,00 0

$2500
280,000 130,000
$412,500

$10,000

-$1000

$125,000 $12,500

Moderat .70 e Heavy .20 Expected Payoff:

440,00 0 740,00 0

308,000 400,000 280,00

0 0

148,000 750,000 150,00

$455,000 $417,500

Other Decision Criteria

Maximin Payoff Criterion choose the best of the worst outcomes. Maximum Likelihood Criterion focus on the most likely event to the exclusion of all others. The Criterion of Insufficient Reason every event has the same probability.

Table vs. Tree

Payoff table: simple decisions Decisions made at different points in time with uncertain events occurring between decisions. Tree gives more flexibility. Tree shows every possible course of action and all possible outcomes.

Decision Tree
A decision tree is a picture of all the possible courses of action and the consequent possible outcomes.

A box is used to indicate the point at which a decision must be made, The branches going out from the box indicate the alternatives under consideration A circle represents an event (usually has a probability) The branches going out from the circle represent outcomes of the event.

Sample Decision Tree

Strong Economy

Large factory

Stable Economy

Weak Economy
Strong Economy

Average factory

Stable Economy

Weak Economy
Strong Economy

Small factory

Stable Economy Weak Economy

Add Probabilities and Payoffs (continued)

Strong Economy (.3) 200 50

Large factory

Stable Economy (.5) Weak Economy (.2)

-120
90 120

Strong Economy (.3)

Average factory

Stable Economy (.5)

Weak Economy

(.2) (.3)

-30
40 30 20

Decision Small factory Uncertain Events (States of Nature)

Strong Economy

Stable Economy (.5)

Weak Economy

(.2)

Probabilities Payoffs

Decision Tree Analysis

Each node is evaluated in terms of its expected payoff.

Event forks: expected payoffs are computed. Act forks: the greatest value is brought back.

The decision tree is folded back by maximizing expected payoff.

Inferior acts are pruned from the tree. The pruned tree indicates the best course of action, the one maximizing expected payoff.

The process works backward in time.

Fold Back the Tree

EV=200(.3)+50(.5)+(-120)(.2)=61

Strong Economy (.3) Stable Economy (.5) Weak Economy (.2)

200 50

Large factory

-120
90 120

EV=90(.3)+120(.5)+(-30)(.2)=81

Strong Economy (.3) Stable Economy (.5)

Average factory

Weak Economy
EV=40(.3)+30(.5)+20(.2)=31

(.2)

-30
40 30 20

Strong Economy (.3) Stable Economy (.5)

Small factory

Weak Economy

(.2)

Make the Decision

EV=61

Strong Economy (.3) Stable Economy (.5) Weak Economy (.2)

200 50

Large factory

-120
90
Maximum

EV=81

Strong Economy (.3) Stable Economy (.5)

Average factory

120

Weak Economy
EV=31

(.2)

EV=81

-30
40 30 20

Strong Economy (.3) Stable Economy (.5)

Small factory

Weak Economy

(.2)