DECISION ANALYSIS - Minimizes the maximum opportunity loss within each Sensitivity Analysis

alternative
Decision Theory is an analytic and systematic approach to - Examines/investigates how decision might change
the study of decision making. with different input data; applicable to 2 SON only
Six Steps in Decision Making 2. Under uncertainty P = probability of favorable market
- Probabilities are not known; there are several
1. Define the problem 1-P = probability of unfavorable market
possible outcomes for each alternative
2. List possible alternatives
EMV = 1st SON payoff P – 2nd SON payoff (1-P)
3. Identify possible outcomes or SON
- outcomes over which the decision maker has little
or no control Decision Tree
4. List the payoff (profits conditional value) of each 3. Under risk
- Probabilities are known; there are several possible - where any problem that can be presented in a
combination of alternatives and outcomes
outcomes for each alternative decision table can be graphically represented; most
- a course of action or a strategy that the decision
- Choose the alternative with the highest expected beneficial when a sequence of decisions must be
maker can choose
monetary value (EMV) made
5. Select one decision theory model
- weighted sum of possible payoffs for each - contains:
6. Apply the model and make decision
alternative Decision points or nodes, from which one of
Types of Decision Making
1st 1st
EMV = (payoff SON x probability SON) + (payoff 2nd several alternatives may be chosen
1. Under certainty
SON x probability 2nd SON) + …. + (payoff last SON x State-of-nature points or nodes, out of which one
- Decision makers know with certainty the
probability last SON) state of nature will occur
consequences of every alternative or decision
choice; chooses the best alternative with best Steps of Decision Tree Analysis:
outcome Expected Value of Perfect Information (EVPI) 1. Define the problem
- Places an upper bound on what to pay for 2. Structure or draw the decision tree
a. Maximax (optimistic) information
3. Assign probabilities to the SON
- Best (maximum) payoff for each alternative is EVPI = EVwPI – Maximum EMV
considered and the alternative with the best 4. Estimate payoffs for each possible combination of
EVwPI = (best payoff 1st SON x probability 1st SON) + (best alternatives and SON
(maximum) of these is selected
payoff 2nd SON x probability 2nd SON) +….+
- Minimization: lower payoffs are better 5. Solve the problem by computing expected monetary
b. Maximin (pessimistic) values (EMVs) for each state of nature node.
- The worst (minimum) payoff for each alternative is
Expected Opportunity Loss Structure:
considered and the alternative with the best
(maximum) of these is selected - Cost of not picking the best solution; will always • Trees start from left to right.
- Minimization: lower payoffs are better result in the same decision as the maximum EMV
• Trees represent decisions and outcomes in sequential
c. Criterion of Realism (Hurwicz) EOL (1st alternative) = (proba x 1st SON Opportunity Loss) + order.
- weighted average between optimism and pessimism (proba x 2nd SON Opportunity Loss)
d. Equally Likely (laplace) • Squares represent decision nodes.
EOL (2nd alternative) = (proba x 1st SON Opportunity Loss) +
- ‘neither’ optimistic nor pessimistic; considers all the • Circles represent states of nature nodes.
(proba x 2nd SON Opportunity Loss)
payoffs in each alternative then chooses the best
• Lines or branches connect the decisions nodes and the
(maximum) payoff
states of nature.
- Minimization: lowest average payoff
e. Minimax Regret
- Based on opportunity loss (amount lost by not picking
the best alternative in a given SON)
Expected Value of Sample Information (EVSI) 3. Causal Models Moving Averages can be used when demand is
- Use variables/factors that might influence the qty. relatively steady over time. This method tends to
- Measures the value of sample information
being forecasted smooth out short-term irregularities in the data series
EVSI = (EV with sample information + cost) – (EV without - Objective: to build a model with the best statistical
sample information)  Moving Average Forecast
rel’p between the variable being forecast and the
independent variables
- Regression analysis is the most common technique
FORECASTING
used in causal modeling
- Main purpose: to reduce uncertainty and make better  Weighted Moving Averages
Measures of Forecast Accuracy
estimates of what will happen in the future
 Mean Absolute Deviation (MAD)
Eight Steps in Forecasting
- we can compute MAD using NAÏVE Forecasting
1. Determine the use of the forecast – objective Model Exponential Smoothing is a type of moving average that
2. Select the items/quantities that are to be forecasted is easy to use and requires little record keeping of data
3. Determine the time horizon of the forecast
4. Select the forecasting model(s)
5. Gather the data needed to make the forecast  Mean Squared Error
6. Validate the forecasting model Note: Objective in selecting the smoothing constant is to generate
7. Make the forecast accurate forecast, this is to be done by selecting the that results in
8. Implement the results the lowest MAD

Forecasting Techniques/Models  Mean Absolute Percent Error Trend Projection fits a trend line to a series of historical
data points. The line is projected into the future for
1. Qualitative Models
medium-to-long-range forecasts.
- Incorporate judgmental or subjective factors
- Useful when subjective factors are thought to be  Regression Analysis
important or when accurate quantitative data is Bias – is the average error
y = a + bX
difficult to obtain
where:
a. Delphi Method – respondents provide input to
decision makers Times-Series Forecasting Models a = intercept
b. Jury of Executive Opinion – collects opinions of a - sequence of evenly spaced events b = slope of the line
small group of high-level managers, possibly using - four components:
X = time period
statistical models for analysis a. Trend (T) – gradual upward/downward movement
c. Sales Force Composite – allows individuals of the data overtime
salespersons estimate the sales in their region and b. Seasonality (S) – pattern of demand fluctuation
the data is compiled at a district or national level above/below the trend line that repeats at regular
d. Customer Market Survey – input is solicited from intervals
customers (potential) regarding their purchasing c. Cycles (C) – patterns in annual data that occur
plans every several years
2. Time-Series Models attempt to predict the future based d. Random Variations (R) – ‘blips’ in the data caused
on past events Note: by chance or unusual situations, and follow no
a. Moving Average Regression Analysis is used in discernible pattern
b. Exponential Smoothing trend projections and one
Decomposition of a Time-Series Decomposition Method of Forecasting
c. Trend Projections type of decomposition model
d. Decomposition  Multiplicative Model: Demand = T x S x C x R Decomposition is the process of isolating linear trend and
 Additive Model: Demand = T + S + C + R seasonal factors to develop more accurate forecasts
 MARKOV ANALYSIS First Method: GRAPHICAL METHOD PROJECT EVALUATION and REVIEW TOOL (PERT)
- Technique deals with probability of future occurrences - Works only when there are two decision variables, but it - appropriate for the projects where the time needed to
by analyzing presently known probabilities provides valuable insight into how larger problems are complete different activities are not known
structured CRITICAL PATH METHOD (CPM)
Four Assumptions of Markov Analysis
Feasible Region – is the set of points that satisfy all the - apt for the projects which are recurring in nature
1. There are limited/finite number of possible states
constraints BASIS FOR
2. The probability of changing states remains the same PERT CPM
over time Infeasible Region – represented as any point outside the COMPARISON
PERT is a project CPM is a statistical
3. We can predict any future states from the previous state shaded area
management technique of
and the matrix of transition probabilities technique, used to project
Second Method: SUBSTITUTION METHOD
4. The size and makeup of the system do not change Meaning manage uncertain management that
during the analysis Third Method: ELIMINATION METHOD activities of a manages well
project. defined activities
States ad State Probabilities
of a project.
- In MA, we assume that states are both collectively SIMPLEX METHOD A technique of A method to
exhaustive and mutually exclusive What is it? planning and control cost and
- Simple yet complex solution procedure
control of time. time.
- Developed by George D. Dantzig
Orientation Event-oriented Activity-oriented
STEPPING STONE METHOD Evolved as Research Evolved as
Evolution & Development Construction
- A procedure for finding the potential of any non-basic project project
variables (empty cells) in terms of the objective function Probabilistic Model Deterministic
Model
Model
Time Time-cost trade-
Focuses on
INVENTORY MANAGEMENT off
LINEAR PROGRAMMING Three time One time estimate
Inventories – any stored resource that is used to satisfy a Estimates
- A widely used mathematical modeling technique that estimates
current or future need; assets that are for sale Appropriate High precision time Reasonable time
helps in resource allocations decisions
Carrying Cost – holding cost; cost incurred (depreciation, for estimate estimate
Objective Function: Management Unpredictable Predictable
labor cost, insurance expense, miscellaneous expense,
of Activities activities
 Maximization -> PROFIT spoilage)
Non-repetitive Repetitive nature
 Minimization -> COSTS Nature of jobs
nature
Ordering Cost – cost of ordering inventory (freight)
Constraints – presence of restrictions; limit the degree to Critical and No differentiation Differentiated
Lead Time – time frame when your order will arrive Non-critical
which the objective can be obtained
Just-In-Time (JIT) – product will only be made when ordered activities
Properties of Linear Programs Research and Non-research
Development projects like civil
1. One objective function Suitable for
Project construction, ship
2. One or more constraints ECONOMIC ORDER QUANTITY in one of the oldest and most
building etc.
3. Alternative courses of action commonly known inventory control techniques
Crashing Not Applicable Applicable
4. Objective function and constraints are linear – Objective: to minimize total inventory cost concept
proportionality and divisibility
5. Certainty
6. Divisibility
7. Nonnegative variables