DECISION MAKING

Need for decision tree.

Time is the another criterion which can be used to classify the decisions, namely
1) Single stage or static decision and
2) Multistage or sequential decisions.
Single stage or static decisions are essentially one-time decisions. Typical
examples of one-time decisions are make-or-buy decisions, product mix
decisions, selection of a site for the plant, selection of manufacturing process etc.
such decisions are very simple & straightforward.
Sequential decisions are those decisions in which outcome of the first decision
affects the desirability of the choices at the next decision stage. Such problems
are generally more complex since the aim is not to get the best outcome at one
stage but to make a series of choices so that the overall best outcome results.
Typical examples of sequential decisions are capacity planning, aggregate
planning, project planning etc.
Problems involving single stage or static decision under risk can be solved using
EMV(Expected Monetary Value) approach but complex problems, especially
those involving several stages & each stage in turn giving rise to different
outcomes &payoffs, cannot be solved by the EMV approach.
Such problems can conveniently be depicted by means of a network called
decision tree.

What are decision trees

Decision trees provide a pictorial method of showing a sequence of inter-related
decision & outcomes. Though decision trees do not show any more information than
could be shown in tabular form, but they provide a clearer overview of the complex
decision making situation. Decision trees reduce the problem to its simplest form,
similar to a tree, using decision alternative, a set of possible events corresponding to
each decision alternative & probabilities associated with the events. Decision tree,
therefore, is an aid to decision making under risk, especially in a situation
where the decision maker must make a sequence of decisions. The use of decision
trees helps to simplify the analysis.
The use of decision tree requires:
1. Identification of decision alternatives.
2. Identification of events corresponding to each decision alternative.
3. Assessing the probabilities of occurrence of the various events.
4. Applying the expected value criterion to identify the best course of action.

Applications of decision trees

Decision trees though can be applied to any given problem involving number of
alternative courses of action wherein the decision require to be taken at different
stages. Typical example of the problems requiring use of decision trees are :
• investment decisions
• replacement decisions
• distribution decisions
• site decisions.

Terminology of decision trees.

1) Decision nodes are the points from which decision alternatives, emerge as
branches of the tree. The decision nodes are depicted by squares.
3) Event nodes are the points from which outcomes emanate as
the branches of the tree. The event nodes are depicted by circles.

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 DECISION MAKING

4) Branches of the tree emanating from the decision nodes

represent decision alternatives and those emerging from event nodes represent
the possible outcomes.

5) Outcomes represent the consequences of the interaction of

the decision alternative and the chance event. Outcomes
are usually expressed in economic terms.
6) Risk represent the probability estimate of occurrence of
each outcome.
7) Forward pass / Backward pass. Decision problems are
solved in two stage known as forward and backward pass.
The forward pass is the computation of each sequence-
outcome node. The backward pass is the evaluation stage
and it involves computation of EMV at each event node and
selection of optimal strategy at each decision node.

How is the decision tree made & used

Basic steps are as under:
1) Identity decision points and decision alternative (strategies) at each point.
Represent the decision point by squares and write numerals inside the
squares to indicate stage of the decision and represent decision alternatives by
branches.
2) Identify chance events that can occur after each decision. Represent chance
events by circles.
3) Assess the outcomes for the chance events and the risk (probability) associated
with each outcome. Represent outcomes by the branches of the tree emanating
from the circles (event nodes).
4) Using roll-back-technique, determine the expected payoff for different course of
action at each event node and select optimal strategy at each decision node.
5) Repeat steps (iv) until the first decision point is reached.
6) Select the optional strategy to be adopted for the situation as a whole.

Decision trees are used in probabilistic decision making situations where a cascade of
decisions and events, are required to be optimized. One prerequisite for using a decision
tree analysis is that all decision alternatives, events and their probabilities have to be known
in advance. So also the outcomes of the final events,

Morphology of the decision tree. The components of the decision tree are:

1. Decision alternatives branching out from decision nodes

2. Events branching out from event nodes
3. Probabilities associated with each event
4.Outcomes resulting from interaction of decision and events.
The following diagram illustrates a simple tree diagram.

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