DECISION MAKING

Real|Rule|Rupal|Sayson|
Senica

NATURE OF DECISION MAKING

Senica, Carmel Christine

NATURE OF DECISION MAKING

process of making a conscious choice between two or
more rational
deciding in advance what to do, how to do it, when to
do it, and who is to do it
required in designing and staffing an organization,
developing methods of motivating subordinates, and
identifying corrective actions in the control process

Chester Barnard, the occasions for decisions originate in

three distinct fields :
(a) from authoritative communications from superiors;
(b) from cases referred for decision by subordinates; and
(c) from cases originating in the initiative of the executive
concerned.

TYPES OF DECISIONS

Routine and nonroutine decisions

 Objective versus bounded rationality

-Rationality requires a complete knowledge and
anticipation of the consequences that will follow on each
choice.
-Since these consequences lie in the future,
imagination must supply the lack of experienced feeling
in attaching value to them.
-Rationality requires a choice among all possible
alternative behaviors.

 Level of Certainty

MANAGEMENT SCIENCE
Rupal, Farizza Ann

DEFINITION
application of quantitative methods and techniques
to the practice of management
concerned with developing and applying models
and concepts that help to illuminate management
issues and solve managerial problems

ORIGINS
Its origins can be traced to operations research,
which made its debut during World War II when the
Allied forces recruited scientists of various disciplines to
assist with military operations. In these early
applications, the scientists utilized simple mathematical
models to make efficient use of limited technologies and
resources. The application of these models within the
corporate sector became known as management
science.

PRIMARY DISTINGUISHING CHARACTERISTICS

1. A systems view of the problem
2. The Team Approach
3. An emphasis on the use of formal mathematical
models and statistical and quantitative techniques.

MODELS AND THEIR ANALYSIS

Model an abstraction or simplification of reality,

designed to include only the essential features that
determine the behavior of a real system.
Physical Models
Conceptual Models
Mathematical Models

PHYSICAL MODEL

CONCEPTUAL MODEL

MATHEMATICAL MODEL

Management science uses a five-step process that begins

in the real world, moves into the model world to solve the
problem, and then returns to the real world for
implementation.

THE ANALYST AND THE MANAGER

To be effective, the management science analyst cannot just
create models in an ivory tower. The problem-solving team
must include managers and others from the department or
system being studiedto establish objectives, explain
system operation, review the model as it develops from an
operating perspective, and help test the model. The user
who has been part of model development, has developed
some understanding of it and confidence in it, and feels a
sense of ownership of it is most likely to use it effectively.

TOOLS FOR DECISION MAKING

Categories of Decision Making
Decision Making under Certainty
Decision Making under Risk
Decision Making under Uncertainty

DECISION MAKING UNDER

CERTAINTY
Sayson, Frances Irah

Decision making under certainty implies that we are

certain of the future state of nature. It means that all the
information the decision maker needs is fully available.
Managers have information on operating conditions,
resource costs or constraints, and each course of action
and possible outcome. However, few decisions are
certain in the real world. Most contain risk or uncertainty.

LINEAR
PROGRAMMING

Linear programming deals with problems such as

maximising profits, minimising costs or ensuring you
make the best use of available resources. From an
applications perspective, mathematical (and therefore,
linear) programming is an optimisation tool, which allows
the rationalisation of many managerial and/or
technological decisions.

STEPS FOR SOLVING LINEAR

PROGRAMMING

The graphical method for solving linear programming problems in two

unknowns is as follows.
1. Define the variables
2. Define the constraints
3. Define the objective function (the function which is to be maximised or
minimised)
4. Graph the feasible region
5. Find the coordinates of the corner points
6. Substitute the coordinates of the corner points into the objective function
to see which gives the optimal value

 Example A small factory produces two types of toys: trucks and

bicycles. In the manufacturing process two machines are used:
the lathe and the assembler. The lathe can be operated for 16
hours a day and there are two assemblers which can each be
used for 12 hours a day. Each bicycle gives profit of 16 and
each truck gives a profit of 14. Formulate and solve a linear
programming problem so that the factory maximises its profit.
The table shows the length of time needed for each toy:

DEFINE THE VARIABLES

Let x be number of bicycles made
Let y be number of trucks made

DEFINE THE CONSTRAINTS

2x + y < 16 (Lathe)
2x + 3y < 24 (Assembler)

DEFINE THE OBJECTIVE FUNCTION

(THE FUNCTION WHICH IS TO BE
MAXIMISED OR MINIMISED)
Maximise P = 16x + 14y

GRAPH THE FEASIBLE REGION

FIND THE COORDINATES OF THE

CORNER POINTS

(0,0)
(8,0)
(6,4)
(0,8)

SUBSTITUTE THE COORDINATES OF

THE CORNER POINTS INTO THE
OBJECTIVE FUNCTION TO SEE WHICH
GIVES THE OPTIMAL VALUE
(0, 0) P = (16 X 0) + (14 X 0) = 0
(8, 0) P = (16 X 8) + (14 X 0) = 128
(6, 4) P = (16 X 6) + (14 X 4) = 152
(0, 8) P = (16 X 0) + (14 X 8) = 112

 Therefore, the factory should make 6 bicycles and 4

trucks each day in order to have profit of 152.

DECISION MAKING UNDER RISK

Rule, Mary Joy
Real, Al Florencio II

EXPECTED VALUE

ARE YOU TAKING ENOUGH

RISKS?

NATURE OF RISK

In decision making under risk one assumes that there exist a

number of possible future states of nature N j . Each has a
known (or assumed) probability P j of occurring, and there may
not be one future state that results in the best outcome for all
alternatives Ai .

NATURE OF RISK
Examples of future states and their probabilities are as follows:
Alternative weather (N1 = rain, N2 = good weather ) will affect
the profitability of alternative construction schedules; here, the
probabilities P1 of rain and P2 of good weather can be estimated
from historical data.
Alternative economic futures (boom or bust) determine the
relative profitability of conservative versus high-risk investment
strategy; here, the assumed probabilities of different economic
futures might be based on the judgment of a panel of
economists.

DECISION MAKING TOOL

Expected Value
Statistical concept aimed at helping executives make
better decisions under conditions of uncertainty.
It focuses on evaluation and qualification of
the magnitude and nature of risk associated with a
particular outcome, in order to decide if the risk
is worth taking.

EXPECTED VALUE
Given the future states of nature and their probabilities,
the solution in decision making under risk is the
alternative that provides the highest Ai expected value
Ei, which is defined as the sum of the products of each
outcome times the probability that the associated state
of nature occurs.

EXPECTED VALUE
The expected value of a given decision in such cases is
the sum of all the values of each outcome, each
diminished by its individual probability.

EXPECTED VALUE EXAMPLE 1

Consider that you own rights to a plot of land under which
there may or may not be oil. You are considering three
alternatives: doing nothing (dont drill), drilling at your
own expense of $500,000, and farming out the
opportunity to someone who will drill the well and give
you part of the profit if the well is successful.
You see three possible states of nature: a dry hole, a
mildly interesting small well, and a very profitable gusher.

EXPECTED VALUE EXAMPLE 1

Choose Alternative 2 if (and only if) you are willing and able to risk losing $500,000 .

EXPECTED VALUE EXAMPLE 2

A local club plans to invest $10000 to host a baseball
game. They expect to sell tickets worth $15000. But if it
rains on the day of game, they won't sell any tickets
and the club will lose all the money invested. If the
weather forecast for the day of game is 20% possibility
of rain, is this a good investment?

EXPECTED VALUE EXAMPLE 2

E= 0.8(5,000) + 0.2 (-10,000) = $2,000

The club can expect a return of $2000. So, it's a good investment,
though a bit risky.

EXPECTED VALUE EXAMPLE 3

Alternative A1 has a constant cost of $200, and A 2 a
cost of $100,000 if future takes place (and none
otherwise).

EXPECTED VALUE EXAMPLE 3

E (A1)= 0.999 (-200) + 0.001(-200)= -$200
E (A2)= 0.999 (0) + 0.001(-100,000)= -$100
Assume that you own a $100,000 house and are offered
fire insurance on it for $200 a year. This is twice the
expected value of your fire loss (as it has to be to pay
insurance company overhead and agent costs).

DECISION TREES
Decision trees provide another technique used in finding
expected value.
They begin with a single decision node (normally represented
by a square or rectangle), from which a number of decision
alternatives radiate.
Each alternative ends in a chance node, normally represented
by a circle.
From each chance node radiate several possible futures, each
with a probability of occurring and an outcome value.

DECISION TREES
A decision tree is a decision support tool that uses a treelike graph or model of decisions and their possible consequences,
including chance event outcomes, resource costs, and utility.

DECISION TREE EXAMPLE 1

Assume that you own a $100,000 house and are

offered fire insurance on it for $200 a year. The chance
of a fire occurring is 99%.

DECISION TREE EXAMPLE 1

DECISION TREE EXAMPLE 2

Jacks garage is considering hiring another mechanic. The
mechanic would cost them an additional $50,000/year in
salary and benefits. If there are lots of accidents in Iowa
City this year, they anticipate making an additional $75,000
in net revenue. If there are only few accidents, they could
lose $20,000 off of last years total revenues. Because of all
the ice in roads, there is a 70% chance of street accidents.
Assume if he doesnt expand, he will have the same
revenue as last year.

DECISION TREE EXAMPLE 2

QUEUING THEORY

WHAT IS A QUEUE?
a line or sequence of people or anything awaiting
their turn to be attended to or to proceed.

WHAT IS A QUEUE?
a line or sequence of people or anything awaiting
their turn to be attended to or to proceed.

WHAT IS A QUEUE?
a line or sequence of people or anything awaiting
their turn to be attended to or to proceed.

WHAT IS A QUEUE?

a line or sequence of people or anything awaiting their turn to be attended to or to

proceed.

WHAT IS A QUEUE?

a line or sequence of people or vehicles awaiting their turn to be attended to or to

proceed.

QUEUING THEORY
Queuing theory is the mathematical study of waiting
lines(or queues) that enables mathematical analysis
of several related processes, including arriving at
the queue, waiting in the queue, being served by
the Service Channels at the front of the queue, and
leaving the queue.

ORIGIN
Queuing theory had its beginning in the research work of a
Danish engineer named Agner Krarup Erlang
Erlang experimented with the fluctuating demand for
telephone calls on the need for automatic dialing equipment.
Published his first paper on Queuing Theory in 1909
At the end of World War II, Erlangs early work was
extended to more general problems and to business
applications of waiting lines.
(Stordahl, pg 136-138).

QUEUING SYSTEM
Model processes in which costumers arrive,Wait
their turn for service, get the service they needed,
and then leave

QUEUING SYSTEMS

WHAT ARE THE INFORMATIONS TO

COLLECT?
Relating to:
Arrival Process
Service Mechanism
Queue Characteristics

ARRIVAL PROCESS
How customers arrive?
How the arrivals are distributed in time?
what is the probability distribution of time between
successive arrivals? (the inter-arrival time
distribution)
Whether there is a finite or infinite population of
customers

SERVICE MECHANISM
How long the service will take?
The number of servers available
Whether the servers are in series or parallel
Series has separate queue
Parallel one queue for all
whether preemption is allowed

QUEUE CHARACTERISTICS
What queuing discipline is fit for the service?
FIFO First In First Out
LIFO Last In First Out
Randomly
Whether there is:
balking (customers deciding not to join the queue if it is too
long)
reneging (customers leave the queue if they have waited too
long for service)
jockeying (customers switch between queues if they think they
will get served faster by so doing)
a queue of finite capacity or (effectively) of infinite capacity

QUEUING MODELS
Deterministic queuing model
Probabilistic queuing model

DETERMINISTIC QUEUING MODEL

= mean number of arrivals per time period
= mean number of units served per
time
period
If > , then waiting line shall be formed and
increased indefinitely and service system would fail
If , there shall be no waiting line

PROBABILISTIC QUEUING MODEL

Poisson stream of arrivals
Coresponds to arrivals at random
Described by a single parameter the average arrival rate
The probability density function for the Poisson distribution is as follows:

Which is interpreted as the probability that exactly n customers will arrive

during a time period of length T will be P_T (n). The parameter is
called lambda, and represents the average number of customers arriving per
single time period. (Recall from your statistics class that e is a constant of
approximately 2.718, and n! = n(n-1)(n-2)...21.)

EXAMPLE
If a single time period is defined as one hour, and an average of 4 customers
arrive each hour, then =4. Note that lambda is a rate, which is expressed in
units (i.e. customers) per time period. If the arrival of customers is random
according to a Poisson probability distribution, what is the probability that exactly
3 customers will arrive in a one-hour time period? (e = 2.718)

RISK AS VARIANCE

WHAT IS VARIANCE?
A measurement of the spread between numbers in a data set.
Measures how far each number in the set from the mean.
calculated by taking the differences between each number in the
set and the mean, squaring the differences (to make them
positive) and dividing the sum of the squares by the number of
values in the set.

EXAMPLE
Consider two investment projects, X and Y, having the
discrete probability distribution of expected cash flow in
each of the next several years as shown.

SOLUTION
Expected cash flows are calculated in the same way as
expected value:

a. E(X) = 0.10(3000)+0.20(3500)+0.40(4000)
+0.20(4500)+0.10(5000)
= $4000
b. E(Y) = 0.10(2000)+0.25(3000)+0.30(4000)
+0.25(5000)+0.10(6000)
= $4000

 Although both projects have the same mean (expected)

cash flows, the expected values of the variances
(squares of the deviations from the mean) differ as
follows
V(X) = 0.10(3000 - 4000)2 + 0.20(3500 - 4000)2 +...
+0.10(5000 - 4000)2
= 300 000
V(Y) = 0.10(2000 - 40000)2 + 0.25(3000 - 4000)2 +... +
0.10(6000 - 4000)2
= 1,300,000

 The standard deviation is the square root of the variance

 Since project Y has the greater variability (whether

measured in variance or in standard deviation), it must
be considered to offer greater risk than does project X.

DECISION MAKING UNDER

UNCERTAINTY
Real, Al Florencio II

UNCERTAINTY
uncertainty occurs when there exists several future
states of nature but the probabilities of each of
these states occuring are not known.

DECISION CRITERIA

The maximax criteria

The maximin criteria
The Hurwicz alpha criteria
The principle of insuficient reason
The minimax regret criteria

MAXIMAX CRITERIA
The optimistic decision maker
The decision maker chooses the alternative that
offers the highest possible outcome ignoring
probabilities.

MAXIMIN CRITERIA
The pessimist decision maker
The decision maker chooses the alternative whose
worst outcome is least bad.

HURWICZ ALPHA CRITERIA

The decision maker may choose a position
somewhere in between optimism and pessimism
The decision payoffs are weighted by a coefficient
of optimism, alpha ().
= 0 pessimistic
= 1 optimistic

EXAMPLE

SOLUTION STEPS USING HURWICZ

ALPHA CRITERIA
1.
2.
3.
4.

Largest payoff & Smallest payoff

Estimate
Expected Value
Optimal solution selection

1.

Largest & smallest payoffs

2.
3.

Value of = 0.2
Expected value =

EV(A2)= [0.2($9,300,000) + (1-0.2)($-500,000)]

= $1,460,000 profit gain
EV(A3)= [0.2($1,250,000) + (1-0.2)($0)]
= $250,000 profit gain

1.

Largest & smallest payoffs

2.
3.

Value of = 0.2
Expected value =

EV(A2)= [0.2($9,300,000) + (1-0.2)($-500,000)]

= $1,460,000 profit gain
EV(A3)= [0.2($1,250,000) + (1-0.2)($0)]
= $250,000 profit gain

PRINCIPLE OF INSUFFICIENT REASON

Laplace Criteria
The decision maker assumes that the states of
nature are equally likely to occur.

EXAMPLE

SOLUTION
Expected value (En)

MINIMAX REGRET CRITERIA

The decision maker attempts to avoid regret by
selecting the decision that minimizes the maximum
regret.

EXAMPLE

The Solution is to choose Strategy 2.

GAME THEORY

GAME THEORY
The future states of nature and their probabilities
are replaced by the decisions of a competitor.

GAME THEORY
Begley and Grant explained:
In essence, game theory provides the model of a
contest. The contest can be a war or an election, an
auction or a childrens game, as long as it requires
strategy, bargaining, threat, and reward.

EXAMPLE