Decision Theory

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(Vivek kumar gupta)

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6 à e decision t eory, also called t e decision
analysis, is to determine optimal strategies
w ere a decision-maker is faced wit several
decision alternatives and an uncertain, or risky,
pattern of future events .
6 A decision may be defined as t e selection by
t e decision-maker of an act, considered to be
t e best according to some pre designated
standard, from among t e available options.
|ecision analysis process divided in 3
parts6
3ingle 3tage |ecision making problems
Bayesian decision Rule
Multi-3tage decision problems
Using Utility for |ecision-making
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6 ë .A bookstore sells a particular book of tax
laws for Rs .It purc ases t e book for Rs 8
per copy. 3ince some of t e tax laws c ange
every year, t e copies unsold at t e end of a year
become outdated and can be disposed of for Rs
3 eac . According to past experience, t e
annual demand for t is book is between 8 and
23 copies. Assuming t at t e order for t is book
can be placed only once during t e year, t e
problem before t e store¶s manager is to decide
ow many copies of t e book s ould be
purc ased for t e next year.
3ince t e annual demand varies between 8
and 23 copies, t ere are 6 possible events.
6 E - 8 copies are demanded
6 E2- copies are demanded
6 E3- 2 copies are demanded
6 E4 -2 copies are demanded

6 A -buy 8 copies
6 A2-buy copies
6 A3-buy 2 copies
6 A4-buy 2 copies
6 A5-buy 22 copies
6 A6-buy 23 copies
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6 ]ay-off is a conditional value-a conditional

profit,loss, or may, a conditional cost.
6 A pay-off table t us represents t e matrix of
t e conditional values associated wit all t e
possible combinations of t e acts and t e
events.
6 |-demand in units of t e product
6 ë-quantity decided to be purc ased
6 If |ë,t en ] ë-8ë or ]2ë
6 If |ë, t en ]2|-5(ë-|) or ]|-5ë
]

! " #

× ×
× × ×× ×
× × × ×
! × × × ×
" × × ×
# × ×
$%&%
6 à e opportunity loss or regret is defined as t e

amount of pay-off foregone by not adopting
t e optimal course of action-t at w ic would
give t e ig est pay-off, for eac possible
event.
6 It represents t e amount of profit foregone by
not stocking as many copies of t e book as
would yield t e ig est profit for eac level of
demand.
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A)|ecisions under Uncertainity
Î ·aplace ]rinciple
Î Maximin or Minimax ]rinciple
Î Maximax or Minimin ]rinciple
Î Hurwicz ]rinciple
Î 3avage ]rinciple
B)|ecision under Risk
Î Maximum likeli ood ]rinciple
Î Expectation ]rinciple
·]
6 Ñ
6
6 Ñ
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6 A2 is adopted.
6 Bookstore manager would buy copies of t e
book according to ·aplace principle.
x x ]
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× ×

× × ×× ×
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- $

6 Maximum is Rs 36
6 A is selected according to maximin principle
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6 Hig est profit is Rs 46
6 3trategy A6 of ordering 23 copies of t e book
is selected.
å
x x !"x#$
"%
!#"x#
% 36 36 .6 X 36 + .4 X 36 36
& 38 3 .6 X 38 + .4 X 3 352
' 4 26 .6 X 4 + .4 X 26 344
( 42 2 .6 X 42 +.4 X 2 336
) 44 6 .6 X 44 + .4 X 6 328
46 .6 X 46 + .4 X 32

6 à e maximum value is 36.
6 A is selected.
3]
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6 A2 is t e optimal c oice according to 3avage
]rinciple.

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6 It is ig est at Rs 42 w en 2 copies are
ordered for.
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6 ùor A ,E]
6 .5x36+. x36+.3x36+.4x36+.
x36+.5x36 Rs 36
6 ùor A2, E]2
.5x3 +. x38+.3x38+.4x38+.
x38+.5x38Rs 36.5
6 ùor A6, E]6
.5x +. x 8+.3x25+.4x32+.
x3+.5x46Rs 288.5

6 Maximum expected pay-off is associated wit
strategy A3
6 2 Copies of t e book is boug t.
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6 Minimum value occurs at A3 .
6 3o decision of buying 2 books is taken.
Example 3.2(N| Vo ra)
àec nico ·td as installed a mac ine costing 4 lacs and
is in process of deciding on an appropriate number of
certain spare parts required for repairs. à e spare parts
cost Rs 4 eac but are available only if t ey are
ordered now. In case t e mac ine fails and no spare parts
are available, t e cost to t e company of mending t e
plant would be Rs 8.à e plant as an estimated life
of 8 years and t e probability distribution of failures
during t is time, based on experience wit same mac ine
is as follows:
0 , -%&'()$
] -.%-.&-.'-.&-.%-.%-
| :

a) à e optimal number of spare parts on t e basis of :
Minimax principle
Minimin principle
·aplace principle
Hurwicz principle taking (Į.)
Expected cost principle
b) à e expected number of failures in t e 8 year
period.
c)à e regret table ,and t e optimal c oice on t e
basis of least expected regret criterion.
3
6 If we let ù represent t e number of failure
6 3 t e number of spares and
6 C t e total cost t en :-
"# (---3/013
and
(---$%,---"0
3#/023
x
0+%')
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Ñ% - . 4 8 2 6 2
Ñ& % .2 8 4 8 2 6 2
Ñ' & .3 36 22 8 2 6 2
Ñ( ' .2 54 4 26 2 6 2
Ñ) ( . 2 58 44 3 6 2
Ñ ) . 6 62 48 34 2
x 4 8 2 6 2
x 6 62 48 34 2
3 45 34 26 2 2

Ñ 4 .4 2.2 2.6 .4 .8 2
6 x
à e maximum values in eac column are
indicated in t e Column maxima row. à e
minimum of t is being 2. t us t e decision of
minimax rule would be 5 spare parts.
6 x
ùrom t e minimum values contained in t e
row column minima t e least value is .à us
t e optimal number of spare parts is Nil
6 ·]
In t is decision is taken on t e basis of t e
simple average cost value. 3ince t e simle
average value is minimum at A5, t e optimal
number of spares is 4.
6 å ]
å !"#$"%
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% . x + .3 x 2.
& . x 4 + .3 x 6 25.6
' . x 8 + .3 x 62 24.2
( . x 2+ .3 x 48 22.8
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. x2+ .3 x 2 2.
3 4
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6 Ñ ]
According to t e table t e minimum value for
expected cost is A4 t us t e optimum policy of
spares is 3 t e expected cost being Rs .4
t ousand.
6 Ñ ,
E(ù) . x+.2x +.3x2+.2x3+. x4+. x52.3

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"Ñ#
Ñ% - . 4 8 2 6 2
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Ñ' & .3 28 4 4 8 2
Ñ( ' .2 42 28 4 4 8
Ñ) ( . 56 42 28 4 4
Ñ ) . 56 42 28 4
Ñ 32.2 2 .4 8.2 8.6 .8

3ince t e expected regret for strategy A4 is t e least t e

optimal policy in t is case is to buy 3 spare parts
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| 

(Vivek kumar gupta)

6 ]ay-off is a conditional value-a conditional

6 à e opportunity loss or regret is defined as t e

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3ince t e expected regret for strategy A4 is t e least t e

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