Scribd
Upload
65 views30 pages

Quantitative Methods: MAT 540 Decision Analysis

This document outlines quantitative methods for decision analysis. It discusses components of decision making situations, various criteria for making decisions without probabilities like maximax and maximin, computing expected value when probabilities are known, expected value of perfect information, constructing decision trees, sequential decision trees, decision analysis with additional information, and expected value of sample information. The objectives are to understand how to analyze and make decisions under uncertainty using these quantitative decision analysis techniques.

Uploaded by

Kristin Howard
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
65 views30 pages

Quantitative Methods: MAT 540 Decision Analysis

This document outlines quantitative methods for decision analysis. It discusses components of decision making situations, various criteria for making decisions without probabilities like maximax and maximin, computing expected value when probabilities are known, expected value of perfect information, constructing decision trees, sequential decision trees, decision analysis with additional information, and expected value of sample information. The objectives are to understand how to analyze and make decisions under uncertainty using these quantitative decision analysis techniques.

Uploaded by

Kristin Howard
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
You are on page 1/ 30

Quantitative Methods

MAT 540
Decision Analysis

Objectives
When you complete this lesson, you will be able to:
List the components of a decision-making situation.
Make decisions without probabilities using the maximax, maximin,
minimax regret, Hurwicz, and equal likelihood criteria.
Compute the expected value of a decision when probabilities are
known.
Compute the expected value of perfect information.
Construct decision trees to calculate the expected value of a decision.
Construct decision trees to calculate the expected value of a sequence
of decisions.
Conduct a decision analysis with additional information.
Compute the expected value and efficiency of sample information.

Components of Decision Making


The decision itself
The states of nature
Payoff table

Decision Making Without


Probabilities
Real estate example

The Maximax Criterion


Maximum of the maximum payoffs
Assumes the most favorable state of nature

The Maximin Criterion


Maximum of the minimum payoffs
Assumes least favorable state of nature

The Minimax Regret Criterion


Minimizes the maximum regret
Good Economic Conditions

Poor Economic Conditions

$100,000 - 50,000 = $50,000

$30,000 - 30,000 = $0

$100,000 - 100,000 = $0

$30,000 (- 40,000) = $70,000

$100,000 - 30,000 = $70,000

$30,000 - 10,000 = $20,000

The Hurwicz Criterion


Compromise between maximax and
maximin
Coefficient of optimism
= 0.4
1 = 0.6
Decision

Values

Apartment building

$50,000(.4) + 30,000(.6) = $38,000

Office building

$100,000(.4) 40,000(.6) = $16,000

Warehouse

$30,000(.4) + 10,000(.6) = $18,000

The Equal Likelihood Criterion


Weights each state of nature equally
Decision

Values

Apartment building

$50,000(.5) + 30,000(.5) = $40,000

Office building

$100,000(.5) 40,000(.5) = $30,000

Warehouse

$30,000(.5) + 10,000(.5) = $20,000

Summary of Criteria Results


Warehouse is dominated by apartment
building
Criterion

Decision (Purchase)

Maximax

Office building

Maximin

Apartment building

Minimax regret

Apartment building

Hurwicz

Apartment building

Equal likelihood

Apartment building

Solution of Decision-Making Problems


Without Probabilities with QM for Windows

Decision Making with


Probabilities
Expected value
Estimate the probability of occurrence of each
state of nature
Compute
n

E x xi P xi
i 1

Expected Value

EV(Apartment) = $50,000(.6) + 30,000(.4) = 42,000


EV(Office) = $100,000(.6) - 40,000(.4) = 44,000
EV(Warehouse) = $30,000(.6) + 10,000(.4) = 22,000

Expected Opportunity Loss

EOL(Apartment) = $50,000(.6) + 0(.4) = 30,000


EOL(Office) = $0(.6) + 70,000(.4) = 28,000
EOL(Warehouse) = $70,000(.6) + 20,000(.4) = 50,000

Solution of Expected Value


Problems with QM for Windows

Expected Value of Perfect


Information

$100,000(.60) + 30,000(.40) = $72,000


EV(office) = $100,000(.60) - 40,000(.40) = $44,000
EVPI = $72,000 - 44,000 = $28,000

Decision Trees

Decision Trees, continued


Compute expected values
EV(node 2) = .60($50,000) + .40(30,000) = $42,000
EV(node 3) = .60($100,000) + .40(-40,000) = $44,000
EV(node 4) = .60($30,000) + .40(10,000) = $22,000

Decision Trees with Excel and


TreePlan

Sequential Decision Trees

Sequential Decision Trees,


continued

Apartment building: $1,290,000 800,000 = $490,000


Land: $1,360,000 200,000 = $1,160,000

Decision Analysis with


Additional Information
Bayesian analysis

EV(office building) = $44,000

Decision Analysis with Additional


Information, continued
Conditional probabilities:
g = good economic conditions, P(g) = .6
p = poor economic conditions, P(p) = .4
P = positive economic report
N = negative economic report
P(P g) = .80 P(N G) = .20
P(P p) = .10 P(N p) = .90

Decision Analysis with Additional


Information, continued
Posterior probabilities
P g P

P P g P g

P P g P g P P p P p

.8 .6

.8 .6 .1 .4
.923

P(g|N) = .25
P(p|P) = 0.77
P(p|N)=.75

Decision Trees with Posterior


Probabilities

Decision Trees with Posterior


Probabilities, continued
Probability of two dependent events
P(AB) = P(A|B)P(B)
P(Pg) = P(P|g)P(g)
P(Pp) = P(P|p)P(p)

Decision Trees with Posterior


Probabilities, continued
Mutually exclusive events
P(P) = P(Pg) + P(Pp)
= P(P|g)P(g) + P(P|p)P(p)
= (.8)(.6) + (.1)(.4)
= .52
P(N) = P(N|g)P(g) + P(N|p)P(p)
= (.2)(.6) + (.9)(.4)
= .48

Decision Trees with Posterior


Probabilities, continued
EV(apartment) = $50,000(.923) + 30,000(.077) = $48,460

The Expected Value of Sample


Information
EVSI = EVwith information EVwithout information
= $63,194 44,000
= $19,194
Efficiency = EVSI EVPI
= $19,194 / 28,000
= .68

Summary

Components of decision making


Decision making without probabilities
Decision making with probabilities
Expected value of perfect information
Decision trees
Sequential decisions
Decision making with additional information
Expected value of sample information

You might also like