1. Decision Analysis 2. Pay-off Table and Opportunity Loss, or Regret Table 3.

Decision Rules
a) Decisions Under Uncertainty
Laplace Principle Maximin or Minimax Principle Maximax or Minimin Principle Hurwicz Principle Savage Principle

b) Decisions Under Risk

Maximum Likelihood Principle Expectation Principle Expected Opportunity Loss or Expected Regret EPPI and EVPI

(continued)
4. Decision Trees
a) Decisions Under Uncertainty b) Decision and Chance Nodes c) Rollback Method

Decision process calls for:

1.

Identification of states of nature, or events Identification of courses of action, or acts Determination of the pay-offs, depicting outcomes of various combinations of acts and events (pay-offs resulting from various act-event combinations can be either gains/losses or costs) Choosing, on the basis of some criterion, from among different alternatives

2.

3.

4.

A conditional pay-off table is set up either using given detailed information or through an algebraically expressed pay-off function A conditional regret matrix can also be set up as follows: When pay-offs are represented as gains: For every event, consider each act one by one and find excess of largest pay-off (coming from optimal act) over pay-off from the act in consideration When pay-offs are represented as costs: For every event, consider each act one by one and find excess of pay-off from the act in consideration over the smallest pay-off (coming from optimal act)

A toy company is bringing out a new type of toy. The company is attempting to decide whether to bring out a full, partial or minimal product line. The company has three levels of product acceptance. The management will make its decision on the basis of anticipated profit from the first year of production. The relevant data are shown in the following table:
Anticipated First Year Profit (in '000 Rs)
Demand High Medium Low Level of Production

Full
180 110 -70

Partial
110 90 -40

Minimal
60 30 10

The given matrix is a conditional pay-off matrix. The levels of demand are the states of nature as they are not in control of manager, while levels of production are the possible courses of action. Profits/losses resulting from various combinations are the pay-offs. Mark the largest value in each row, and subtract each value of the row from it. It gives the regret values.
Conditional Regret Matrix
Demand High Medium Low

Level of Production
Full
0 0 80

Partial
70 20 50

Minimal
120 80 0

Decisions under Uncertainty

Laplace Principle: assumes equal likelihood of various states of nature Maximin (or Minimax in case of pay-offs as cost) Principle: pessimists criterion considers best of the worst Maximax (or Minimin in case of pay-offs as cost) Principle: optimists criterion considers best of the best

Hurwicz Principle: uses decision-makers degree of optimism

Savage Principle: uses minimum of the maximum regret values of various acts

Demand High

Level of Production

Full
180

Partial
110

Minimal
60

Medium
Low Average Minimum Maximum Hurwicz ( = 0.6)

110
-70 73.3 -70 180 80

90
-40 53.3 -40 110 50

30
10 33.3 10 60 40

(continued)
S. No.
1 2

Criterion
Laplace Maximin

Decision
Full Production Minimal Production

3
4 5

Maximax
Hurwicz ( = 0.6) Minimax Regret

Full Production
Full Production Partial Production

Demand High Medium Low Maximum Regret

Level of Production Full

0 0 80 80

Partial
70 20 50 70

Minimal
120 80 0 120

Decisions under Risk

Maximum likelihood principle: for event with highest probability, choose the act with best pay-off Expectation principle: choose the act with best expected pay-off (highest in case of gains and lowest in case of costs) Expected regret principle: choose the act with lowest expected regret value; decision identical to one under expectation principle

EVPI: Expected Value of Perfect Information

EVPI = Expected regret with optimal course of action. Also, In case of gains as pay-offs:
EVPI = EPPI minus Expected pay-off under optimal action EPPI = Expected Pay-off under Perfect Information

In case of costs as pay-offs:

EVPI = Expected pay-off under optimal action minus ECPI ECPI = Expected Cost under Perfect Information

(continued)
Suppose the probabilities of high, medium and low demands are 0.2, 0.3 and 0.5 respectively Maximum likelihood is for low demand. The best pay-off is for minimal prod production.
Decision is: Minimal Production

Expected Pay-off:
Full Production: 34 Partial Production: 29 Minimal Production: 26

Optimal Decision

Expected Regret:
Full Production: 40 Partial Production: 45 Minimal Production: 48

Note that the decision on the basis of expected pay-off criterion is same as on the basis of expected regret. It is in fact always so

Expected Pay-off Information

under

Perfect
= 74

(EPPI) = 0.2180+0.3110+0.510 (thousand rupees)

Expected Value of Perfect Information

EVPI = EPPI Expected Pay-off of Optimal Policy = 74 34 = 40 (thousand rupees)

(continued)
For every course of action, note that Expected Pay-off + Expected Regret = EPPI For Partial Production: 29 + 45 = 74 For Minimal Production: 26 + 48 = 74 Maximisation of Expected Pay-off obviously leads to minimisation of Expected Regret

Uses additional given information in taking decisions Using given information, prior probabilities are revised and posterior probabilities calculated

Decision taken probabilities

using

posterior

Expected Value of Sample Information,

EVSI = Expected pay-off with given information minus Expected pay-off without given information

Efficiency of EVSI = {EVSI/EVPI}100

Used where sequential decisionmaking is involved

Decision trees are drawn taking appropriate decision nodes (where decision-maker has control) and chance nodes (where decisionmaker has no control) Optimal sequence of decisions is determined by rolling back technique and using the expected value criterion

Decision Node 1
Water, 0.2 Drill Up to 25 m No Water Drill 20 m 0.3 Stop Rs 25,000 Water 0.7 Rs 10,000 Rs 12,500 No Water Rs 27,500

Decision Node 2

Buy Water Rs 15,000 Rs 15,000 + Rs 10,000 = Rs 25,000

Decision Tree for Example 13.19

Decision Node

Options

Expected Cost
0.8(15,000 +12,500) + 0.212,500 = Rs 24,500 Rs 25,000 0.324,500+ 0.710,000 = Rs 14,350 Rs 15,000

Decision

Drill to 25 m

Stop 2 Drill to 20 m Do not Drill

Optimal Decision: Drill up to 20 m, if no water, then drill up to 25 m