Decision Theory & Sequencing

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Learning out Come

After undergoing this module, the student must be able to exhibit the knowledge about

1. List the steps of the decision-making process.

2. Describe the types of decision-making environments.

3. Finding decisions under uncertainty using Minmax and Maxmin approach.

4. Finding Decision under risk through Expected value approach

5. Develop accurate and useful decision trees.

4.1. Introduction

  • Decision theory is an analytical and systematic way to tackle problems.
  • A good decision is based on logic.

4.2. The Six Steps in Decision Theory

1. Clearly define the problem at hand.

2. List the possible alternatives.

3. Identify the possible outcomes.

4. List the payoff or profit of each combination of alternatives and outcomes.

5. Select one of the mathematical decision theory models.

6. Apply the model and make your decision.

Example-1

• Mr. Krishnappa is having a 50X80 commercial site in Gandhinagar.

Presently he is paying tax of Rs.25,000/- per year. He has got three options

A. To create Luxury Suites / Deluxe / ordinary rooms

B. To Lease out the space for parking / trade fair /functions

C. No Plans

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Example-2

• Mr. Ramappa is having a Industrial site in Peenya. Presently he is paying tax of Rs.75,000/- per year. He has got three options

A. To Construct Large factory

B. Average factory

C. Small factory

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4.3. List Possible Actions or Events

A. Pay off Table

B. Decision Tree

A. Payoff Table

A payoff table shows alternatives, states of nature, and payoffs

Example 1

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4.4. Types of Decision-Making Environments

Type 1: Decision making under certainty.

Decision maker knows with certainty the consequences of every alternative or decision choice.

Type 2: Decision making under risk.

The decision maker does know the probabilities of the various outcomes.

Decision making under uncertainty.

The decision maker does not know the probabilities of the various outcomes

4.5 Decision Making under Uncertainty

A. Maximin- pacimistic approach

B. Minmax and Opportunity loss

C. Equally likely (Laplace)

D. Criterion of realism

E. Maximax

First two Methods are available in syllabus.

A. Maximin- pacimistic approach

Example-1

• Mr. Krishnappa is having a 50X80 commercial site in Gandhinagar.

Presently he is paying tax of Rs.25,000/- per year. He has got three options

A. To create Luxury Suites / Deluxe / ordinary rooms

B. To Lease out the space for parking / trade fair /functions

C. No Plans

image

Example-2

• Mr. Ramappa is having a Industrial site in Peenya. Presently he is paying tax of Rs.75,000/- per year. He has got three options

A. To Construct Large factory

B. Average factory

C. Small factory

image

image

B. Maximin- pacimistic approach

Example-1

• Mr. Krishnappa is having a 50X80 commercial site in Gandhinagar.

Presently he is paying tax of Rs.25,000/- per year. He has got three options

A. To create Luxury Suites / Deluxe / ordinary rooms

B. To Lease out the space for parking / trade fair /functions

C. No Plans

image

Example-2

• Mr. Ramappa is having a Industrial site in Peenya. Presently he is paying tax of Rs.75,000/- per year. He has got three options

A. To Construct Large factory

B. Average factory

C. Small factory

image

image

C. Decision Making under Uncertainty- Minimax Regret:

Choose the alternative that minimizes the maximum opportunity loss

· Opportunity Loss is defined as the chance of earning the profit is lost due to Drop error.

· Drop error is nothing but the an alternative supposed to be opted is rejected because of any of the reasons.

D. . Decision under Risk- Expected value

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Solution

EMV=Max((75,000X0.25+25,000X0.5+(-40000X0.25)), (1,00,000X0.25+35,000X0.5+(-60000X0.25)),) = 27,500/=

4.6. Decision Tree

It is a pictorial representation of all possible outcomes with assigned set of probabilities.

Example 1

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