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**Learning Objectives Discuss how decision making relates to planning**

Explain the process of engineering problem solving Solve problems using three types of decision making tools Discuss the differences between decision making under certainty, risk, and uncertainty Describe the basics of other decision making techniques

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**DECISION MAKING Preview**

Decision making and problem solving are used in all management functions, although usually they are considered a part of the planning phase.

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Relation to Planning Decision Making: The Process of making a conscious choice between 2 or more alternatives producing most desirable consequences (benefits) relative to unwanted consequences (costs). If Planning is truly Deciding in advance what to do, how to do it, when to do it and who is to do it, then Decision Making is an essential part of Planning

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**Occasions for Decision**

Occasions are in 3 distinct fields: 1. From Authoritative Communications from superiors 2. From Cases Referred for Decision by Subordinates 3. From Cases Originating in the Initiative of the executive concerned

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Types of Decisions Routine Decisions (e.g. payroll processing, paying suppliers etc) Recur frequently Involve Standard Decision Procedures Has a Minimum of Uncertainty Structured Situations Nonroutine Decisions Unstructured and Novel Situations Nonrecurring Nature High Level of Uncertainty

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**Objective versus Bounded Rationality**

A Decision is objectively rational if it is the correct behavior for maximizing given values in a given situation. Rationality requires A complete knowledge and anticipations of consequences after a choice Imagination since Consequences lie in future A choice among all possible alternatives. We can only talk about bounded rationality

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**Objective versus Bounded Rationality**

Objective Rationality looks for the ‘best’ solution whereas Bounded Rationality looks for the ‘good enough’ solution.

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**Management Science Models?**

Quantitative techniques used in business for many years in applications such as return on investment, inventory turnover, and statistical sampling theory. Quantitative solutions of complex Problems in operations and management. Today is called management science. After the World war II, these techniques were applied to long range military problems and industrial organizations. Management science characteristics: 1. A System View of Problem: significant interrelated variables contained in the problem. 2. Team Approach : training work together on specific problems. 3. Emphasis on the Use of Formal Mathematical Models and Statistical and Quantitative Methods Models?

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**Models and Their Analysis**

Model: Abstraction and Simplification of Reality (Designed to include Essential Features) Simplest Model net income = revenue - expenses - taxes

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**5 Steps of Modeling Real World Simulated (Model) World**

1. Formulate Problem (Define objectives, variables and constraints) 2. Construct a Model (simple but realistic representation of system) 3. Test the Model’s Ability 4. Derive a Solution from Model 5. Apply the Model’s Solution to Real System, Document its Effectiveness

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**Categories of Decision Making**

Decision Making Under Certainty: Linear Programming Decision Making Under Risk: expected value, decision trees, queuing theory, and simulation Decision Making Under Uncertainty: Game Theory

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**Payoff (Benefit) Table - Decision Matrix**

N N2 ……… Nj ……… Nn P P2 ……… Pj ……… Pn A O O12 ……… O1j ……… O1n A O O22 ……… O2j ……… O2n … … … ……… … …… … Ai Oi Oi ……… Oij ……… Oin Am Om Om ……… Omj …… Omn Alternative State of Nature / Probability Outcome Sum of n values of pj must be 1

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**A1, A2,…. Am Decision alternatives**

N1 , N2 , Nj ……… Nn Decision alternatives, state of nature P P2 ……… Pj ……… Pn Probability of occurrence Om Om ……… Omj …… Omn Outcomes

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**Decision Making Under Certainty**

Implies that we are certain of the future state of nature (or assume we are). Linear programming is a tool for the decision making under certainty. This means:- the probability of pj of future Nj is 1 and all other futures have zero probability

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**Example for linear programming**

A factory is producing two types of products; X and Y. If you can realize 10$ profit per unit of product X and 14$ per unit of product Y. The factory employs five workers: 3 machinists and 2 assemblers and each works only 40 hours a week. Meanwhile, product X requires 3 hours of machining and one hour of assembly per unit. Product Y requires two hours of machining and two hours of assembly per hour. What is the production level of product X and product Y to maximize the profit ?

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**Decision Making Under Certainty**

Linear Programming COMPUTER SOLUTION In reality, we have more than 2 variables (dimensions) not like machining and assembling only. Computer solution called Simplex method has been developed to be used with many variables. For example, an AT&T model of current and future telephone demand has got variables taking 4 to 7 computer hours for single run. For example, one model of the domestic long-distance network has variables and would take weeks for one solution. Narendra Karmarkar at AT&T Laboratories has developed a shortcut method * based on “projective geometry” that is 50 to 100 times faster. * “The Startling Discovery Bell Labs Kept in Shadows”, Business Week, September 21, 1987, pp.69, 72, 76

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**Payoff Table This means:-**

Decision Making Under Risk Payoff Table This means:- Each Nj has a known (or assumed) probability of pj and there may not be one state that results best outcome.

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**Payoff Table This means:-**

Decision Making Under Uncertainty Payoff Table This means:- Probabilities pj of future states are unknown.

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**Payoff Table Decision Making Under Risk**

There exist a number of possible future states of Nature Nj. Each Nj has a known (or assumed) probability pj of occurring. There may not be one future state that results in the best outcome for all alternatives Ai. Examples of future states and their probabilities Alternative weather (N1=rain, N2=good weather) will affect the probability of alternative construction schedule; the probabilities P1 of rain and p2 of good weather can be estimated from historical data 2. Alternative economic futures (boom and bust) determine the relative Profitability of high risk investment strategy.

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** Payoff Table (pjOij) Ei= Decision Making Under Risk n**

Expected Values (Ei) : given the future states of nature and their probabilities, the solution in decision making under risk is the alternatives Ai that provides the highest expected value Ei, which is defined as the sum of the products of each outcome Oij times the probability pj that the associated state of nature Nj occurs n j=1 (pjOij) Ei= Choose the Alternative Ai giving the highest expected value

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** Example of Decision Making Under Risk Alternatives**

Calculate Expected Values (Ei) Example of Decision Making Under Risk Not Fire in your house P1 = P2=0.001 Insure house $ $-200 Do not Insure house $-100,000 Alternatives Fire State of Nature Probabilities n j=1 (pjOij) Ei= Would you insure your house or not? E1=$-200 E1=0.999*(-200)+0.001*(-200) E2=$-100 E2=0.999* *(-100,000)

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**Example: 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 (don’t drill), drilling your own expense of $ (Drill alone), and farming out, the opportunity to someone who will drill the well and give you part of the profit if the well is successful. Drilling your own a small Well will make $ profit and a Big well $. Farm out alternative with Dry hole will not cost at all, but a small Well Will make $ and a Big Well will make $ profit. Constitute the Payoff table and calculate the expected value of each alternative solve the problem.

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**$720,000 Alternative State of Nature / Probability**

Decision Making Under Risk Calculate Expected Values (Ei) Well Drilling Example-Decision Making Under Risk N1:Dry Hole N2 :Small Well N3:Big Well P1= P2= P3=0.1 A1:Don’t Drill $ $ $0 A2:Drill Alone $-500, $300, $9,300,000 Alternative State of Nature / Probability A3:Farm Out $ $125, $1,250,000 Expected Value E1=0.6*0+0.3*0+ 0.1*0 $0 E2=0.6*(-500,000)+0.3*(300,000)+ 0.1*(9,300,000) $720,000 E3=0.6*0+0.3*(125,000)+ 0.1*(1,250,000) $162,000 $720,000 A2 is the solution if you are willing to risk $500,000

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**Mathematical solution is identical, visual representation is different**

Decision Making Under Risk Calculate Expected Values (Ei) Decision Trees Decision node Ai Chance node Nj Outcome (Oij) Probability (Pj) Expected Value Ei x = No Fire: (-200) x (0.999) = (-199.8) + = $-200 Insure (-200) x (0.001) = (-0.2) Fire: No Fire: (0) x (0.999) = (0) Don’t Insure + =$-100 Fire: (-100,000) x (0.001) = (-100) Mathematical solution is identical, visual representation is different

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**Decision Making Under Uncertainty**

We do not know the probabilities pj of future states of nature Nj

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**Decision Making Under Uncertainty**

Decision Making Under Risk Decision Making Under Uncertainty N1:Dry Hole N2 :Small Well N3:Big Well A1:Don’t Drill $ $ $0 A2:Drill Alone $-500, $300, $9,300,000 Alternative State of Nature / Probability A3:Farm Out $ $125, $1,250,000

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**Decision Making Under Uncertainty**

Decision Making Under Uncertainty: Example Coefficient of optimism (Maximax) (Maximin) Hurwicz Equally Alternative Maximum Minimum (=0.2) Likely Optimist Pessimist Maximize [(best outcome)+(1-)(worst outcome)] $1,450,000* [0.2(9,300,000)+(1-0.2)(-500,000)] A2:Drill Alone $9,300,000 * $-500,000 $3,033,333* E2=-500, ,000+9,300,000 3 [0.2(1,250,000)+(1-0.2)(0)] $250,000 A3:Farm Out $1,250, $0* $458,333 E3=0+125,000+1,250,000 3

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**Alternative Alternative State of Nature / Probability**

Decision Making Under Risk Decision Making Under Uncertainty: Maximum Regret N1:Dry Hole N2 :Small Well N3:Big Well A1:Don’t Drill $ $ $0 A2:Drill Alone $-500, $300, $9,300,000 Alternative State of Nature / Probability A3:Farm Out $ $125, $1,250,000 N1:Dry Hole N2 :Small Well N3:Big Well We do not know probabilities A1:Don’t Drill $ $300, $9,300,000 A2:Drill Alone $500, Alternative State of Nature / Probability A3:Farm Out $ $175, $8,050,000 Maximum Regret $9,300,000 $500,000 $8,050,000

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**Alternative State of Nature / Probability**

Decision Making Under Uncertainty: Maximum Regret State of Nature / Probability Alternative N1:Dry Hole N2 :Small Well N3:Big Well Maximum Regret We do not know probabilities A1:Don’t Drill $ $300, $9,300,000 $9,300,000 A2:Drill Alone $500, $500,000 A2 is the solution. We choose the minimum among maximum regrets. A3:Farm Out $ $175, $8,050,000 $8,050,000

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**Integrated Data Bases, MIS, DSS and Expert Systems**

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**4 Types of Information Systems**

Transaction Processing Systems (TPS) Management Information Systems (MIS) Decision Support Systems (DSS) Expert Systems (ES)

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**Payroll System Personnel Data Projects Data Tax Data Personnel Data**

Traditional Approach and Data (User) Oriented Approach Payroll System Project Management System Personnel Data Projects Data Tax Data Personnel Data Traditional Approach

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**Payroll System Personnel Data Projects Data Tax Data**

Traditional Approach and Data (User) Oriented Approach Payroll System Project Management System Personnel Data Projects Data Tax Data Database Approach

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**4 Types of Information Systems**

Transaction Processing Systems (TPS) Automate handling of data about business activities (transactions) Management Information Systems (MIS) Converts raw data from transaction processing system into meaningful form Decision Support Systems (DSS) Designed to help decision makers Provides interactive environment for decision making

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**4 Types of Information Systems**

Expert Systems (ES) Replicates decision making process Knowledge representation describes the way an expert would approach the problem

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**For many companies, information systems **

Competition needs very fast decisions and rapid development of information systems. Concentrate on what to do rather than how to do. For many companies, information systems cost 40 percent of overall costs.

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**Effect of Management Level on Decisions**

Management Number of Cost of Making Information Level Decisions Poor Decisions Needs Top Least Highest Strategic Middle Intermediate Intermediate Implementation First-Line Most Lowest Operational

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**Decisions are useless unless they are put into practice. **

Implementation Decisions are useless unless they are put into practice. Courage is the willingness to submerge oneself in the loneliness, the anxiety, and the guilt of a decision maker.

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Decision Theory McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

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