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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 1.A complete knowledge and anticipations of consequences after a choice 2.Imagination since Consequences lie in future 2.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 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? 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:

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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 1 N 2 ……… N j ……… N n P 1 P 2 ……… P j ……… P n A 1 O 11 O 12 ……… O 1j ……… O 1n A 2 O 21 O 22 ……… O 2j ……… O 2n …. …. … ……… … …… … A i O i1 O i2 ……… O ij ……… O in …. …. … ……… … …… … A m O m1 O m2 ……… O mj …… O mn Alternative State of Nature / Probability Outcome Sum of n values of p j must be 1

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A1, A2,…. Am Decision alternatives N 1, N 2, N j ……… N n Decision alternatives, state of nature P 1 P 2 ……… P j ……… P n Probability of occurrence O m1 O m2 ……… O mj …… O mn 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 p j of future N j 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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Decision Making Under Risk This means:- Each N j has a known (or assumed) probability of p j and there may not be one state that results best outcome. Payoff Table

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

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Decision Making Under Risk There exist a number of possible future states of Nature N j. Each N j has a known (or assumed) probability p j of occurring. There may not be one future state that results in the best outcome for all alternatives A i. Examples of future states and their probabilities 1.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. Payoff Table

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Decision Making Under Risk 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 (p j O ij ) Ei=Ei= Choose the Alternative A i giving the highest expected value Payoff Table

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n j=1 (p j O ij ) Ei=Ei= Decision Making Under Risk Calculate Expected Values (E i ) E 1 =0.999*(-200)+0.001*(-200) E 1 =$-200 E 2 =0.999* *(-100,000) E 2 =$-100 Example of Decision Making Under Risk Not Fire in your house P 1 =0.999 P 2 =0.001 Insure house $-200 $-200 Do not Insure house 0 $-100,000 Alternatives Fire in your house State of Nature Probabilities Would you insure your house or not?

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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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Decision Making Under Risk Calculate Expected Values (E i ) Well Drilling Example-Decision Making Under Risk N 1 :Dry Hole N 2 :Small Well N 3 :Big Well P 1 =0.6 P 2 =0.3 P 3 =0.1 A 1 :Don’t Drill $0 $0 $0 A 2 :Drill Alone $-500,000 $300,000 $9,300,000 Alternative State of Nature / Probability A 3 :Farm Out $0 $125,000 $1,250,000 Expected Value E 1 =0.6*0+0.3*0+ 0.1*0 $0 E 2 =0.6*(-500,000)+0.3*(300,000)+ 0.1*(9,300,000) $720,000 E 3 =0.6*0+0.3*(125,000)+ 0.1*(1,250,000) $162,000 $720,000 A 2 is the solution if you are willing to risk $500,000

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Decision Making Under Risk Calculate Expected Values (E i ) Decision Trees Insure Don’t Insure No Fire: Fire: No Fire: Fire: Decision node A i Chance node N j Outcome (O ij ) Probability (P j ) Expected Value E i (-200)(0.999) x = x = (-199.8) (-200)(0.001) x = (-0.2) (0)(0.999) x = (0) (-100,000)(0.001) x = (-100) + + = $-200 =$-100 Mathematical solution is identical, visual representation is different

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Decision Making Under Uncertainty We do not know the probabilities p j of future states of nature N j

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Decision Making Under Risk Decision Making Under Uncertainty N 1 :Dry Hole N 2 :Small Well N 3 :Big Well A 1 :Don’t Drill $0 $0 $0 A 2 :Drill Alone $-500,000 $300,000 $9,300,000 Alternative State of Nature / Probability A 3 :Farm Out $0 $125,000 $1,250,000

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Decision Making Under Uncertainty Decision Making Under Uncertainty: Example A 2 :Drill Alone $9,300,000 * $-500,000 Alternative Maximum Minimum ( =0.2) Likely A 3 :Farm Out $1,250,000 $0* Hurwicz Equally $3,033,333* E 2 =-500, ,000+9,300,000 3 $458,333 E 3 =0+125,000+1,250,000 3 Coefficient of optimism (Maximax) (Maximin) Maximize [ (best outcome)+(1- )(worst outcome)] $1,450,000* [0.2(9,300,000)+(1-0.2)(-500,000)] [0.2(1,250,000)+(1-0.2)(0)] $250,000 Optimist Pessimist

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Decision Making Under Risk Decision Making Under Uncertainty: Maximum Regret N 1 :Dry Hole N 2 :Small Well N 3 :Big Well A 1 :Don’t Drill $0 $0 $0 A 2 :Drill Alone $-500,000 $300,000 $9,300,000 Alternative State of Nature / Probability A 3 :Farm Out $0 $125,000 $1,250,000 N 1 :Dry Hole N 2 :Small Well N 3 :Big Well We do not know probabilities A 1 :Don’t Drill $0 $300,000 $9,300,000 A 2 :Drill Alone $500, Alternative State of Nature / Probability A 3 :Farm Out $0 $175,000 $8,050,000 Maximum Regret $9,300,000 $500,000 $8,050,000

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Decision Making Under Uncertainty: Maximum Regret N 1 :Dry Hole N 2 :Small Well N 3 :Big Well We do not know probabilities A 1 :Don’t Drill $0 $300,000 $9,300,000 A 2 :Drill Alone $500, Alternative State of Nature / Probability A 3 :Farm Out $0 $175,000 $8,050,000 Maximum Regret $9,300,000 $500,000 $8,050,000 A2 is the solution. We choose the minimum among maximum regrets.

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Integrated Data Bases, MIS, DSS and Expert Systems

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Transaction Processing Systems (TPS) Management Information Systems (MIS) Decision Support Systems (DSS) 4 Types of Information Systems Expert Systems (ES)

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

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

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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 4 Types of Information Systems

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

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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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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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