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Module 16 – Decision Theory Chapter 5 Supplement.

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Presentation on theme: "Module 16 – Decision Theory Chapter 5 Supplement."— Presentation transcript:

1 Module 16 – Decision Theory Chapter 5 Supplement

2 What is decision theory? Definition – Payoff table (certainty) POSSIBLE FUTURE DEMAND AlternativesLowModerateHigh Small facility$10 Medium facility 7 12 Large facility (4) 2 16

3 What is decision theory? Basic concepts – Certainty vs uncertainty – Utility values – Expected utility

4 Expected utility example Outcome 1: Utility = 100, probability = 75% Outcome 2: Utility = -40, probability = 25% Expected utility =  100 X.75 = 75  -40 X.25 = -10  75 + (-10) = 65

5 Decision making under uncertainty 4 possible decision criteria – Maximin – Maximax – Laplace – Minimax regret

6 Decision making under uncertainty Problem 1 Maximax – 80, Expand Maximin – 50, Do nothing NEXT YEAR’S DEMAND AlternativesLowHIGH Do nothing$50$60 Expand 20 80 Subcontract 40 70

7 Decision making under uncertainty Problem 1 Laplace – Now we have problem! NEXT YEAR’S DEMAND AlternativesLowHIGH Do nothing$50$60 Expand 20 80 Subcontract 40 70 ($20+$80)/2 = $50 ($50+$60)/2 = $55 ($40+$70)/2 = $55

8 Decision making under uncertainty Problem 1 Minimax regrets (opportunity losses) NEXT YEAR’S DEMAND AlternativesLowHIGH Do nothing$50$60 Expand 20 80 Subcontract 40 70

9 Decision making under uncertainty Problem 1 Minimax regrets – subcontract NEXT YEAR’S DEMAND AlternativesLowHIGHWORST Do nothing$50 - $50 = 0$80 – 60 = 20$20 Expand 50 – 20 = 30 80 – 80 = 0 30 Subcontract 50 – 40 = 10 80 – 70 = 10 10


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