© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Analysis of Decisions and Risks Decision Elements Decision and Risk Analysis Intuition Expected Value Decision Making Conflicts of Interest and Incentives Expected Utility Decision Making

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Prior Constraints, Commitments Example: SU will consider building a dorm, but not an amusement park, because the charter wouldn’t allow one Decision Frame Focus Analytic Resources Here Example: Should SU build the Baseline Green Dorm, or the Living Lab? Details Too Small to Address Example: Don’t spend time choosing carpet colors, because SU might not want carpet at all! A Decision Frame Sets Analytic Range

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Decisions Require a Balanced Basis Decision Basis has 3 parts: 1.Alternatives (Options) 2.Information (Analyses) 3.Preferences (Preferences) Also need a Decision Rule, such as MACDADI, Decision Analysis, voting, bargaining, …

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Analysis of Decisions and Risks Decision Elements Decision and Risk Analysis Intuition Expected Value Decision Making Conflicts of Interest and Incentives Expected Utility Decision Making

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Intuition for Decision Analysis Decision Analysis (DA) is applied Decision Theory; a Structured Conversation leading to Clarity of Action  “DA” is appropriate only if a conversation is possible and clarity is needed

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Uncertainty Makes Decisions Complex How Much Tornado-Proofing Makes Sense?

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Intuition for Risk Analysis Often Important: Soil Conditions, Weather, Earthquakes, Defects, Real Estate Market … Rarely Important: Nuclear War (can’t act on the risk), labor rates (don’t change much)… Magnitude of a risk = event probability times consequence Probability Consequence High Magnitude Risks Low Magnitude Risks Importance of risk for a decision = Effect on risk magnitude Earthquake (shear walls) Earthquake (shear walls) Nuclear War (no decision) Nuclear War (no decision) Price Escalation (minimize steel) Price Escalation (minimize steel)

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Analysis of Decisions and Risks Decision Elements Decision and Risk Analysis Intuition Expected Value Decision Making Conflicts of Interest and Incentives Expected Utility Decision Making

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Formal Method 1: Maximize Expected Value (Average Result) = Sum (probabilities times outcomes) Ex: Structural Decision Using Expected Value EV(Profit | Steel) = $30M x $0M x 0.50 = $15M EV(Profit | Concrete) = $10M x 1.00 = $10M Reinforced Concrete $10M profit $10M profit 100% Steel Steel is Cheap 50% (Heads) Steel is Expensive 50%(Tails) $30M profit $30M profit $0M profit $0M profit How can a large, profit-seeking company choose between these structural design options?

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Analysis of Decisions and Risks Decision Elements Decision and Risk Analysis Intuition Expected Value Decision Making Conflicts of Interest and Incentives Expected Utility Decision Making

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Getting the Team to Decide Well is Complex How can the company ensure employees make the best choices (e.g., Steel)? Managers have differing payoffs from the company, “conflicts of interest” (e.g, politics, self-aggrandizement, personal aesthetic views) This classic challenge is known as a “Principal Agent” problem. A common solution: try to “align incentives” to share the benefits of success What if your incentive for the structural decision was 10% of profit?

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design What if your incentive for the structural decision was 10% of profit? Best Decision Depends on Individual $3M $0M 100% $1M EV(Income | Steel) = $3M x $0M x 0.50 = $1.5M EV(Income | Concrete) = $1M x 1.00 = $1M What if you were a billionaire?

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Analysis of Decisions and Risks Decision Elements Decision and Risk Analysis Intuition Expected Value Decision Making Conflicts of Interest and Incentives Expected Utility Decision Making

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Ex: Structural Decision Using Expected Utility To formally analyze decisions with “high risk,” assess each outcome’s utility (usefulness) Formal Method 2: Maximize Expected Utility (Avg. Satisfaction) = Sum (probabilities times outcome utilities) Good Market 50% (Heads) Bad Market 50%(Tails) $3M $0M $1M 100% Example: assume that $3M is 1.5x as useful as $1M

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Intuition: Risk Attitude is Personal Risk Averse If each dollar is less useful than the last, it’s generally better to avoid big gambles Risk Seeking (less common) If each dollar is more useful than the last, it’s generally better to take big gambles Risk Neutral If each dollar is about as useful as the last, decisions can use expected value Rule of thumb: If range of outcomes is < 1/8 total wealth, use Risk Neutrality as an approximation e.g., Insure catastrophes only MACDADI uses risk neutrality, but can be changed

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Analysis of Decisions and Risks Decision Elements Decision and Risk Analysis Intuition Expected Value Decision Making Conflicts of Interest and Incentives Expected Utility Decision Making

© John Chachere– CEE 115/215 Goals and Methods of Sustainable Building Design Questions and Comments