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## DECISION MAKING

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**DECISION MAKING**- Decision Making and problem solving are used in all management functions, although usually they are considered a part of the planning phase.**Relation to Planning**• Decision Making: Process of making a conscious choice between 2 or more alternatives producing most desirable consequences (benefits) relative to unwanted consequences (costs). • Decision Making is essential part of Planning. • Planning: Deciding in advance what to do, how to do it, when to do it and who is to do it.**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**State of Nature / Probability**N1 N2 ……… Nj ……… Nn Alternative P1 P2 ………Pj ……… Pn A1 O11 O12 ……… O1j ……… O1n A2 O21 O22 ……… O2j ………O2n Outcome …. …. … ………… ……… Ai Oi1 Oi2 ……… Oij ………Oin …. …. … ………… ……… Am Om1 Om2 ……… Omj …… Omn Sum of n values of pjmust be 1 Payoff Table (Decision Matrix)**Decision Making**Under Certainty Implies that we are certain of the future state of nature (or assume we are) This means:- the probability of pj of future Nj is 1 and all other futures have zero probability.**Decision Making**Under Risk This means:- Each Nj has a known (or assumed) probability of pj and there may not be one state that results best outcome.**Decision Making**Under Uncertainty This means:- Probabilities pj of future states are unknown.**n** j=1 (pjOij) Ei= Decision Making Under Risk - Calculate Expected Values (Ei) - Choose the Alternative Ai giving the highest expected value**Example of Decision Making Under Risk**Not Fire in your house Fire in your house State of Nature Alternatives Probabilities P1 =0.999 P2=0.001 n j=1 Insure house $-200 $-200 (pjOij) Do not Insure house 0 $-100,000 Ei= Would you insure your house or not? E1=$-200 E1=0.999*(-200)+0.001*(-200) E2=$-100 E2=0.999*0+0.001*(-100,000)**Decision Trees**Decision node Ai Chance node Nj Outcome (Oij) Probability (Pj) Expected Value Ei x = No Fire: (-200) x (0.999) (-199.8) = + = $-200 Insure (-200) x (0.001) (-0.2) = Fire: (0) x (0.999) (0) No Fire: = Don’t Insure + =$-100 (-100,000) x (0.001) (-100) Fire: = Mathematical solution is identical, visual representation is different**Well Drilling Example-Decision Making Under Risk**State of Nature / Probability Alternative N1:Dry Hole N2 :Small Well N3:Big Well Expected Value P1=0.6 P2=0.3 P3=0.1 $0 A1:Don’t Drill$0 $0 $0 A2:Drill Alone$-500,000 $300,000 $9,300,000 $720,000 $162,000 A3:Farm Out$0 $125,000 $1,250,000 E1=0.6*0+0.3*0+ 0.1*0 E2=0.6*(-500,000)+0.3*(300,000)+ 0.1*(9,300,000) E3=0.6*0+0.3*(125,000)+ 0.1*(1,250,000) $720,000 A2 is the solution if you are willing to risk $500,000**Decision Making Under Uncertainty**We do not know the probabilities pj of future states of nature Nj**State of Nature / Probability**Alternative N1:Dry Hole N2 :Small Well N3:Big Well A1:Don’t Drill$0 $0 $0 A2:Drill Alone$-500,000 $300,000 $9,300,000 A3:Farm Out$0 $125,000 $1,250,000 Decision Making Under Uncertainty