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Decision Analysis
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How to make a difficult decision? Uncertainty regarding the future Conflicting values or objectives Goal of Decision Analysis: –Help people make good decisions
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Good Decisions vs Good Outcomes Good decisions don’t always result in good outcomes Not necessarily the fault of the decision maker A structured approach to decision making should lead to more good outcomes than if decisions were made haphazardly
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Characteristics Decisions Alternatives States of nature
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Decisions Decision must involve at least 2 alternatives –Alternative: course of action intended to solve a problem
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Alternatives Alternatives are evaluated on the basis of the value added to one or more decision criteria –Criteria: various factors that are important to the decision maker and influenced by the alternatives
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States of Nature States of nature correspond to future events that are not under the decision maker’s control
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Magnolia Inns Example Decision Alternatives –Buy at A –Buy at B –Buy at A & B –Buy nothing States of Nature –Airport built at A –Airport built at B
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Magnolia Inns Cash Flow
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Payoff Matrix
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Maximax Decision Rule Alternative with largest payoff
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Maximin Alternative with largest minimum payoff –Hedge against worst possible outcome
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Expected Monetary Value (EMV) Decision alternative with largest EMV Example: 40% chance A, 60% chance B
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Sensitivity Analysis
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Expected Value of Perfect Info EV of PI = EV with PI – max EMV
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Decision Trees Decision nodes Event nodes Terminal nodes Magnolia Inns Example (page 731)
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TreePlan Excel add-in from Prof. Mike Middleton
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