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Decision Analysis

Decision Analysis. How to make a difficult decision?. Uncertainty regarding the future Conflicting values or objectives Goal of Decision Analysis: Help people make good decisions. Good Decisions vs Good Outcomes. Good decisions don’t always result in good outcomes

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Decision Analysis

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  1. Decision Analysis

  2. How to make a difficult decision? • Uncertainty regarding the future • Conflicting values or objectives • Goal of Decision Analysis: • Help people make good decisions

  3. 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

  4. Characteristics • Decisions • Alternatives • States of nature

  5. Decisions • Decision must involve at least 2 alternatives • Alternative: course of action intended to solve a problem

  6. 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

  7. States of Nature • States of nature correspond to future events that are not under the decision maker’s control

  8. 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

  9. Magnolia Inns Cash Flow

  10. Payoff Matrix

  11. Maximax Decision Rule • Alternative with largest payoff

  12. Maximin • Alternative with largest minimum payoff • Hedge against worst possible outcome

  13. Expected Monetary Value (EMV) • Decision alternative with largest EMV • Example: 40% chance A, 60% chance B

  14. Sensitivity Analysis

  15. Expected Value of Perfect Info • EV of PI = EV with PI – max EMV

  16. Decision Trees • Decision nodes • Event nodes • Terminal nodes • Magnolia Inns Example (page 731)

  17. TreePlan • Excel add-in from Prof. Mike Middleton

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