Session 4

Learning Objectives:
s

Have a working knowledge of basic probability concepts.

Concepts of conditional, marginal & joint probabilities s Construct diagrams illustrating independent & dependent situations s Revise probabilities using Bayes Theorem s Compute EV, variance & std. dev. of a random var.
s

Session 4
s

Learning Objectives:
s

Have a working knowledge of binomial & normal probability functions to be able to:
Determine probabilities using both the binomial formula & the binomial table. s Solve normal distribution problems by using z-scores and obtaining probabilities from the standardized normal distribution table; s Use built-in spreadsheet functions to determine probabilities for binomial & normal distributions
s

Chapter 5 Introduction to Probability

Space shuttle has 25,000 black tiles to protect it s Some need to be replaced or repaired after every flight s Pate-Cornell & Fischbeck used probabilistic risk analysis to study risk due to tile failure s Researchers divided the 25,000 tiles into 33 zones
s

Real-life Application: Space Shuttle Tiles

Real-life Application: Space Shuttle Tiles

s

Researchers divided the 25,000 tiles into 33 zones based on the ff. prob.
s

How susceptible they were to damage s Vulnerability of adjacent tiles once one is lost s Probability of burn-through s Probability of loss of critical subsystem after a burn-through

Real-life Application: Space Shuttle Tiles

Use of historical data on debris & debonding and expert assessment s Analysis enabled NASA to rank the tiles on riskcriticality index & set priorities for inspection. s Probability of failure reduced by about 70%
s

s s s s s s s s s s

Game Theory Fundamentals of Decision Theory Decision Trees and Utility Theory Decision Making and the Normal Distribution Statistical Quality Control Forecasting Inventory Control Models Queuing Theory Simulation Markov Analysis

Other Tools That Use Probability

Fundamental Probability Concepts

Fundamental Probability Concepts

1. 0 P (Any Event) 1 s 2. Sum of Probabilities for All Outcomes of an Event = 1
s

Mutually Exclusive vs. Collectively Exhaustive

s

Mutually Exclusive Events

s

Only one of the events can occur on any one trial The list of outcomes includes every possible outcome

Collectively Exhaustive Events

s

Addition Law for Events That Are Mutually Exclusive

P (A)

P (B)

P (A or B) = P(A) + P (B)

Addition Law for Events That Are Not Mutually Exclusive

P(A)

P(A and B)

P(B)

P (A or B) = P(A) + P (B) - P(A and B)

Joint Probabilities
s

For Independent Events

s

P(AB) = P(A) x P(B) P(AB) = P(A|B) x P(B)

For Dependent Events

s

Conditional Probabilities
s

For Independent Events

s

P(A|B) = P(A) P(A|B) = P(AB)

P(B|A) = P(B)

For Dependent Events

s

P(B)

Using Bayess Process

Prior Probabilities Bayess Process New Information Posterior Probabilities

Examples of Random Variables

Experiment Stock 50 Christmas trees Inspect 600 items Send out 5,000 sales letters Build an apartment building Test the lifetime of a bulb Outcome Number of Christmas trees sold Number of acceptable items Number of respondents % of building complete after 4 months Length of time bulb lasts up to 80,000 minutes Random Variables X = number of Christmas trees sold Y = number of acceptable items Z = number of respondents R = % of building completed after 4 months S = time the bulb burns

Range of Random Variables

0, 1, 2, ..., 50

0, 1, 2, ..., 600

0, 1, 2, ..., 5,000 0 R 100

80,000

Random Variables for Outcomes That Are Not Numbers Range of

Experiment Students respond to a questionnaire Outcome Strongly agree (SA) Agree (A) Neutral (N) Disagree (D) Strongly disagree (SD) Defective Not defective Good Average Poor Random Variables 5 if SA 4 if A 3 if N 2 if D 1 if SD 0 if defective 1 if not 3 if good 2 if average 1 if poor Random Variables 1, 2, 3, 4, 5

X=

One machine is inspected Consumers respond to how they like a product

Y= Z=

0, 1 1, 2, 3

Normal Distribution with Different Values for

40 = 50 Smaller , same = 40 50 Larger , same 60 60

40

50

= 60

Normal Distribution with Different Values for

Same , smaller

Same , larger

Areas Under Normal Curves

16% 68% 16% 2.3% 95.4% 2.3%

-1 +1 a b .15% 99.7%

-2 a .15%

+ 2 b

-3

+ 3

Negative Exponential Distribution

f(X)

Sample Poisson Distribution with = 2

P(X)
0.30 0.25 0.20 0.15 0.10 0.05 0.00 0 1 2 3 4 5 6 7 8

Alternative Example S2.1 Sales over the past 30 days

SALES 8 9 10 11 Total NO. DAYS 10 12 6 2 30 PROBABILITY .333 .400 .200 .067 1.000

Alternative Example S2.2 Grades for the past 5 years

OUTCOME A B C D F Withdraw/Drop PROBABILITY .25 .30 .35 .03 .02 .05 1.00

Mutually exclusive and collectively exhaustive

Alternative Example S2.3

P (Drawing a 3 from a deck of cards) = 4/52 = 1/3 P (Drawing a club on the same draw) = 13/52 = 1/4 Neither mutually exclusive nor collectively exhaustive.

Alternative Example S2.4

Probability for 3 or club P (3 or Club) = P(3) + P(Club) - P(3 and Club) = 4/52 + 13/52 - 1/52 = 16/52 = 4/13

Alternative Example S2.5

A class contains 30 students. Ten are female (F) and U.S. citizens (U); 12 are male (M) and U.S. citizens; 6 are female and non-U.S. citizens (N); 2 are male and non-U.S. citizens.

A name is randomly selected from the class roster and it is female. What is the probability the students is a U.S. citizen?

Alternative Example S2.5

P(FU) = 10/30 = .333 P(FN) = 6/30 = .200 P(MU) = 12/30 = .400 P(MN) = 2/30 = .067 P(F) = P(FU) + P(FN) = .333 + .200 = .533 P(M) = P(MU) + P(MN) = .400 + .067 = .467 P(U) = P(FU) + P(MU) = .333 + .400 = .733 P(N) = P(FN) + P(MN) = .200 + .067 = .267 By Bayess law, .333 P(FU) = P(U|F) = = .625 .533 P(F)

Alternative Example S2.7

P (Regular class chosen) = .5 P (Advanced class chosen) = .5 P (> 1/2 As | regular class ) = .25 P (> 1/2 As | advanced class) = .50 P (> 1/2 As and regular class) = P (> 1/2 As | regular) x P (regular) = (.25) (.5) = .125 P (> 1/2 As and advanced class) = P (> 1/2 As | advanced) x P (advanced) = (.50) (.5) = .25 So, P (> 1/2 As) = .125 + .25 = .375 P (Advanced and > 1/2 As) P (Advanced | > 1/2 As) = P ( > 1/2 As) .25 = = 2/3 .375

Alternative Example S2.8

QUESTION RESULTS: strongly agree agree neutral disagree strongly disagree 40 30 20 10 0 100

Alternative Example S2.8

NUMERIC SCALE: strongly agree agree neutral disagree strongly disagree 5 4 3 2 1

Alternative Example S2.8

OUTCOME strongly agree agree neutral disagree strongly disagree

PROBABILITY, PX 0.4 0.3 0.2 0.1 0.0 1.0 = = = = = = 40/100 30/100 20/100 10/100 0/100 100/100

Alternative Example S2.8

0.4 0.3

Probability

0.2 0.1 0

Possible Outcomes

Alternative Example S2.9

E(x) =

xiP(xi) = xiP(x1) + x2P(x2) + x3P(x3)

5(0.4) + 4(0.3) + 3(0.2) + 2(0.1) + 1(0) 4.0

i =1

+ x4P(x4) + x5P(x5)

= =

Alternative Example S2.10

Variance =
5 i =1

(xi- E(x))2P(xi)

= (5 - 4)2(.4) + (4 - 4)2(.3) + (3 - 4)2(.2) + (2 - 4)2(.1) = (1)2(.4) + (0)2(.3) + (-1)2(.2) + (-2)2(.1) = 0.4 + 0.0 + 0.2 + 0.4 = 1.0 The standard deviation is
= Variance =1 =1
PG AE S2.10

Real Life Application: Du Pont

SBU losing market share & declining prices. s Evaluate possible strategies to take (diff., low cost, S.Q.) s Influence diagrams & cumulative risks were derived s Chose option that will increase value by $175mill
s

Steps in Decision Theory

1. Clearly Define the Problem at Hand s 2. List the Possible Alternatives s 3. Identify the Possible Outcomes s 4. List the Payoff or Profit s 5. Select One of the Decision Theory Models s 6. Apply the Model and Make Your Decision
s

Decision-Making Environments
Decision Making Under Certainty s Decision Making Under Risk s Decision Making Under Uncertainty
s

Maximax s Maximin s Equally Likely s Criterion of Realism s Minimax

s

Decision Making Under Risk

Expected Monetary Value (EMV) s Expected Value of Perfect Information (EVPI) s Opportunity Loss
s

Decision Making Under Uncertainty

Five Criteria
s

1. MAXIMAX - find the alternative that maximizes the maximum outcome for every alternative 2. MAXIMIN - find the alternative that maximizes the minimum outcomes for every alternative 3. MINIMAX REGRET CRITERION - find the alternative that minimizes the maximum regret 4. EQUALLY LIKELY - find the alternative with the highest average outcome 5. COEFFICIENT OF REALISM - a weighted average approach

Thomson Lumber Company

John Thompson, the founder & president is interested in expanding his product line by manufacturing a new product, backyard storage sheds. s He has identified three alternative courses of actions on the said matter: build (1) a large plant, (2) a small plant, or no plant at all.
s

Thompsons Decision Table (Table 2.4)

States of Nature Favorable Unfavorable Market Market ($) ($) 200,000 100,000 0 -180,000 -20,000 0

Alternatives Construct large plant Construct small plant Do nothing

Thompsons Maximax Decision (Table 2.5)

States of Nature Favorable Unfavorable Market Market ($) ($) 200,000 100,000 0 -180,000 -20,000 0 Maximum in Row ($) 200,000 100,000 0
maximax

Alternatives Construct large plant Construct small plant Do nothing

Thompsons Maximin Decision (Table 2.6)

States of Nature Favorable Unfavorable Market Market ($) ($) 200,000 100,000 0 -180,000 -20,000 0 Minimum in Row ($) -180,000 - 20,000 0
maximin

Alternatives Construct large plant Construct small plant Do nothing

Thompsons Minimax Decision (Table 2.7)

States of Nature Favorable Unfavorable Market Market ($) ($) 0 100,000 200,000 180,000 20,000 0 Maximum Regret in row 180,000 120,000 200,000
minimax

Alternatives Construct large plant Construct small plant Do nothing

Thompsons Equally Likely Decision (Table 2.8)

States of Nature Favorable Unfavorable Market Market ($) ($) 200,000 100,000 0 -180,000 -20,000 0 Row Average ($) 10,000 40,000 0
equally likely

Alternatives Construct large plant Construct small plant Do nothing

Thompsons Criterion of Realism Decision

(Table 2.9)
Criterion of Realism or States of Nature Weighted Favorable Unfavorable Average Market Market ( = .8) ($) ($) ($) 200,000 100,000 0 -180,000 -20,000 0 124,000 76,000 0
Realism

Alternatives Construct large plant Construct small plant Do nothing

Decision Making Under Risk

Expected Monetary Value (EMV) s Expected Value of Perfect Information (EVPI) s Opportunity Loss
s

Thompsons Decision Table (Table 2.4 b)

States of Nature Favorable Unfavorable Market Market ($) ($) 200,000 100,000 0 0.60 -180,000 -20,000 0 0.40

Alternatives Construct large plant Construct small plant Do nothing Probabilities

Thompsons Expected Monetary Value (Table

2.10)
States of Nature Favorable Unfavorable Market Market ($) ($) 200,000 100,000 0
0.60

Alternatives Construct large plant Construct small plant Do nothing

Probabilities

EMV Computed ($) 48,000 52,000 0

-180,000 -20,000 0
0.40

Best EMV

Thompsons Sensitivity Analysis (Table 2.10)

Expected Monetary Values EMV EMV EMV = 0.0 = 0.5 = 1.0 ($) ($) ($) -180,000 -20,000 0 10,000 40,000 0 200,000 100,000 0

Alternatives Construct large plant Construct small plant Do nothing

Sensitivity Analysis
(Points of Indifferences)
Point 1 EMV(nothing) = EMV (small plant) Point 1 EMV(nothing) = EMV (small plant) 0* + 0*(1- ))= 100,000* --20,000*(1- )) 0* + 0*(1- = 100,000* 20,000*(1- = 20,000/120,000 = 20,000/120,000 = 0.167 = 0.167 Point 2 EMV (small plant) = EMV (large plant) Point 2 EMV (small plant) = EMV (large plant) 100,000* --20,000*(1 -- ))= 200,000* --180,000*(1- )) 100,000* 20,000*(1 = 200,000* 180,000*(1- = 160,000/260,000 = 160,000/260,000 = 0.62 = 0.62

Thompsons Expected Value of Perfect Information (Table 2.11)

States of Nature Favorable Unfavorable Market Market ($) ($) 0 Expected Values ($) 120,000 52,000 68,000

Alternatives

Best Outcome 200,000 Maximum EMV Value of Perfect Information

Probabilities 0.60 0.40

Thompsons Opportunity Loss (Table

2.12)
States of Nature Favorable Unfavorable Expected Market Market Opportunity ($) ($) Loss ($) 0 100,000 200,000
0.60

Alternatives Construct large plant Construct small plant Do nothing

Probability

180,000 20,000 0
0.40

72,000 68,000 120,000

Lowest EOL

Marginal Analysis
In cases where possible alternatives are too numerous to evaluate individually, it is more expedient to apply marginal analysis to arrive at the best decision without using a large decision table. (E.g. deciding on a stock level when demand ranges from 0 to 100 units.)

Steps of Marginal Analysis with Discrete Distribution

1. Determine the value of P for the problem. 2. Construct a probability table and add a cumulative probability column. 3. Keep increasing stock level as long as the probability of selling at least one additional unit is greater than P.

Caf du Donut
Caf du Donut is a popular New Orleans dining spot on the edge of the French Quarter. Its specialty is coffee and doughnuts; it buys doughnuts fresh daily from a large industrial bakery. The caf pays $4 for each carton (containing two dozen doughnuts) delivered each morning. Any cartons not sold at the end of the day are thrown away, for they would not be fresh enough to meet cafs standards. If a carton of doughnuts is sold, the total revenue is $6. Hence the marginal profit per carton of doughnut is MP = $2 (i.e. $6 - $4). The marginal loss is ML= $4.

Caf du Donut
Caf du Donut Probability Distribution Daily Sales (Cartons of Doughnuts) 4 5 6 7 8 9 10 Probability Sales will be at this level 0.05 0.15 0.15 0.20 0.25 0.10 0.10 Total = 1.00

Caf du Donut
The Marginal Analysis General Equation: P*(MP) => (1 - P)*ML P*(MP) => ML - P*ML P*(MP) + P*ML => ML P*(MP + ML) => ML P => ML/(MP + ML) Substituting Caf du Donuts values: P => ML/(MP + ML) $4/($4 + $2) 4/6 0.66

Caf du Donut Marginal Analysis

Daily Sales (Cartons of Doughnuts) 4 5 6 7 8 9 10 Probability that Sales will be at this level 0.05 0.15 0.15 0.20 0.25 0.10 0.10 Probability that Sales will be at this Level or Greater 1.00 => 0.66 0.95 => 0.66 0.80 => 0.66 0.65 0.45 0.20 0.10

Marginal Analysis with the Normal Distribution

Steps of Marginal Analysis with the Normal Dist. Find four values: Average or mean sales, Standard deviation of sales, Marginal profit for product Marginal loss for the product MP ML

Determine the value of P = ML/(MP + ML) Locate P on the normal distribution. For given area under the curve, we can find Z. Using relationship Z = (X* - )/ , we can solve for X*, the optimal stock.

Chicago Tribune
Demand for Chicago Tribune newspaper at Joes Newsstand is normally distributed and has averaged 50 papers per day, with a standard deviation of 10 papers. With a marginal loss of 4 cents and a marginal profit of 6 cents, what daily stocking policy should Joe follow?

Joes Stocking Decision for Chicago Tribunes

1. Mean Sales, 3. Marginal Profit, MP 2. Standard Deviation, 4. Marginal Loss, ML
Z= P= X* - ML ML + MP

Marginal Analysis:

4 4 + 6

4 10

.40

Mean Daily Sales Area Under the Curve is .40

- 50

X*

Optimal Stocking Policy (53 Newspapers)

Fundamentals of Decision Theory

s

The three types of decision models: s 1. Decision making under certainty s 2. Decision making under risk s 3. Decision making under uncertainty Terms: s 1. Alternative: course of action or choice s 2. State of nature: an occurrence over which the decision maker has no control

Fundamentals of Decision Theory

Symbols used in decision tree: Symbols used in decision tree: A decision node from which one of A decision node from which one of
several alternatives may be selected several alternatives may be selected

A state of nature node out of which A state of nature node out of which
one state of nature will occur one state of nature will occur

Analyzing Problems with Decision Trees

s

The Five Steps

1. Define the problem s 2. Structure or draw the decision tree s 3. Assign probabilities to the states of nature s 4. Estimate the payoffs for each possible combination of alternative and state of nature s 5. Solve the problem by computing expected monetary values (EMV) for each state of nature node
s

Thompsons Decision Tree

A State of Nature Node A Decision Node Construct Large Plant Construct Small Plant Favorable Market 1 Unfavorable Market Favorable Market 2 Unfavorable Market

Do Nothing

A More Complex Decision for Thompson Lumber

Before deciding about building a plant, John has the option of conducting his own marketing research survey at a cost of $10,000. While the survey may not give him perfect information, it may give him better indicators of the market. Probabilities relevant to the survey are as follows: Prob. Survey indicates favorable market .45 Prob. FM given positive survey result Prob. UM given positive survey result Prob. Survey indicates unfavorable market .55 Prob. FM given negative survey result Prob. UM given negative survey result .73

.78 .22 .27

Conducting a Market Survey

1st Decision Point

(Fig. 3.4) 2nd Decision

Point $106,400 Large 2 Plant $63,500 Small Plant 3

Payoffs $190,000 -$190,000 $90,000 -$30,000 -$10,000 $190,000 -$190,000 $90,000 -$30,000 -$10,000 $200,000 -$180,000 $100,000 -$20,000

$106,400

Survey Results Favorable (0.45)

Favorable Market (0.78) Unfavorable Market (0.22) Favorable Market (0.78) Unfavorable Market (0.22) No Plant

Conduct Market Survey

$49,200 1 Survey Results Negative (0.55)

$49,200

-$87,400 Large Plant 4

Favorable Market (0.27) Unfavorable Market (0.73)

Do Not Conduct Survey

$2,400

$2,400 Favorable Market (0.27) Small Unfavorable Market (0.73) Plant 5 No Plant $10,000 Favorable Market (0.50) Unfavorable Market (0.50) Favorable Market (0.50) Unfavorable Market (0.50) No Plant

$40,000

Large Plant Small Plant

6 $40,000 7

Basis for Probabilities of Survey

Market research specialists told John that, statistically, of all new favorable market (FM) products, market survey were positive and predicted success correctly 70% of the time. On the other hand, when there was actually an unfavorable market (UM) for a new product, 80% of the surveys correctly predicted negative results. Without any survey information, Johns best estimates of a FM and UM are: P(FM) = 0.50 P(UM) = 0.50

Review of Bayes Theorem

P(A = P(AB)/P(B) B) P(B = P(AB)/P(A) A)
[which can be rewritten as P(AB) = P(B A)P(A)] and

(1) (2) (3)

P(B = P(AB)/P(A) A)
[which can be rewritten as P(AB) = P(B A)P(A)]

Furthermore, by definition, we know that P(B) = P(AB) + P(AB) = P(B A)P(A) + P(B A)P(A) from (2) & (3) P(B A)P(A) P(B A)P(A) + P(B A)P(A) (4)

Substituting Equation 2 & 4 into equation 1, we have P(A = B)

Market Survey Reliability in Predicting Actual States of Nature

ACTUAL STATES OF NATURE Favorable Market Unfavorable Market P(surv.+| UM) = 0.20

Survey Result

Positive P(surv.+| FM) = 0.70 (Predicts favorable market for product)

Negative P(surv.-| FM) = 0.30 P(surv.-| UM) = 0.80 (Predicts unfavorable market for product)

Probability Revisions Given a Negative Survey

(Table 3.3)
P(FM|Survey negative) = = P (Survey negative |FM) P(FM) P(Survey negative| FM P(FM) + P(Survey negative|UM) P(UM) (0.30)(0.50) (0.30)(0.50) + (0.80)(0.50) = 0.15 = 0.27 0.55

P(UM|Survey negative) = = P (Survey negative |UM) P(UM) P(Survey negative| UM P(UM) + P(Survey negative|FM) P(FM) (0.80)(0.50) (0.80)(0.50) + (0.30)(0.50) = 0.40 = 0.73 0.55

Probability Revisions Given a Negative Survey (Table 3.3) (contd.)

Conditional Probabilities State of P(Survey negative| Nature State of Nature) Prior Prob. Joint P Prob.

Posterior Probabilities State of Survey Nature negative 0.15 0.55 0.40 0.55

FM UM

0.30 0.80

x x

0.50 = 0.15 0.50 = 0.40 0.55

= 0.27 = 0.73 1.00

P(Survey results negative) =

Lottery Ticket (Figs. 3.5)

You are the lucky holder of a lottery ticket. Five minutes from now a fair coin could be flipped, and if it comes out tails, you win $5 million. If it comes up head, you win nothing. Just a moment ago a wealthy person offered you $2 million for your ticket. Assuming you are sure of the validity of the offer, would you accept it?

EMV = $2,500,000 Reject Offer Tails (0.5) Heads (0.5) $5,000,000 $0

Accept Offer

$2,000,000

Utility Theory
Definition - a theory that allows decision makers to incorporate their
risks preference and other factors into the decision-making process.

Utility Assessment - the process of determining the utility of various

outcomes. This is normally done using a standard gamble between any outcome for sure and a gamble between the worst and best outcomes.

Utility curves - a graph or curve that reveals the relationship between

utility and monetary values. Once this curve has been constructed, utility values from the curve can be used in decision making.

Jane Dicksons Utility Curve

Jane would like to construct a utility curve revealing her preference for money between $0 and $10,000. If the money is invested in the bank, in three years Jane would have $5,000. If she invested in the real estate, after three years she could have either nothing or $10,000. Jane, however, is very conservative. Unless there is an 80% chance of getting $10,000 from the real estate deal, Jane would prefer to have her money in the bank where it is safe. What Jane has done here is to assess her utility for $5,000. When there is an 80% chance (this means p is 0.8) of getting $10,000, Jane is indifferent between putting her money in real estate or putting it in the bank. Janes utility for $5,000 is thus equal to 0.8, which is the same value for p.

Standard Gamble and the Utility of $5,000 (Figs. 3.6 &

3.7)
(P)
Alternative 1 Alternative 2 Invest in Real Estate Best Outcome Utility = 1 Worst Outcome Utility = 0 Other Outcome Utility = ?

(1 - P)

p = 0.80 (1 - P) = 0.20

$10,000 U($10,000) = 1.0 $0 U($0.00) = 0.0 $5,000 U($5,000) = p = 0.80

Invest in Bank

Utility Curve for Jane Dickson

(Fig. 3.8)
1 0.9 0.8 0.7

U($10,000) = 1.0 U($7,000) = 0.90 U($5,000) = 0.80

Utility

0.6 0.5 0.4 0.3 0.2 0.1 0 0

U($3,000) =0.50

U($0) = 0

$1,000

$3,000

$5,000

$7,000

$10,000

Monetary Value

Preferences for Risk

(Fig. 3.9)
Risk Avoider

Utility

Risk Indifference

Risk Seeker

Monetary Outcome

Alternative Example 3.1

1st Decision Point $18,802 Conduct Market Survey Survey (.62) Results Favorable 1 2nd Decision Point $33,390 Rob 1 Rob 2 Payoffs Favorable Market (.871) 2 3 Unfavorable Market (.129) Favorable Market (.871) Unfavorable Market (.129) Do Nothing Favorable Market (.158) Survey (.38) Results Negative Do Not Conduct Survey Rob 1 Rob 2 -$5,000 $14,000 Rob 1 Rob 2 7 6 4 Unfavorable Market (.842) Favorable Market (.158) 5 Unfavorable Market (.842) Do Nothing Favorable Market (.60) Unfavorable Market (.40) Favorable Market (.60) Unfavorable Market (.40) Do Nothing $45000 -$45,000 $25,000 -$25,000 -$5,000 $45,000 -$45,000 $25,000 -$25,000 -$5,000 $50,000 -$40,000 $30,000 -$20,000

Alternative Example 3.3

RESULTS OF SURVEY Positive (P) Negative (N)

FAVORABLE MARKET (FM) P(P | FM) = .9 P(N | FM) = .1

UNFAVORABLE MARKET (UM) P(P | UM) = .2 P(N | UM) = .8

Alternative Example 3.3 Probability Revision Given a Positive Survey Result

STATE OF NATURE FM UM CONDITIONAL PROB. .9 .2 PRIOR PROB. .6 .4 TOTAL JOINT PROB. .54 .08 .62 POSTERIOR PROB. .54/.62 = .871 .08/.62 = .129 1.00

Alternative Example 3.3 Probability Revision Given a Negative Survey Result

STATE OF NATURE FM UM CONDITIONAL PROB. .1 .8 PRIOR PROB. .6 .4 TOTAL JOINT PROB. .06 .32 .38 POSTERIOR PROB. .06/.38 = .158 .32/.38 = .842 1.00

Alternative Example 3.4

U(=$10,000) = .8 U($0) = .9 U($10,000) = 1 So, U(Mark plays the game) = .45(1) + .55(.8) = .89 U(Mark doesnt play the game) = .9 Mark is a risk avoider.

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

Assigning each job to Machine 1 Assignment Lower Bound on Total Cost _

A done on M 1: 90 + 14 + 2 + 23 = 129 (feasible sol.) B done on M 1: 69 + 5 + 2 + 23 = 99 (feasible sol.) C done on M 1: 57 + 5 + 48 + 23 = 133 D done on M 1: 7 + 5 + 2 + 73 = 87

Alternative Example 11.2

A=1 B=1 37 C=1 133 D=1 87 129*

99*

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

Assignment (when D = M 1) Assignment Lower Bound on Total Cost _

A done on M 2: (7) + 5 + 2 + 79 = 93 B done on M 2: (7) + 14 + 2 + 73 = 96 (feasible sol.) C done on M 2: (7) + 93 + 48 + 73 = 221

Alternative Example 11.2

A=1 B=1 37 C=1 133 D=1 B=2 87 C=2 221 96* 129*

99* A=2 93

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

COST FOR EACH JOB-MACHINE ASSIGNMENT Jobs A B C D _ 1 90 69 57 7 Machines 2 5 14 93 77 3 48 83 2 75 _ 4_ 73 86 79 23

Alternative Example 11.2

Assignment (when D = M 1 and A = M 2) Assignment Lower Bound on Total Cost _

B done on M 3: (7 + 5) + 83 + 79 = 174 (feasible sol.) C done on M 2: (7 + 5) + 2 + 86 = 100 (feasible sol.)

Alternative Example 11.2

A=1 B=1 37 C=1 133 D=1 87 129*

99*

Alternative Example 11.2

A=1 B=1 37 C=1 133 D=1 B=2 87 C=2 221 96* 129*

99* A=2 93

Alternative Example 11.2

A=1 B=1 37 C=1 133 D=1 B=2 87 C=2 221 96* 100* 129* B=3, C=4 99* A=2 93 B=4, C=3 174*

Multicriteria Decision Making

s

Decision problem often involve two or more conflicting criterion or objectives:

s

Investing: s risk vs. return Choosing Among Job Offers: s salary, location, career potential, etc. Selecting a Camcorder: s price, warranty, zoom, weight, lighting, etc. Choosing Among Job Applicants: s education, experience, personality, etc.

Well consider two techniques for these types of problems:

The Multicriteria Scoring Model The Analytic Hierarchy Process (AHP)

The Multicriteria Scoring Model

s s

Score (or rate) each alternative on each criterion. Assign weights the criterion reflecting their relative importance.

For each alternative j, compute a weighted average score as:

w s
i

i ij

wi = weight for criterion i sij = score for alternative i on criterion j

See file Fig15-43.xls

The Analytic Hierarchy Process (AHP)

s

Provides a structured approach for determining the scores and weights in a multicriteria scoring model. Well illustrate AHP using the following example:
s

s s

A company wants to purchase a new payroll and personnel records information system. Three systems are being considered (X, Y and Z). Three criteria are relevant: s Price s User support s Ease of use

Pairwise Comparisons
s

The first step in AHP is to create a pairwise comparison matrix for each alternative on each criterion using the following values:

Value Preference 1 Equally Preferred 2 Equally to Moderately Preferred 3 Moderately Preferred 4 Moderately to Strongly Preferred 5 Strongly Preferred 6 Strongly to Very Strongly Preferred 7 Very Strongly Preferred 8 Very Strongly to Extremely Preferred 9 Extremely Preferred Pij = extent to which we prefer alternative i to j on a given criterion.

We assume Pji = 1/Pij See price comparisons in file Fig15-47.xls

Normalization & Scoring

s

To normalize a pairwise comparison matrix, 1) Compute the sum of each column, 2) Divide each entry in the matrix by its column sum. The score (sj) for each alternative is given by the average of each row in the normalized comparison matrix.

See file Fig15-47.xls

Consistency
s

We can check to make sure the decision maker was consistent in making the comparisons.
P s
i j j

The consistency measure for alternative i is:

j

Ci =

si

where Pij = pairwise comparison of alternative i to j sj = score for alternative j If the decision maker was perfectly consistent each Ci should equal to the number of alternatives in the problem.

Consistency
s

(contd)

Typically, some inconsistency exists. The inconsistency is not deemed a problem provided the Consistency Ratio (CR) is no more than 10%
CI CR = 0.10 RI

where,

Ci CI = n n /( n 1) n = the number of i atives altern

RI = for n = 0.00 2 0.58 3 0.90 4 1.12 5 1.24 6 1.32 7 1.41 8

Obtaining Remaining Scores & Weights

s

This process is repeated to obtain scores for the other criterion as well as the criterion weights. The scores and weights are then used as inputs to a multicriteria scoring model in the usual way. See file Fig15-47.xls