Decision Analysis Essay

In business today, many decision-making situations occur under conditions of uncertainty. The demand for a product can be one number this week and double that number next week or vice versa. There are several decision-making techniques to aid the decision maker in dealing with these types of uncertainties. There are two classes of decision situations, situations where probabilities can be assigned to future occurrences and probabilities that cannot be assigned. A decision-making situation includes several components, the decision itself and the actual events that can occur in the future, we refer to those as states of nature. The states of nature can be good and bad economic conditions, cold or warm weather, and an accident or no accident. The state of nature that does occur will determine the outcome of the decision, but the decision maker has no control over which state occurs. Payoff tables are organized so that the decision situations can be analyzed. Using a payoff table is a means of organizing a decision situation, including the payoffs from different decisions, given the various states of nature. Each decision will result in a specific outcome corresponding to the particular state of nature that occurs in the future. Payoffs are usually expressed as revenues or costs, but the can be expressed in a variety of values. Once a payoff table has been organized, there are several criteria available for making the actual decision. One of those is the maximax criterion. The maximax criterion results in the maximum of the maximum payoffs. The decision maker would be very optimistic. They would assume the most favorable state of nature would occur. When considering profit, the decision maker would pick the state of nature that gains the highest revenue. When considering cost, the decision maker would select the minimum of the minimum of costs, which is also referred to as the minimin criterion. The maximin criterion is another criteria that can be used. The maximin criterion results in the maximum of the minimum payoff. This is a pessimistic criterion. The decision maker assumes that the minimum payoff will occur. Of those minimum payoffs, the maximum is selected. If the decision maker were to consider costs instead of profits as the payoff, the conservative approach would to select the maximum cost for each decision. Then they would select the minimum of those costs. The minimax regret criterion minimizes the maximum regret. Regret is the difference between the payoff from the best decision and all other decision payoffs. With this criterion, the decision maker attempts to avoid regret by selecting the decision alternative that minimizes the maximum regret. To use this criterion, the decision maker selects the maximum pay off under each state of nature and then subtracts the other payoffs from those amounts. The Hurwicz criterion is a compromise between the maximax and maximin criteria. The decision maker is not totally optimistic not totally pessimistic. With this criterion, the payoffs are weighted by a cofficient of optimism, which is a measure of the decision maker’s optimism. The coefficient of optimism must be determined by the decision maker, which is a limitation. It can be difficult for a decision maker to accurately determine his or her degree of optimism. This is a completely subjective decision making criterion. The equal likelihood criterion is done in the same way. The equal likelihood criterion multiplies the decision payoff for each state of nature by an equal weight. In conclusion, decision making analysis is a key component to maximizing profit and minimizing cost. There are several different decision-making criteria. Which criteria is used would be based on the decision makers outlook on the future.