DECISION MAKING

APROACHES IN SOLVING PROBLEMS

In decision-making, the engineer manager is faced with problems which may either be simple or
complex. To provide him with some guide, he must be familiar with the following approaches:
1. Qualitative Approach; and
2. Quantitative Approach.

The decision alternative with highest average is regarded as optimal.

 Qualitative
Approach
This term refers to evaluation of alternatives
using intuition and subjective judgment.
Stevenson states that managers tend to use the
qualitative approach when
(1) the problem is fairly simple,
(2) the problem is familiar,
(3) the costs involved are not great / low cost
and
(4) immediate decisions are needed.
 A factory operates on three shifts with the following
schedule:

An example (1) First shift — 6:00 A.M. to 2:00 P.M.

(2) Second shift — 2:00 P.M. to 10:00 P.M and
of an (3) Third shift — 10:00 P.M. to 6:00 A.M.
evaluation
Each shift consists of 200 workers manning 200
using the machines. On September 16, 1996, the operations went
smoothly until the factory manager, an engineer, was
qualitative notified at 1:00 P.M. that five of the workers assigned to
the second shift could not report for work because of
approach is injuries sustained in a traffic accident while they were on
their way to the factory. Because of time constraints, the
as follows: manager made an instant decision on who among the
first shift workers would work overtime to man the five
machines.
 Quantitative
It concentrates on the quantitative facts or data
associated with the problem and develop
mathematical expression that describes the
objectives, constraints, and other relationships
that exist in the problem. Used when:
1. The problem is complex, and the manager cannot
develop a good solution without the aid of
quantitative analysis,
2. The problem is very important (e.g. great deal of money is involved),

3. The problem is new and the manager has no

previous experience from which to draw,
4. The problem involves many variables,
5. There are data which describe the decision
environment,
6. There are data which describe the value or utility
of the different possible alternatives,
7. The goals of the decision maker or her
organization can be described in quantitative term
and
8. Workable models are available for these situations
Decision
Making
The Act of choosing one alternative from among a set of alternatives
Key Factors in the Decision Making Process
 What is the BEST Decision?
To reach a decision the best alternative is usually selected.
What is meant ‘Best’?
Does it mean efficient or effective?
Does it always mean to increase?
Are decisions only used to solve problems?

Best = Effective
“Efficiency is doing things right; effectiveness is doing the right things.” - Peter Drucker

An effective decision is one that maximize or minimize

Managers make decisions about both problems and opportunities
 Decision Making Conditions
Conditions of decision-making are
main factors influencing managers
during decision process
Decision Making Under Conditions of
Certainty - only one state of nature
exists. There is complete certainty
about the future.

Decision Making Under Conditions of

Risk - More than one state of nature
exists, but now the decision maker has
information which will support the
assignment of probability values to
each of the states

Decision Making Under Conditions of

Uncertainty - More than one state of
nature exists, but the decision maker
has no knowledge about the various
states
Conditions
of
Decision-Making

There are main factors influencing

managers during decision process.
There are three general conditions:
certainty, risk and uncertainty.
Manager, preparing a decision,
must take into account: type of
decision and specific conditions
which may occur in business
environment. Turbulence and the
unpredictability of economic life,
makes uncertainty most common
condition of decision making.
Decision Making under
Conditions of Certainty

A condition under which taking a decision involves

reasonable degree of certainty about its result, what
are the opportunities and what conditions accompany
this decision.
It boils down to the fact that the manager sees all the
possibilities and risks of possible alternatives, which in
the simplest example, there are two. Unfortunately
there is little organizational decision be taken in
conditions of genuine certainty. Cyclic decisions bear a
certain degree of certainty, but if the recurrence is
upset (for example through the bankruptcy of one of
the suppliers) the decision-making process must be
carried out with a certain amount of risk, and this is
due, first of all, a wide range of possibilities, secondly,
ignorance of the other actors, secondly a continuous
volatility and unpredictability of market changes.
 Decision Making
under Conditions of Risk
A condition in which the availability of the various
opportunities and associated with each of them the
potential benefits and costs are known with some
estimated probability.
Important here is the ability to predict by the manager,
the potential results of the actions. Managers should
skillfully use own individual qualities such as intuition,
and capitalize on the experience of the past. Risk
condition is accompanied by the average level of
confusion and moderate risk of taking the wrong
decision. Scientists link this type of condition with
gambling. In management, risky decision is being made
knowing the opponent cards, at least in a substantial
part of it. On the other hand, it is not known what
effects can bring decision preferring either party.
Decision-making under
Conditions of uncertainty

A condition in which decision maker does not know all the

choices, as well as risks associated with each of them and
possible consequences.

In this condition most of today's serious decision are being

made. The dynamics of economic life determines the managers
to decide without knowing all alternatives, as well as knowledge
of the risks associated with the known alternatives. Such
situation is associated with a very high probability of erroneous
decision, which could trigger a counterproductive effects. First
of all, in order to reduce the risk: managers should collect as
much relevant information, and then try to make rational and
logical choice. Intuition, correct judgement and experience are
in such conditions, the priority, although you should not forget
about other methods that may help to decide.
QUANTITATIVE MODELS FOR DECISION MAKING
Inventory Models - consist of several types all designed to help the engineering manager make decision regarding inventory. They are as follows:
Economic order quantity model - calculate the number of items that should be ordered at one time to minimize yearly cost of placing orders and
carrying items in inventory Production Order Quantity Model – economic order quantity technique applied to production orders, Back Order Inventory
Model – used for planned shortages, Quantity Discount Inventory Model – minimize the total cost when quantity discounts are offered by suppliers

Networks - models where the large tasks are broken into smaller segments that can be managed independently. Two most prominent network models
are: Program Evaluation Review Technique (PERT)– enables managers to schedule, monitor and control large and complex projects with three time
estimates for each activity Critical Path Method (CPM) – network technique using only one-time factor per activity

Queuing Therory - describes how to determine the number of service units that will minimize both customer waiting time and cost of service. This is
applicable to companies where waiting lines are a common situation. Examples are cars waiting for service at the car wash center, ships and barges
waiting at the harbor for loading and unloading by dockworkers, etc.

Forecasting - the collection of past and current information to make predictions about the future
•Naive
•Moving Ave

Simulation - a model constructed to represent reality on which conclusions about real-life problems can be used

Linear Programming - quantitative technique that is used to produce an optimum solution within the bounds by constraints upon the decision
Inventory In inventory management, economic order quantity is the order
quantity that minimizes the total holding costs and ordering costs. It is
Models one of the oldest classical production scheduling models.
 Economic Order Quantity
Total Inventory Cost
Holding costs - the costs of holding or
“carrying” inventory over time; e.g.
obsolescence, insurance, extra staffing,
interest, pilferage, damage,
warehousing, etc.
Transaction Cost
• Ordering costs - the costs of placing
an order and receiving goods; eg.
Supplies, forms, order processing,
clerical support, etc.
• Setup costs - cost to prepare a
machine or process for
manufacturing an order; e.g. clean-
up costs, re-tooling costs, adjustment
costs, etc.
Economic Order Quantity
Basic Assumptions

• Demand is known, constant, and independent

• Lead time is known and constant
• Receipt of inventory is instantaneous and complete
• Quantity discounts are not possible
• Only variable costs are setup and holding
• Stock outs can be completely avoided
EOQ Model Equations
Optimal Order Expected Number of Orders, N Expected Time Between Order, T
Quantity, Q*
𝐷 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 / 𝑦𝑒𝑎𝑟
2𝐷𝑆 𝑁= 𝑇=
𝑄∗ = 𝑄∗ 𝑁
𝐻

Setup Cost Holding Cost

𝐷 𝑄
𝑆𝑒𝑡𝑢𝑝 𝐶𝑜𝑠𝑡 = 𝑆 𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 = 𝐻
𝑄
2
Q = Number of pieces/units per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
Example 1
Forever 25, a famous clothing manufacturer company, wanted to determine the number of units of
needles that they should order to minimize the yearly cost of placing orders. They also want to know
how many times do they need to order in a year, the optimal time between order/replenishment and the
total annual cost for ordering the needles in a year. Following data was provided by the procurement
department.

D = 1,000 pcs per year S = ₱100.00 per order H =₱5.00 per pc per year

2𝐷𝑆
𝑄∗ =
𝐻

1000 𝑝𝑐𝑠 ₱100

2
𝑦𝑒𝑎𝑟 𝑜𝑟𝑑𝑒𝑟
= ₱5
𝑝𝑐𝑠
( )
𝑦𝑒𝑎𝑟

= 200 𝑝𝑐𝑠 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟.

Example 1 continuation
Forever 25, a famous clothing manufacturer company, wanted to determine the number of units of
needles that they should order to minimize the yearly cost of placing orders. They also want to know
how many times do they need to order in a year, the optimal time between order/replenishment and the
total annual cost for ordering the needles in a year. Following data was provided by the procurement
department.

D = 1,000 units per year S = ₱ 100 per order H = ₱ 5 per pcs. per year

𝐷
𝑁=
𝑄

1000 𝑝𝑐𝑠
𝑦𝑒𝑎𝑟
𝑁=
200 𝑝𝑐𝑠
𝑜𝑟𝑑𝑒𝑟

= 5 𝑜𝑟𝑑𝑒𝑟𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

Example 1 continuation
Forever 25, a famous clothing manufacturer company, wanted to determine the number of units of
needles that they should order to minimize the yearly cost of placing orders. They also want to know
how many times do they need to order in a year, the optimal time between order/replenishment and the
total annual cost for ordering the needles in a year. Following data was provided by the procurement
department.

D = 1,000 units per year S = ₱100 per order H = ₱5 per pcs. per year

𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 / 𝑦𝑒𝑎𝑟

𝑇=
𝑁

250 𝑑𝑎𝑦𝑠
𝑦𝑒𝑎𝑟
= 5 𝑜𝑟𝑑𝑒𝑟𝑠
𝑦𝑒𝑎𝑟

= 50 𝑑𝑎𝑦𝑠 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑜𝑟𝑑𝑒𝑟𝑠

Example continuation
Forever 25, a famous clothing manufacturer company, wanted to determine the number of units of needles that
they should order to minimize the yearly cost of placing orders. They also want to know how many times do they
need to order in a year, the optimal time between order/replenishment and the total annual cost for ordering the
needles in a year. Following data was provided by the procurement department.

D = 1,000 pcs per year S = ₱100 per order Q= 200 pcs per year H = ₱5 per pcs per year per order

𝐷 𝑄
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 = 𝑆𝑒𝑡𝑢𝑝 𝐶𝑜𝑠𝑡 + 𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 = 𝑄 𝑆 + 2 𝐻

1000 𝑝𝑐𝑠 ₱𝟓
𝑦𝑒𝑎𝑟 ₱100 200 𝑝𝑐𝑠 𝒑𝒄𝒔 1000 𝑝𝑐𝑠 𝑂𝑟𝑑𝑒𝑟 ₱100 200𝑝𝑐𝑠 1 ₱5 𝑜𝑟𝑑𝑒𝑟
= + 𝒚𝒆𝒂𝒓 = +
200 𝑝𝑐𝑠 𝑜𝑟𝑑𝑒𝑟 2 𝑦𝑒𝑎𝑟 200 𝑝𝑐𝑠 𝑜𝑟𝑑𝑒𝑟 𝑜𝑟𝑑𝑒𝑟 2 𝑝𝑐𝑠 𝑌𝑒𝑎𝑟
𝒐𝒓𝒅𝒆𝒓

₱500 ₱500
= +
𝑦𝑒𝑎𝑟 𝑦𝑒𝑎𝑟
= ₱1,000 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
Example 2
Forever 25, a famous clothing manufacturer company, wanted to determine the number of
units of needles that they should order to minimize the yearly cost of placing orders. They
also want to know how many times do they need to order in a year, the optimal time
between order/replenishment and the total annual cost for ordering the needles in a year.
Following data was provided by the procurement department.
D = 1,000 per Month S = $10 per order H = $.50 per
D= 1000x12months = 12000 per year
2𝐷𝑆
𝑄∗ = 𝐻

2 12,000 (10)
=
(0.50)

= 692.82 𝑢𝑛𝑖𝑡𝑠
Example 2 continuation
Forever 25, a famous clothing manufacturer company, wanted to determine the number of units of
needles that they should order to minimize the yearly cost of placing orders. They also want to know
how many times do they need to order in a year, the optimal time between order/replenishment and
the total annual cost for ordering the needles in a year. Following data was provided by the
procurement department.
D = 1,000 units per year S = 100 per order H = 5 per unit per year

𝐷
𝑁=
𝑄∗

12,000
=
692

= 17.22 𝑜𝑟𝑑𝑒𝑟𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟 𝑜𝑟 18

Example 2 continuation
Forever 25, a famous clothing manufacturer company, wanted to determine the number of units of
needles that they should order to minimize the yearly cost of placing orders. They also want to know
how many times do they need to order in a year, the optimal time between order/replenishment and
the total annual cost for ordering the needles in a year. Following data was provided by the
procurement department.
D = 12,000 units per year S = 100 per order H = 5 per unit per year

𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 / 𝑦𝑒𝑎𝑟

𝑇=
𝑁
250
=
17.32 𝑜𝑟 18

= 13.8 𝑑𝑎𝑦𝑠 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑜𝑟𝑑𝑒𝑟𝑠

Example 2continuation
Forever 25, a famous clothing manufacturer company, wanted to determine the number of units of needles that
they should order to minimize the yearly cost of placing orders. They also want to know how many times do they
need to order in a year, the optimal time between order/replenishment and the total annual cost for ordering the
needles in a year. Following data was provided by the procurement department.

D = 12,000 units per year S = 10 per order Q*= 692.800 units H = .50 per
unit per year
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 = 𝑆𝑒𝑡𝑢𝑝 𝐶𝑜𝑠𝑡 + 𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝐶𝑜𝑠𝑡

𝐷 𝑄
𝑇𝑜𝑡𝑎𝑙 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑠𝑡 = 𝑆 + 𝐻
𝑄 2

12000 693
= 100 + 5
693 2

= 1732.05 + 1732.05
= 3464.10 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
STATISTICAL DECISION THEORY /
DECISION ANALYSIS
A rational way to conceptualize, analyze and solve problems in situations involving limited or partial
information about the decision environment.

Three classifications of decision environment are the following:

(1) Decision Making Under Conditions of Certainty,

(2) Decision Making Under Conditions of Uncertainty and
(3) Decision Making Under Conditions of Risk.

Definition of terms:

Decision Alternative – the workable options that must be considered in the decision
States of Nature – the probable future events that can occur, not under the control of the decision maker
Payoff Table – a table which shows the payoffs (profit or loss) which would result from each possible
combination of decision alternative and state of nature
 There Maximax Criterion (Optimist)
are
five
DECISION types Maximin Criterion (Pessimist)
MAKING of
criteria
UNDER that Minimax Regret Criterion
CONDITIONS we (Opportunist)

OF will Criterion of Realism (Realist).

look
UNCERTAINTY at
Criterion of Equally Likely (Laplace)
Example (payoff table is expressed as Profit) MaxiMax
Consider the following problem of ABC Company. The company has to
choose whether they will have to expand, build or subcontract a building for
company expansion. Come up with a decision using the different criteria
under conditions of uncertainty. The table shows the profit– for example, if
they choose to expand but the demand (states of nature) of their product is
high then they will make a profit of ₱ 500,000.
Decision Alternatives
States of Nature
Expand Build Subcontract
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Low -250,000 -400,000 -10,000

Failure -450,000 -800,000 -100,000

Example (payoff table is expressed as Loss) MaxiMax
Consider the following problem of ABC Company. The company has to
choose whether they will have to expand, build or subcontract a building for
company expansion. Come up with a decision using the different criteria
under conditions of uncertainty. The table shows the loss – for example, if
they choose to expand but the demand (states of nature) of their product is
low then they will make a loss of ₱250,000.
Decision Alternatives
States of Nature
Expand Build Subcontract
High -500,000 -700,000 -300,000
Moderate -250,000 -300,000 -150,000
Low 250,000 400,000 10,000

Failure 450,000 800,000 100,000

 Maximax Criterion (Optimist)
The maximax rule involves selecting the alternative that maximizes the maximum
payoff available. In the optimistic criterion, select the decision alternative which
would maximize his maximum payoff. Select the maximum payoff possible for
each decision alternative then choose the alternative that provides the maximum
payoff within the group.
States of Decision Alternatives States of Decision Alternatives
Nature Nature Expand Build Subcontract
Expand Build Subcontract
High 500,000
High 500,000 700,000 300,000
Moderate 250,000
Moderate 250,000 300,000 150,000
Low -250,000 - 400,000 - 10,000 Low - 250,000
Failure - 450,000 - 800,000 - 100,000 Failure - 450,000
Maximum
500,000
Payoff

The optimistic decision-maker locates the maximum payoff for each decision alternatives.
The maximum of these payoffs is identified and the corresponding alternative is selected.
 Maximax Criterion (Optimist)
The maximax rule involves selecting the alternative that maximizes the maximum
payoff available. In the optimistic criterion, select the decision alternative which
would maximize his maximum payoff. Select the maximum payoff possible for
each decision alternative then choose the alternative that provides the maximum
payoff within the group
States of Decision Alternatives States of Decision Alternatives
Nature Nature Expand Build Subcontract
Expand Build Subcontract
High 500,000 700,000
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000 Moderate 250,000 300,000

Low -250,000 - 400,000 - 10,000 Low - 250,000 - 400,000

Failure - 450,000 - 800,000 - 100,000 Failure - 450,000 - 800,000
Maximum
500,000 700,000
Payoff

The optimistic decision-maker locates the maximum payoff for each decision alternatives.
The maximum of these payoffs is identified and the corresponding alternative is selected.
 Maximax Criterion (Optimist)
The maximax rule involves selecting the alternative that maximizes the maximum
payoff available. In the optimistic criterion, select the decision alternative which
would maximize his maximum payoff. Select the maximum payoff possible for
each decision alternative then choose the alternative that provides the maximum
payoff within the group
States of Decision Alternatives States of Decision Alternatives
Nature Nature Expand Build Subcontract
Expand Build Subcontract
High 500,000 700,000 300,000
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000 Moderate 250,000 300,000 150,000

Low -250,000 - 400,000 - 10,000 Low - 250,000 - 400,000 - 10,000

Failure - 450,000 - 800,000 - 100,000 Failure - 450,000 - 800,000 - 100,000
Maximum
500,000 700,000 300,000
Payoff

The optimistic decision-maker locates the maximum payoff for each decision alternatives.
The maximum of these payoffs is identified and the corresponding alternative is selected.
 Maximax Criterion (Optimist)
The maximax rule involves selecting the alternative that maximizes the maximum
payoff available. In the optimistic criterion, select the decision alternative which
would maximize his maximum payoff. Select the maximum payoff possible for
each decision alternative then choose the alternative that provides the maximum
payoff within the group.
Decision Alternatives States of Decision Alternatives
States of
Nature Expand Build Subcontract
Nature Expand Build Subcontract
High 500,000 700,000 300,000
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Moderate 250,000 300,000 150,000
Low -250,000 - 400,000 - 10,000 Low - 250,000 - 400,000 - 10,000

Failure - 450,000 - 800,000 - 100,000 Failure - 450,000 - 800,000 - 100,000

Maximum
500,000 700,000 300,000
Payoff

The optimal decision alternative in the example, based on this criterion, is to

Build with a maximum payoff of Php700,000.
 There Maximax Criterion (Optimist)
are
five
DECISION types Maximin Criterion (Pessimist)
MAKING of
criteria
UNDER that Minimax Regret Criterion
CONDITIONS we (Opportunist)

OF will Criterion of Realism (Realist).

look
UNCERTAINTY at
Criterion of Equally Likely (Laplace)
Example
Consider the following problem of ABC Company. The company has to choose whether
they will have to expand, build or subcontract a building for company expansion. Come
up with a decision using the different criteria under conditions of uncertainty. The table
shows the profit or loss – for example, if they choose to expand but the demand (states
of nature) of their product is low then they will make a loss of Php250,000. (Amount in
Php)

Decision Alternatives
States of Nature
Expand Build Subcontract
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Low -250,000 - 400,000 - 10,000

Failure - 450,000 - 800,000 - 100,000

 MaxiMin Criterion (Pessimist)
The pessimistic criterion, it is to maximize his minimum possible payoff or to
choose the best of the worst. Select the minimum payoff possible for each
decision alternative then choose the alternative that provides the maximum payoff
within the group.

States of Decision Alternatives States of Decision Alternatives

Nature Expand Build Subcontract Nature Expand Build Subcontract
High 500,000 700,000 300,000 High 500,000
Moderate 250,000 300,000 150,000 Moderate 250,000
Low -250,000 - 400,000 - 10,000 Low -250,000
Failure - 450,000 - 800,000 - 100,000
Failure - 450,000
Minimum
- 450,000
Payoff
The pessimistic decision-maker locates the minimum payoff for each decision alternatives. The
maximum of these minimum payoffs is identified and the corresponding alternative is selected.
 MaxiMin Criterion (Pessimist)
The pessimistic criterion, it is to maximize his minimum possible payoff or to
choose the best of the worst. Select the minimum payoff possible for each
decision alternative then choose the alternative that provides the maximum payoff
within the group.

States of Decision Alternatives States of Decision Alternatives

Nature Expand Build Subcontract Nature Expand Build Subcontract

High 500,000 700,000 300,000 High 500,000 700,000

Moderate 250,000 300,000 150,000 Moderate 250,000 300,000
Low -250,000 - 400,000 - 10,000 Low - 250,000 - 400,000
Failure - 450,000 - 800,000 - 100,000 Failure - 450,000 - 800,000
Maximum
-450,000 -800,000
Payoff

The pessimistic decision-maker locates the minimum payoff for each decision alternatives. The
maximum of these minimum payoffs is identified and the corresponding alternative is selected.
 MaxiMin Criterion (Pessimist)
The pessimistic criterion, it is to maximize his minimum possible payoff or to
choose the best of the worst. Select the minimum payoff possible for each
decision alternative then choose the alternative that provides the maximum payoff
within the group.

States of Decision Alternatives States of Decision Alternatives

Nature Nature Expand Build Subcontract
Expand Build Subcontract
High 500,000 700,000 300,000
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000 Moderate 250,000 300,000 150,000

Low -250,000 - 400,000 - 10,000 Low - 250,000 - 400,000 - 10,000

Failure - 450,000 - 800,000 - 100,000 Failure - 450,000 - 800,000 - 100,000
Minimum
-450,000 -800,000 -100,000
Payoff

The pessimistic decision-maker locates the minimum payoff for each decision alternatives. The
maximum of these minimum payoffs is identified and the corresponding alternative is selected.
 MaxiMin Criterion (Pessimist)
The pessimistic criterion, it is to maximize his minimum possible payoff or to
choose the best of the worst. Select the minimum payoff possible for each
decision alternative then choose the alternative that provides the maximum payoff
within the group.

Decision Alternatives States of Decision Alternatives

States of
Nature Expand Build Subcontract
Nature Expand Build Subcontract
High 500,000 700,000 300,000
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Moderate 250,000 300,000 150,000
Low -250,000 - 400,000 - 10,000 Low - 250,000 - 400,000 - 10,000

Failure - 450,000 - 800,000 - 100,000 Failure - 450,000 - 800,000 - 100,000

Maximum
-450,000 -800,000 -100,000
Payoff

Since –Php100,000 is maximum out of the minimum payoffs, the optimal decision alternative is to
Subcontract.
 There Maximax Criterion (Optimist)
are
five
DECISION types Maximin Criterion (Pessimist)
MAKING of
criteria
UNDER that Minimax Regret Criterion
CONDITIONS we (Opportunist)

OF will Criterion of Realism (Realist).

look
UNCERTAINTY at
Criterion of Equally Likely (Laplace)
Example
Consider the following problem of ABC Company. The company has to
choose whether they will have to expand, build or subcontract a building for
company expansion. Come up with a decision using the different criteria
under conditions of uncertainty. The table shows the profit or loss – for
example, if they choose to expand but the demand (states of nature) of their
product is low then they will make a loss of Php250,000. (Amount in Php)

Decision Alternatives
States of Nature
Expand Build Subcontract
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Low -250,000 - 400,000 - 10,000

Failure - 450,000 - 800,000 - 100,000

 MiniMax Regret Criterion (Opportunist)
Assume that a states of nature actually happened, solve for the regret. Choose
the minimum of these regret values. It is useful for a risk-neutral decision maker.
Essentially, this is the technique for a 'sore loser' who does not wish to make the
wrong decision.

States of Decision Alternatives Regret is defined as the opportunity

Nature Expand Build Subcontract
loss through having made the wrong
High 500,000 700,000 300,000
decision.
Moderate 250,000 300,000 150,000
Low -250,000 - 400,000 - 10,000
Regret = state largest payoff - decision alternative payoff
Failure - 450,000 - 800,000 - 100,000
 MiniMax Regret Criterion (Opportunist)
Using the same example, if the demand is high, they will make a maximum profit
of 700,000 if they build. If they had decided to expand, they will only make a profit
of 500,000. The difference or regret between the 500,000 profit and the maximum
of 700,000 achievable profit for that state of nature (high) is 200,000.

Decision Alternatives States of Decision Alternatives

States of
Nature Expand Build Subcontract
Nature Expand Build Subcontract 700,000 - 500,000
High
High 500,000 700,000 300,000 200,000
Moderate 250,000 300,000 150,000 Moderate
Low -250,000 - 400,000 - 10,000 Low
Failure - 450,000 - 800,000 - 100,000 Failure
Maximum
Regret
 MiniMax Regret Criterion (Opportunist)
Using the same example, if the demand is high, they will make a maximum profit
of 700,000 if they build. If they had decided to build, they will only make a profit of
700,000. The difference or regret between the 700,000 profit and the maximum of
700,000 achievable profit for that state of nature (high) is 0.

Decision Alternatives States of Decision Alternatives

States of
Nature Expand Build Subcontract
Nature Expand Build Subcontract 700,000 - 700,000
High 200,000
High 500,000 700,000 300,000 0
Moderate 250,000 300,000 150,000 Moderate
Low -250,000 - 400,000 - 10,000 Low
Failure - 450,000 - 800,000 - 100,000 Failure
Maximum
Regret
 MiniMax Regret Criterion (Opportunist)
Using the same example, if the demand is high, they will make a maximum profit
of 700,000 if they build. If they had decided to subcontract, they will only make a
profit of 300,000. The difference or regret between the 300,000 profit and the
maximum of 700,000 achievable profit for that state of nature (high) is 400,000.

Decision Alternatives States of Decision Alternatives

States of
Nature Expand Build Subcontract
Nature Expand Build Subcontract 700,000 - 300,000
High 200,000 0
High 500,000 700,000 300,000 400,000
Moderate 250,000 300,000 150,000 Moderate
Low -250,000 - 400,000 - 10,000 Low
Failure - 450,000 - 800,000 - 100,000 Failure
Maximum
Regret
 MiniMax Regret Criterion (Opportunist)
The regrets can be tabulated as follows:
Regret Table
States of Decision Alternatives
Nature Expand Build Subcontract
Payoff Table 700,000 - 500,000 700,000 - 700,000 700,000 - 400,000

High 200,000 0 400,000

States of Decision Alternatives
300,000 - 250,000 300,000 - 300,000 300,000 - 150,000
Nature Expand Build Subcontract
Moderate 50,000 0 150,000
High 500,000 700,000 300,000
- 10,000 - (- 250,000) -10,000 - (- 400,000) - 10,000 - (- 10,000)
Moderate 250,000 300,000 150,000
Low -250,000 - 400,000 - 10,000
Low 240,000 390,000 0
Failure - 450,000 - 800,000 - 100,000 - 100,000 - (- 450,000) -100,000- (-800,000) - 100,000 - (- 100,000)

Failure 350,000 700,000 0

Maximum
Regret
 MiniMax Regret Criterion (Opportunist)
The regret criterion is based upon the minimax principle, i.e., the decision-maker tries to minimize the
maximum regret. Thus, the decision-maker selects the maximum regret for each of the decision
alternatives and out of these the alternatives which corresponds to the minimum regret is regarded as
optimal.
Decision Alternatives
States of Nature
Expand Build Subcontract
700,000 - 500,000 700,000 - 700,000 700,000 - 400,000
High 200,000 0 400,000
300,000 - 250,000 300,000 - 300,000 300,000 - 150,000
Moderate 50,000 0 150,000
- 10,000 - (- 250,000) -10,000 - (- 400,000) - 10,000 - (- 10,000)
Low 240,000 390,000 0
- 100,000 - (- 450,000) -100,000- (-800,000) - 100,000 - (- 100,000)
Failure 350,000 700,000 0
Maximum Regret 350,000 700,000 400,000

Since Php350,000 is the minimum regret, the optimal alternative is to Expand.

 There Maximax Criterion (Optimist)
are
five
DECISION types Maximin Criterion (Pessimist)
MAKING of
criteria
UNDER that Minimax Regret Criterion
CONDITIONS we (Opportunist)

OF will Criterion of Realism (Realist)

look
UNCERTAINTY at
Criterion of Equally Likely (Laplace)
Example
Consider the following problem of ABC Company. The company has to
choose whether they will have to expand, build or subcontract a building for
company expansion. Come up with a decision using the different criteria
under conditions of uncertainty. The table shows the profit or loss – for
example, if they choose to expand but the demand (states of nature) of their
product is low then they will make a loss of Php250,000. (Amount in Php)

Decision Alternatives
States of Nature
Expand Build Subcontract
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Low -250,000 - 400,000 - 10,000

Failure - 450,000 - 800,000 - 100,000

Criterion of Realism (Realistic)
It is considering both optimism and pessimism. Alpha is used as an index of
optimism. Determine the maximum and the minimum payoff for each decision
alternative.

Decision Alternatives
States of Nature
Expand Build Subcontract
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Low - 250,000 - 400,000 - 10,000
Failure - 450,000 - 800,000 - 100,000
Maximum Payoff 500,000 700,000 300,000
Minimum Payoff - 450,000 - 800,000 - 100,000
Criterion of Realism (Realistic)
Then a weighted average/measure of realism of the maximum and minimum
payoffs of an action, with α and 1 - α as respective weights, is computed.

Decision Alternatives
States of Nature States of Nature
Decision Alternatives

High ExpandExpand 500,000 Build Subcontract300,000

Build
700,000 Subcontract
Moderate 250,000 300,000 150,000
High Low 500,000
- 250,000 700,000
- 400,000 - 10,000 300,000
Failure - 450,000 - 800,000
- 100,000
Moderate Maximum Payoff 250,000500,000 300,000
700,000 300,000 150,000
Minimum Payoff - 450,000 - 800,000
- 100,000
Low Measure of Realism
- 250,000
500,000*0.6 + -450,000*0.4
- 400,000
500,000*0.6 + -450,000*0.4 500,000*0.6 + -450,000*0.4
- 10,000
120,000 100,000 140,000
Failure - 450,000 - 800,000 - 100,000
Maximum Payoff 500,000 700,000 300,000
Minimum Payoff - 450,000 - 800,000 - 100,000
Measure of Realism
 Criterion of Realism (Realistic)
Then use the formula:
𝑀𝑒𝑎𝑠𝑢𝑟𝑒 𝑜𝑓 𝑅𝑒𝑎𝑙𝑖𝑠𝑚 = 𝑀𝑎𝑥𝑖𝑚𝑢𝑚 𝑃𝑎𝑦𝑜𝑓𝑓 𝛼 + (𝑀𝑖𝑛𝑖𝑚𝑢𝑚 𝑃𝑎𝑦𝑜𝑓𝑓) 1- 𝛼
A decision using criterion of realism with an index of optimism at α = 60%.
States of Decision Alternatives
Nature Expand Build
Decision Alternatives
Subcontract
States of Nature
High High 500,000 Expand 500,000 Build
700,000 700,000
Subcontract
300,000 300,000
Moderate 250,000 300,000
Moderate Low 250,000 - 250,000 - 400,000 300,000-150,000
10,000 150,000
Failure - 450,000 - 800,000 - 100,000
Low Maximum Payoff - 250,000 500,000 700,000 - 400,000 300,000 - 10,000
Minimum Payoff - 450,000 - 800,000 - 100,000
Failure - 450,000
Measure of Realism
500,000*0.6 + -450,000*0.4
- 800,000
500,000*0.6 + -450,000*0.4 500,000*0.6 + -450,000*0.4
- 100,000
120,000 100,000 140,000
Maximum
500,000 700,000 300,000
Payoff
Minimum
- 450,000 - 800,000 - 100,000
Payoff
Measure of 500,000*0.6 + -450,000*0.4 700,000*0.6 + -800,000*0.4 500,000*0.6 + -100,000*0.4
Realism 120,000 100,000 140,000
Criterion of Realism (Realistic)
The decision alternative with highest average is regarded as optimal.

Decision Alternatives
States of Nature
Expand Build Subcontract
High 500,000
States of Nature
Decision Alternatives 700,000 300,000
Moderate High 250,000 Expand 500,000 Build Subcontract
300,000
700,000 300,000 150,000
Moderate 250,000 300,000 150,000
Low Low - 250,000 - 250,000 - 400,000 - 10,000
- 400,000 - 10,000
Failure - 450,000 - 800,000 - 100,000
Failure Maximum Payoff
Minimum Payoff
- 450,000 500,000
- 450,000
- 800,000 - 300,000
700,000
- 800,000 100,000
- 100,000
Maximum Payoff Measure of Realism 500,000
500,000*0.6 + -450,000*0.4
700,000
500,000*0.6 + -450,000*0.4
300,000
500,000*0.6 + -450,000*0.4

120,000 100,000 140,000

Minimum Payoff - 450,000 - 800,000 - 100,000
Measure of
120,000 100,000 140,000
Realism

Since the average for Subcontract is the maximum, 140,000 it is the optimal alternative.
 There Maximax Criterion (Optimist)
are
five
DECISION types Maximin Criterion (Pessimist)
MAKING of
criteria
UNDER that Minimax Regret Criterion
CONDITIONS we (Opportunist)

OF will Criterion of Realism (Realist).

look
UNCERTAINTY at
Criterion of Equally Likely (Laplace)
Example
Consider the following problem of ABC Company. The company has to
choose whether they will have to expand, build or subcontract a building for
company expansion. Come up with a decision using the different criteria
under conditions of uncertainty. The table shows the profit or loss – for
example, if they choose to expand but the demand (states of nature) of their
product is low then they will make a loss of Php250,000. (Amount in Php)

Decision Alternatives
States of Nature
Expand Build Subcontract
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Low -250,000 - 400,000 - 10,000

Failure - 450,000 - 800,000 - 100,000

 Equally Likely Criterion
The equally likely criterion is where the probability of each outcome is not known
with certainty. In this case, the equally likely criterion assumes that each possible
outcome is equally likely to occur, even if the actual probabilities are not known.

Decision Alternatives
States of Nature
Expand Build Subcontract
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Low - 250,000 - 400,000 - 10,000
Failure - 450,000 - 800,000 - 100,000
 Equally Likely Criterion
In this example, the equally likely criterion assumes that there is a 25% chance of
the market for the four state of nature or 100% divided by 4 states of nature.

States of Probability Decision Alternatives

100% / number of Expand Build Subcontract
Nature
State of nature
1. High 25% 500,000 700,000 300,000
2. Moderate 25% 250,000 300,000 150,000
3. Low 25% - 250,000 - 400,000 - 10,000
4. Failure 25% - 450,000 - 800,000 - 100,000
 Equally Likely Criterion
The equally likely criterion is where the probability of each outcome is not known
with certainty. In this case, the equally likely criterion assumes that each possible
outcome is equally likely to occur, even if the actual probabilities are not known.
Multiply the probability to the Decision Alternative Value.

States of Probability Decision Alternatives

100% / number of Expand Build Subcontract
Nature
State of nature
1. High 25% (.25)(500,000)=125,000 700,000 300,000
2. Moderate 25% (.25)(250,000)=62,500 300,000 150,000
3. Low 25% (.25)(-250,000)=-620500 - 400,000 - 10,000
4. Failure 25% (.25)(-450,000)=112,5000 - 800,000 - 100,000
=12,500
 Equally Likely Criterion
The equally likely criterion is where the probability of each outcome is not known
with certainty. In this case, the equally likely criterion assumes that each possible
outcome is equally likely to occur, even if the actual probabilities are not known.
Multiply the probability to the Decision Alternative Value.

States of Probability Decision Alternatives

100% / number of Expand Build Subcontract
Nature
State of nature
1. High 25% 125,000 (.25)(700,000)=175,000 300,000
2. Moderate 25% 62,500 (.25)(300,000)=75,000 150,000
3. Low 25% 620500 (.25)(-400,000)=-100,000 - 10,000
4. Failure 25% 112,5000 (.25)(-800,000)=-200,000 - 100,000
12,500 -50,000
 Equally Likely Criterion
The equally likely criterion is where the probability of each outcome is not known
with certainty. In this case, the equally likely criterion assumes that each possible
outcome is equally likely to occur, even if the actual probabilities are not known.
Multiply the probability to the Decision Alternative Value.
States of Probability Decision Alternatives
100% / number of Expand Build Subcontract
Nature
State of nature
1. High 25% 125,000 175,000.00 (.25)(300,000)=750,000
2. Moderate 25% 62,500 75,000.00 (.25)(150,000)=37,500
3. Low 25% 620500 - 100,000.00 (.25)(- 10,000)=-2,500
4. Failure 25% 112,5000 - 200,000.00 (.25)(- 100,000)=-25,000
Total
Expected 12,500 - 50,000.00 85,000
Value
 Equally Likely Criterion
Get the total Expected Value for all decision Alternatives

States of Probability Decision Alternatives

100% / number of State of Expand Build Subcontract
Nature
nature
1. High 25% 125,000 175,000.00 75,000.00
2. Moderate 25% 62,500 75,000.00 37,500.00
3. Low 25% 620500 - 100,000.00 - 2,500.00
4. Failure 25% 112,5000 - 200,000.00 - 25,000.00
Total Expected Value 12,500 - 50,000.00 85,000.00
 Equally Likely Criterion
Choose the largest Expected value among the Decision Alternative
Decision Alternatives
States of Nature
Expand Build Subcontract
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Low - 250,000 - 400,000 - 10,000
Failure - 450,000 - 800,000 - 100,000
Expected Value =12,500 =-50,000 =85,000

Since the largest Expected Value is 85,000, then the decision is to Subcontract
TIPS
Switch table Orientation
Convert Loss Payoff Table to Profit payoff table
Table Orientation
Alternative in Columns and State of Nature in rows
States of Decision Alternatives
Nature Expand Build Subcontract
High 500,000 700,000 300,000
Moderate 250,000 300,000 150,000
Low -250,000 -400,000 -10,000
Failure -450,000 -800,000 -100,000

Alternative in rows and State of Nature in columns

Decision States of Nature

Alternatives High Moderate Low Failure
Expand 500,000 250,000 -250,000 -450,000
Build 700,000 300,000 -400,000 -800,000
Subcontract 300,000 150,000 -10,000 -100,000