MANSCI Midterm Exam Notes: Chapter 1 ultimately to combine the two sources in order to make the best

possible decision.
Management Science - an approach to decision making based on the
scientific method SOME REASONS WHY A QUANTITATIVE APPROACH MIGHT BE
USED IN THE DECISION-MAKING PROCESS:
 Makes extensive use of quantitative analysis
1. The problem is complex, and the manager cannot develop a good
 Also known as “operations research” and “decision science”
solution without the aid of quantitative analysis.
2. The problem is especially important (e.g., a great deal of money is
Problem Solving - the process of identifying a difference between the actual
involved), and the manager desires a thorough analysis before
and the desired state of affairs and then taking action to resolve the difference
attempting to make a decision.
 Involves the following steps: 3. The problem is new, and the manager has no previous experience
1. Identify and define the problem from which to draw.
2. Determine the set of alternative solutions 4. The problem is repetitive, and the manager saves time and effort
3. Determine the criterion or criteria that will be sued to by relying on quantitative procedures to make routine decision
evaluate the alternatives recommendations.
4. Evaluate the alternatives
5. Choose an alternative
6. Implement the selected alternative
7. Evaluate the results to determine whether a satisfactory
solution has been obtained

DECISION MAKING
 The term generally associated with the first five steps of the
problem-solving process
1. Define the problem
2. Identify the alternatives
3. Determine the criteria
4. Evaluate the alternatives
5. Choose an alternative  The more the analyst is involved in the process of structuring the
o Single-Criterion Decision Problems – problems in which the problem, the more likely the ensuing quantitative analysis will
objective is to find the best solution with respect to one criterion make an important contribution to the decision-making process
o Multicritieria Decision Problems – problems that involve more
than one criterion  The process of developing and solving models is the essence of the
quantitative analysis process

MODEL DEVELOPMENT
 Models – representations of real objects or situations and can be
presented in various forms
o Iconic Models – physical replicas (e.g., toy cars)
o Analog Models – physical in form but do not have the
same physical appearance as the object being modeled
(e.g., speedometer, thermometer)
o Mathematical Models – representations of a problem
by a system of symbols and mathematical relationships
or expressions
 The success of the mathematical model and quantitative approach
will depend heavily on how accurately the objective and
constraints can be expressed in terms of mathematical equations
or relationships.
o Constraints – restrictions or limitations imposed on a
problem
o Objective Function – a mathematical expression that
describes the problem’s objective

Qualitative Analysis – based primarily on judgment and experience; includes

an intuitive “feel” for the problem and is more an art than science
Quantitative Analysis – concentrates on the quantitative facts or data  Uncontrollable Factors – can affect both the objective function
associated with the problem and is used to develop mathematical expressions and the constraints to the model
that describe the objectives, constraints, and other relationships that exist in o Deterministic Model - all uncontrollable inputs to a
the problem model are known and cannot very
o Stochastic/Probabilistic Model – any of the
 A manager who is knowledgeable in quantitative decision-making uncontrollable inputs are uncertain to the decision
procedures is in a much better position to compare and evaluate maker
the qualitative and quantitative sources of recommendations and
  Controllable Inputs/Decision Variables – inputs that are  Decision Tree – provides a graphical representation of the
completely controlled or determined by the decision maker; decision-making process; shows the natural or logical progression
decision alternatives specified by the manager that will occur time

DATA PREPARATION DECISION MAKING WITHOUT PROBABILITIES

 Data – the values of the uncontrollable inputs to the model 1. Optimistic Approach – evaluates each decision alternative in terms of
the best payoff that can occur
General Notation: 2. Conservative Approach – evaluates each decision alternative in terms of
c = profit per unit the worst payoff that can occur; the decision alternative recommended is
a = production time in hours per unit the one that provides the best of the worst possible payoffs
b = production capacity in hours 3. Minimax Regret Approach – evaluates the decision alternative that
minimizes the maximum state of. Regret that could occur over all
General Model: possible states of nature
Max cx  Regret/Opportunity Loss – the difference between the payoff
s.t. associated with a particular decision alternative and the
ax  b payoff associated with the decision yielding the most
x  0 desirable payoff for a given state of nature

A separate data preparation step to identify the values for c, a, and b, would DECISION MAKING WITH PROBABILITIES
then be necessary to complete the model.  Expected Value Approach

MODEL SOLUTION
- In this step, the analyst will attempt to identify the values of the
decision variables that provide the best output for the model
 Optimal Solution – the specific decision-variable value or values
providing the best output o Expected Value – the sum of weighted payoffs for the decision
 Infeasible – when a particular decision alternative does not satisfy alternative
one or more of the model constraints
 Feasible – when all constraints are satisfied and the decision
alternative can be considered a candidate for the best solution or
recommended decision
o Weight for a Payoff – the probability of the associated state of
MODELS OF COST, REVENUE, AND PROFIT nature and therefore the probability that the payoff will occur
 Fixed Cost – the portion of the total cost that does not depend on
the production volume; remains the same no matter how much is  Expected Value of Perfect Information
produced
 Variable Cost – the portion of the total cost that is dependents on
and varies with the production volume
 Marginal Cost – the rate of change of the total cost with respect to
production volume; the cost increase associated with a one-unit  EVPI = expected value of perfect information
increase in the production volume  EVwPI = expected value with perfect information about the
 Marginal Revenue – the rate of change of total revenue with states of nature
respect to sales volume; the increase in total revenue resulting from  EVwoPI = expected value without perfect information about
a one-unit increase in sales volume the states of nature
 Total Profit – total revenue minus total cost
 Breakeven Point – the volume that results in total revenue o Perfect Information – information regarding the states of nature
equaling total cost that could help determine with certainty, prior to making a
MANSCI Midterm Exam Notes: Chapter 13 decision, which state of nature is going to occur
o Decision Strategy – a decision rule that specifies the decision
PROBLEM FORMULATION alternative to be selected after new information becomes available
1. Verbal statement of the problem
2. Identify decision alternatives RISK ANALYSIS AND SENSITIVITY ANALYSIS
o Chance events – uncertain future events  Risk Analysis – helps the decision maker recognize the difference
o Consequences – associated with each combination of between the expected value of a decision alternative and the payoff
decision alternative and chance event outcome that may actually occur
 Sensitivity Analysis – helps the decision maker by describing how
 States of Nature – the possible outcomes for a chance event; one and changes in the state-of-nature probabilities and/or changes in the
only one of the possible states of nature will occur payoff affect the recommended decision alternative
These are defined so that they are:
o Mutually Exclusive – no more than one can occur Risk Analysis
o Collectively Exhaustive – at least one must occur  Risk Profile – shows the possible payoffs along with their
associated probabilities
 Influence Diagram – a graphical device that shows the relationships
among the decisions, the chance events, and the consequences for a Sensitivity Analysis
decision problem - If a small change in the value of one of the inputs causes a change
 Nodes – represent the decisions, chance events, and consequences in the recommended decision alternative, the solution to the
o Decision Nodes – rectangles or squares decision analysis problem is sensitive to that particular input.
- On the other hand, if a modest-to-large change in the value of one
o Chance Nodes – circles or ovals
of the inputs does not cause a change in the recommended decision
o Consequence Nodes – diamonds alternative, the solution to the decision analysis problem is not
o Arcs/Branches – lines connecting the nodes showing sensitive to that particular input.
the direction of influence that the nodes have on one
another DECISION ANALYSIS WITH SAMPLE INFORMATION
 Payoff – the consequence resulting from a specific combination of - Decision makers have preliminary or prior probability assessments
a decision alternative and a state of nature for the states of nature that are the best probability values available
 Payoff Table – a table showing payoffs for all combinations of at that time.
decision alternatives and states of nature
 - However, to make the best possible decision, the decision maker
may want to seek additional information about the states of nature.
- Most often, additional information is obtained through experiments
designed to provide sample information about the states of nature.
- Experiments that enable management to revise or update the state-
of-nature probabilities are called posterior probabilities.

Decision Strategy
 Decision Strategy – a sequence of decisions and chance outcomes
where the decisions chosen depend on the yet-to-be-determined
outcomes of chance events

The approach used to determine the optimal decision strategy is based on a

backward pass through the decision tree using the following steps:
1. At chance nodes, compute the expected value by multiplying the
payoff at the end of each branch by the corresponding branch
probabilities.
2. At decision nodes, select the decision branch that leads to the best
expected value. This expected value becomes the expected value at
the decision node.

Risk Profile
 Risk Profile – shows the possible payoffs with their associated
probabilities

Expected Value of Sample Information

 EVSI = expected value of sample information

EVwSI = expected value with sample information about the
states of nature
 EVwoSI = expected value without sample information about
the states of nature

Efficiency of Sample Information

 Efficiency – a measure used to express the value of the market
research information