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2.Decision Theory - Decision Tables and Decision Trees, Game Theory
2.1 Introduction and Basic Terms
Decision theory represents a generalized approach to decision making. It enables the decision maker to analyze a set of complex situations with many alternatives and many different possible consequences to identify a course of action consistent with the basic economic and psychological desires of the decision maker Decision theory problems are characterized by the following: a decision criterion a list of alternatives a list of possible future events (states of nature) payoffs associated with each combination of alternatives and events the degree of certainty of possible future events There is a wide range of management decision problems. Among them there are capacity and order planning, product and service design, equipment selection, location planning, and so on. Some examples of alternatives and possible events for these alternatives are shown in Table 2.1.

Alternatives To order 10, 11, … units of a product To make or to buy a product To buy or not to buy accident insurance

Events Demand for the product may be 0, 1, … units The cost of making may be 20, 22, … $thousands An accident may occur, or may not occur

Table 2.1 “Examples of Alternatives and Events”

Various properties of decision problems enable a classification of decision problems. Solution to any decision problem consists of these steps: 1. Identify the problem 2. Specify objectives and the decision criteria for choosing a solution

3. 4. 5. 6. 7.

Develop alternatives Analyze and compare alternatives Select the best alternative Implement the chosen alternative Verify that desired results are achieved

Decisions problems that involve a single decision are usually best handled through payoff tables, whereas problems that involve a sequence of decisions, are usually best handled using decision trees

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