Maximin criterion: decision choice method that provides the best of the worst possible outcomes.
- This criterion states that the decision makes should select the alternative that provides the best of the worst possible outcomes.
- This is done by finding the worst possible outcome for each decision alternative and then choosing the option whose worst possible outcome provides the highest payoff,
- This criterion instructs one to maximise the minimum possible outcome.
- Although the maximin criterion suffers from the obvious shortcoming of focusing on the most pessimistic outcome for each decision alternative, it should not be dismissed as naive and unsophisticated.
- The maximin criterion implicitly assumes a very strong aversion to risk and is quite appropriate for decisions involving the possibility of catastrophic outcomes.
- Similarly, if the state of nature that prevails depends on the course of action taken by the decision maker, the maximum criterion might be appropriate.
Computer simulations allows detailed analysis of a managerial problems involving complex cost and revenue relations.
- Investment analyst identifies probability values for significant factors.
- Using computer simulation software, analyst randomly selects sets of investment characteristics based on their chances of turning up in the future.
- Return on Investment (ROI) is estimated for specific scenario.
- ROI is reestimated hundreds or thousands, of times under alternative scenarios to give clear picture of return distribution (investment risk).
Learning curve: average cost reduction over time due to production experience.
When knowledge gained is used to increase production methods so that output is produced with increasing efficiency, the resulting decline in average costs is said to reflect the effects of the firm's learning curve.
Learning through production experience permits the firm to produce output more efficiently at each and every output level.
To isolate the effect of learning/experience on average cost, it is necessary to identify carefully that portion of average-cost changes over time which is due to other factors.
Learning curves relate cost differences to total cumulative output for a product.
Reported learning/experience rates include the effects of both learning and economies of scale.
Managers have found that the use of the learning-curve concept can substantially improve their ability to forecast production costs based on projected cumulative output which improves pricing decisions and production strategies.
Average costs decline substantially as cumulative total output increases.
Break-even analysis: determination of product volume where revenues equal total costs or costs associated with two alternative processes are the same.
- Company view: refers to determining how much volume of business the company must do in order to break-even, that is, to have neither profits/losses where total revenues equal total costs.
- Operational view: two processes have equal costs for a specific level of volume.
Revenues versus Costs
Determine how much volume of business, a company has to do to break-even. The volume can be stated in either monetary units/product units.
Linear model assumptions:
- The selling price per unit is constant;
- Variable costs per unit remain constant;
- Fixed costs remain constant.
Choice of Processes
Also used to choose from among alternative processes a company can use.
Assume that both variable costs per unit and fixed costs remain constant.
Break-even point as that volume where we are indifferent with respect to the costs of the two alternative processes.