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SUSTAINABILITY, OPTION, THEORY, AND QUALITY CONTROL
Citation:
Pawlowski**, C. W., H C. Cabezas*, J. Duggempudi, AND U. M. Diwekar. SUSTAINABILITY, OPTION, THEORY, AND QUALITY CONTROL. Presented at 2003 Int. Soc. Industrial Ecology 2nd Int. Conf, Ann Arbor, MI, June 29 - July 02, 2003.
Impact/Purpose:
To inform the public
Description:
Recently, Cabezas and Fath (2000) hypothesized that constant Fisher Information is a necessary condition for the persistence, i.e., sustainability of a dynamic regime of a system. A sustainable dynamic regime is one that persists and an unsustainable regime is one that does not persist. The form of the Fisher Information on which the condition is based is a measure of order in the dynamic regime of the system. A change in the dynamic regime of the system is characterized by a change in order, and a corresponding change in Fisher Information. Fisher Information provides a basis for including the concepts and features of multiple disciplines such as ecology, hydrology, law and economics in the study and management of sustainable systems. Cabezas and Faith developed the beginning steps in this theory using simple ecological models. The aim of this research is to use concepts from economic option theory to enhance the applicability of the theory further by including time dependent uncertainties and coupling it with an off-line quality control method to obtain optimal decisions. Most investment decisions share three important characteristics in varying degrees. First, the investment is partially or completely "irreversible". In other words, the initial cost of investment is at least partially "sunk"; you cannot recover it all should you change your mind. Second, there is "uncertainty" over the future rewards from the investment. The best you can do is to assess the probabilities of the alternative outcomes that can mean greater or smaller profit (or loss) for your venture. Third, you have some leeway on the "timing" of your investment. You can postpone action to get more information but not with complete certainty. These three characteristics interact to determine the optimal decisions or "options" for investors. A firm with an opportunity is holding an "option" to buy an asset at some future time of its choosing. When a firm makes an irreversible expenditure, it exercises, or "kills", its option to invest. This lost option value is an opportunity cost that must be included as part of the cost of investment. Also, this opportunity cost is highly sensitive to the uncertainty over the future value of the project. Similar to the options theory, irreversibility, uncertainty, and possibility of delay are also important characteristics of sustainability. Also, there are significant differences between the concept of sustainability, and profitability, the objective used in financial market. For sustainability it is important to have stable and constant Fisher information over time rather than an increase in Fisher information. In this project, we combine financial option theory and concepts from quality control to obtain optimal decision rules that can maintain the stability of Fisher information over time. Parameter design or off-line quality control is a method popularized by the Japanese quality expert G. Taguchi, for designing products and manufacturing processes that are robust in the face of uncontrollable variations. At the design stage, the goal of parameter design is to identify design settings that make the product performance less sensitive to the effects of manufacturing and environmental variations, and deterioration (Diwekar and Rubin, 1994). Because parameter design reduces performance variation by reducing the influence of the sources of variation rather than by controlling them, this method can be used to for optimal decision making for sustainability where feed back control can take a long time to influence sustainability.