In general, decisions may be made using many criteria, ranging from gut feel, qualitative analysis of advantages/disadvantages. In economic and financial analysis, common methods involve the calculation of the profitability, time-to-breakeven, rate-of-return, net present value, and similar methods. (See also the general introductory materials on this site for further discussion and some examples).
It is evident that when quantitative methods are used, then the models used need to be able to calculate or evaluate these items, and therefore the models must also include any input variables and intermediate calculations necessary to do so. One can therefore first establish the decision criteria to be used and then work backwards conceptually to identify the variables required within the model.
In general, there are many criteria that may be used to make decisions. Broadly speaking, these can be classified into four main groups:
This involves basing a decision on:
Key examples here include where decisions aim for:
These are where multiple criteria are considered, but the relationships between the items is not tightly defined, nor quantified, and the trade-offs between them are not aimed to be explicit. The main types are:
These are where multiple criteria are used, and are integrated by using quantitative approaches. Where possible the trade-offs between criteria are explicit in the analysis, or at least are made more transparent than in non-quantitative approaches, for example:
Importantly, this category includes many approaches used in economic and financial modelling: The quantification of “advantages-disadvantages”, or of “cost-benefit” approached to create integrated approaches are important examples. For example, sales revenue may be considered as a “benefit”, whilst operational expenditure is a “cost”, and these are “integrated” by calculating the profit, and so on.