15.060 Data, Models, Decisions 15.060 Data, Models, Decisions

15.
060 Data, Models, Decisions

Decisions
Final Review
Review
December 15 2007
DMD Fall 07 Final Review
Robert Freund, David Gamarnik, and Andreas Schulz, course materials for 15.060 Data, Models, and Decisions, Fall 2007.
MIT OpenCourseWare (http://ocw.mit.edu), Massachusetts Institute of Technology. Downloaded on [DD Month YYYY].
Final Exam
Exam
Date: Monday, December 17

Time: 9am-12pm
9am 12pm
Place: See MIT Server (come early!)
Closed book exam
No laptops or communication devic
devices
You can bring a calculator
Formula Sheet will be provided
BUT get a good night
nightss sleep!
December 15 2007
Table of Contents
Contents
Topic 1 : Decision Analysis

Topic 2 : Discrete Random Variables
T i 3: C
Topic
Covariance
ovariance
i
and Correl
orrela
ati
ttition
io
Topic 4 : Continuous Random Variables
Topic 5 : Statistical Sampling
Sampling
Topic 6 : Simulation
Top
pic 7 : Reg
gression
Topic 8 : Linear Optimization
Topic 9 : Nonlinear Optimization
Topic 10 : Discrete Optimization
December 15 2007
You are NOT responsible for:
TOPIC 1:
1:
Decision Analysis
Analysis
Conditional Probabilities
December 15 2007
TOPIC
PIC
2
2:
2:
Discrete Random Variables

Variables
December 15 2007

Variables
A probability distribution for a discrete random variable X consists of

(i)
possible values
x1, x2, . . . , xn,
(ii)
corresponding probabilities
p 1, p2, . . . , pn,
so that: P(X = x1) = p1, P(X = x2) = p2, . . . , P(X = xn) = pn .

0 50
0.50
A histogram is a
display of
probabilities as a
bar chart
0.40
0.30
P(Y= y)
0.20
0.10
0.00
0
Probabilities are non-negative, must sum to 1,

The possible values are mutually exclusive
and collectively
y exhaustive ((describe all the p
possibilities that can happen).
pp )
December 15 2007
3 important measures
measures
1. Expected Value or Mean: (measured in units of X)

Average outcome measure of central tendency
E( X )
PX
P( X
xi )xi
px
i i
2. Variance: (in units of X squared)

2.
Squared deviation around the mean measure of spread
Var(( X ) V X2
P(( X
xi )(
)(xi P X ) 2
2
p
(
x

P
)
i i X
i
3. Standard Deviation: (in units of X)

M
Measure off spread
VX
December 15 2007
Var( X )
You are NOT responsible for:
The Binomial distribution

distribution
December 15 2007
TOPIC 3:
3
Covariance and Correlation
December 15 2007
Covariance:
Covariance:
Cov( X ,Y )
E[( X P X )(Y PY )]
P(( X
xi ; Y
y j )(
)(xi P X )( y j PY )
i, j
Measures the extent to which two random variables

vary together.
Correlation:
CORR(X, Y)
COV(X, Y)
X Y
Correlation is unitless
CORR(X, Y) always between -1 and 1.
December 15 2007
10
Wo
W
orking with joint distributions
Suppose X and Y are two random variables with

joint distribution P((X=xi; Y=y
yk):
E[ X ] = xi P( X = xi )
i
Var( X ) = X = (xi X ) 2 P( X = xi )
2
P( X = xi ) = P( X = xi ;Y = yk )
k
Marginal distribution of X
December 15 2007
Joint distribution of X and Y
11
Sums of random variables

variables
Mean of a sum:
E(aX bY c) = aE( X ) bE(Y ) c

Variance of a sum:
V ( X bY c)) = a 2Var(( X ) b 2Var(Y

Var(aX
V (Y ) 2
2.a.b.COV ( X ,Y
Y)
2 2
2 2
a
V

b
V Y 2.a.b.V X V Y CORR( X ,Y )
=
X
December 15 2007
12
TOPIC 4:
4:
Conti
Con
C
ti
tinuous ran
rand
d
dom
om vari
variia
abl
bles
es
December 15 2007
13
Continuous random variables

variables
A continuous r.v can take any value in some interval

Examp
ple: W Time sp
pent waiting
gin line at Au Bon Pain!
There are an infinite number of possible values that the
random variable can assume
For a continuous random variable
variable, questions are phrased in
terms of a range of values.
NOTE:
You would never say: Probability to wait exactly 10.5 minutes!
P(W=10.5)=0
B t Probability
But:
P b bilit tto wait
it :
Less than 10 minutes: P(W<10);
More than 20 minutes; P((W>20));
Between 10 and 15 minutes: P(10<W<15).
December 15 2007
14
Density functions
functions
Probability density function:

Denoted
f(t): gives a picture of
the distributio
distribution
(think of a smoothed histogram)
0.35
03
0.3
0.25
0.2
0.15
Area
under the curve between 2
values a and b: P(a
P(a X b)
b)
0.1
0.05
0
0
0.5
1.5
2.5
3.5
4.5
Total
area under the curve = 1
(total probability)
Cumulative density function:
1.2
1
F(t)
= P(X t)
0.8
P(X
t) = 1-F(t)
0.4
0.6
0.2
X b) = P(X b) - P(X a) =
F(b) F(a)
P(a
December 15 2007
0
0
0.5
1.5
2.5
3.5
4.5
15
The normal distribution

distribution
0.12
Bell-shaped curve
0.1
0.08
0.06
0.04
0.02
0
-6
-4
-2
10
12
Computing probabilities with the Normal distribution:

You want : P(a X b) where X is N(,)
1. Define : Z = X
: Z is N(0,1)
P(a X b) = P(
= P(Z
) P(Z
Z
a
2 Use the standard normal probabilit

2.
probability table (Z table)
December 15 2007
16
68.3%
95.4%
PV
PV
PV
.0228
.1587
PV
PV
PV
.5
.8413
.9772
December 15 2007
17
Sum of i.i.d random variables:

Central Limit Theorem
X1, X2, ..., Xn independent identically distributed random variables:
E[X
[ i] = , Var(X
( i) = 2
For n>30, Sn = X1 + X 2 +...+ X n is approximately normal with
2 (standard deviation n.
mean
n
n.
and
variance
n
n.
mean n and
n
(standard deviation n
n )
Mn =
X 1 + X 2 + ...+ X n
n
For n>30,
is approximately normal with
mean and
d variance
i
2//n
(( tt dd dd deviation
dd ii titi /n
/ )
/ (standard
The probability distribution of Xi does not matter;
n does not have to be very large ( 30 is good enough);
CLT requires only 2 pieces of information:the mean and SD of Xi
December 15 2007
18
TOPIC
PIC
5
5:
5:
Statistical Sampling
Sampling
December 15 2007
19
Sample mean of a population

population
Estimator of the mean of a

population (): Sample mean X
X =
X 1 + ... + X
n
Population of size N
where X1,,,X
, n are n R.Vs following
g
the population distribution (unknown
mean , unknown std dev )
Random sample 2:
sample
l mean x2
Random sample 1:
sample mean x1
X is a random variable !
By Central Limit Theorem, if n>30, then X is approximately
normal with mean and standard deviation /n
normal,
December 15 2007
20
Sample standard deviation

Population of size N
Estimator of the standard
deviation of a population ():
The sample standard
deviation S :
S =
(X
X )2
n 1
Random sample 2:
sample std dev s2
Random sample 1:
sample
l std
d dev
d s1
S2 is an unbiased estimator of the variance, i.e. E[S

[ 2]]=2
S is a random variable !
December 15 2007
21
Confidence interval for sample mean

mean
How confident are we that X is a good estimate of the true mean of

the population ?
The realized values of X and S in the sample of size n are:x and s
if n>30, then a % confidence interval for the mean is:
c.s
c.s
,x +
x
n
n
What sample size do we need to be sure that the % confidence

i t
interval
l is
i within
i hi +// L off the
h true mean ?
the required sample size is:
c2s2
n= 2
L
c is such that P( -c <Z< c) = %, where Z~N(0,1):
= 90 c = 1.645,,
December 15 2007
= 95 c = 1.960,, = 99 c = 2.576.
22
3 types of CI problems
There are 3 main types of confidence interval problems you should

know how to do:
1. Given x , s, n, E% -> find c -> find Confidence Interval [ , ]
2. Given x, s , n , L (or the interval itself [ , ])
-> find c -> find the E % confidence level
3. Design Problem: given E%, s , L -> find c -> find the required
sample size n
December 15 2007
23
Confidence interval for proportion

proportion
Let X = number of observations in a sample of size n to have a certain

characteristic, p = the actual proportion of the population to have that
characteristic.
X
p=
The sample proportion
n is approximately normally distributed
with mean p, standard deviation
.
p(1 p)
A % confidence interval for p is: p c p (1 p ) ; p + c p (1 p )

n
n
where c is that number for which : P(-c<Z<c)

c<Z<c) = %
%, Z~N(0,1)
Z~N(0 1)
Note: p is unknown:
Option 1: replace it by its estimate p
Option 2: p=1/2 (worst case) because p(1-p) for all p
December 15 2007
24
TOPIC
PIC
6
6:
6:
Simulation
Simulation
December 15 2007
25
Some lessons on simulation

simulation
1. Provides more info than average case analysis and simple formulas.
1.
formulas
2. You generate random variables that obey a variety of discrete and continuous
probability distributions (e.g uniform, binomial, etc).
3. The results are not precise
precise, due to the inherent randomness in a simulation.
We typically obtain estimates of the distributions of particular quantities of
interest, means and standard deviations of these distributions.
F
From
these
h
distributions,
di ib i
one can d
derive
i confidence
fid
intervals
i
l and
d other
h inferences
i ff
of statistical sampling.
4. The question of how many trials or runs of a simulation can become a
4.
compl
complex
lex st
stati
ati
tissti
tical
call iissue.
ssue Fortunatel
F t
t ly, with
ith ttod
day''s computi
ting power,
this is not a paramount issue for most problems.
5. In practice, one should recognize that gaining managerial confidence in

5.
a simulation model will depend on at least three factors
factors:
(i) a good understanding of the underlying management problem,
(ii) one's ability to use the concepts of pr

probability
obability and statistics correctly,
correctly
(iii) one's ability to communicate these concepts effectively.
effectively
Decem
So what happens on the final exam? You may get Sampling questions !
26
TOPIC
PIC
7
7:
7:
Regression
Regression
December 15 2007
27
Multiple regression
Explanatory variables :
X1, X2, ,Xk taking values x1i, x2i, . . . ,xki (i = 1, . . . ,n)
Depend
ependent vari
variabl
blee :
taking values yi (i = 1,. . . n)
Model: Yi = 0 + 1x1ii + . . . + kxki + i

1, 2, . . . , n are iid random variables, N(0, )
Goal: Choose b0, b1, . . . , bk to minimize the residual sum of squares
y i = b0 + b1x1i + . . . + bkxki ,
n
Mi
Mini
nimize
i =1
December 15 2007
e 2i =
ei = yi -
y i
(y i y i )
i =1
28
Regression Output
Output
1)
Regr
Regression
ession coefficients
coefficients:: b0, b1, . . . , bk sample estimates of E0, E1, . . . , Ek
2)
Standard error : estimate of V
a measure off the

h amount off noiise in
i th
he model
d l
3)
Standard errors
errors of the coefficients:
coefficients: sb0 , sb1 , . . . , sbk
same role as the estimate of the standard deviation of the sample mean in
sampling
bm E
m
Prior to observing bm and sbm,
has t-dist. with (n - k - 1) d.o.f.
sbm
s
Degr
Degrees
ees of fr
freedom
eedom:: n - (k + 1) = n - k - 1
n pieces of data;
used up (k + 1)) degrees

g
of freedom to estimate b0,, b1,, . . . , bk
used to test the existence of a linear relationship between Y and xm;

+
What is 95% confidence interval for Em?
+
Does the interval contain 0?
December 15 2007
29
4) Significance test: Is m significantly different from zero?

The % confidence interval for m is:
(bm - c sbm, bm + c sbm),

where c is such that : P( -c < T < c) = /100.
Steps to finding the Confidence
Confidence Interval:
1) d.o.f. = n k 1
2) using % and d.o.f. , find c on the t-table
3) using c, bm , sbm write the interval above.
If zero does not lie in the confidence interval we are confident at the %
level that m is different from 0.
If zero lies in the confidence interval, then m is not significantly different
from zero:
we should be skeptical
p
that Y depends
p
linearly
y on xm and we might
g want to
eliminate xm from the model.
December 15 2007
30
Coefficient of determination
determination::
6)
(y i y i )
( y is sample mean of yis.)
Variation not accounted for by x variables

Total variation
Variation that is accounted for by x variables
=
Total variation
= 1
R 2 = 1 i =n1
(y i y )2
i =1
R2 takes values between 0 and 1:

30
35
30
25
20
15
10
5
0
25
20
15
10
5
0
0
10
15
20
25
30
10
15
20
25
30
R2 = 1; x values completely account

for Y values
R2 = 0; x values account for none of

the variation in the Y values
A good value of R2 depends on the situation

December 15 2007
31
Checklist for evaluating linear regression models

Linearity: If there is only one explanatory variable, construct a scatter-plot of the
data to check for linearity. Otherwise, use common sense to decide if a linear
relationship is reasonable. (Rule of thumb for choosing no of factors n > 5(k + 2) )
Signs of Regression Coefficients: Check to see that the signs make intuitive sense
Significance tests: check if the regression coeffs are significantly different from zero
R2: Check if the value of R2 is reasonably high.
Normality: Check that the residuals are approximately Normally distributed by
constructing a histogram of residuals.
Heter
Heteroscedasticity:
oscedasticity: Do error terms have constant standard deviation?
Plot the residuals with the observed values of each of the explanatory variables.
Autocorrelation: Are error terms independent? If data are time-dependent,
plot the residuals over time to check for any apparent patterns.
Multicollinearity: Are two explanatory variables correlated?

Signs: if regression coeffs have wrong sign or we find high R2 but one or more
of the regression coeffs is not significantly different from 0.
Look at the correlation matrix. Large positive or negative correlations between the
explanatory variables are bad.
Heteroscedasticity
20.00
20.00
10.00
10.00
0.00
-10.00
00
0.0
10
1.0
0.00
20
2.0
-10.00
0.0
1.0
2.0
-20.00
-20.00
Advertising Expenditures
Advertising Expenditures
No Evidence of Heteroscedasticity
Evidence of Heteroscedasticity
Autocorrelation
20.00
20.00
10.00
10.00
0.00
0.00
-10.00
10
15
10
15
-20.00
-20.00
i
No evidence of Autocorrelation
December 15 2007
10 00
-10.00
Evidence of Autocorrelation
33
Important regression issues you should know
Know how to interpret the regression output. Explain in English what

the coefficients mean and give intuition about how they affect the
dep
pendent variable.
Know how to build the confidence intervals for the coefficients using
the t-table.
Know how to read and interpret the regression graph and the output
output
residual graphs (histogram, autocorrelation, heteroscedasticity)

Know how to improve your model

Checkk the
Ch
h signs,
i
significance,
i ifi
correlation,
l i
etc which
hi h variables
i bl
to
add and drop (explaining why)
Check linearity: if it fails, can you modify your data to make a

b tt mod
better
del.l Exampl
E
le: makke a pollynomiiall
Dummy variables: you need to know how to model categorical

data. Example: beer bottles red x green.
December 15 2007
34
TOPIC
PIC
8
8:
8:
Linear Optimization
Optimization
December 15 2007
35
Optimization terminology
terminology
Decision Variable:
Variable:
Describes a decision that needs

to be made, e.g. how many items
to produce.
Objective Function:
Functio : An expression (in terms of the
Function:
Function
variables) that needs to be
minimized or maximized.
Constraint:
Constraint:
December 15 2007
An expression that restricts the

values of the variables.
variable
36
Steps in formulation
formulation
1.
1.
Define the decision variables.
2.
2. Write the objective as a function of these vars.
Determine whether max or min
min..
3. Write the constraints as functions of these vars.
Either , , = .
4.
4. Determine the variable restrictions,
e.g. non-negative, integer.
Be careful of units!
units!
December 15 2007
37
A Fundamental Point
y
4
40
30
20
10
0
0
0
0
0
0
10
20
x
30
40
If an optimal solution exists, there is

always a corner point optimal solution!
December 15 2007
38
About Shadow Prices

Prices
Associated with each constraint is a shadow price. (=0 for non

binding constraints)
The shadow pri

Th
price is
i the
th change
h
in
i the
th objective
bj ti value
l per unit
it
change in the right hand side, given all other data remain the
same.
Associated with each shadow price is a range over which this

shadow price holds.
h
If r.
r.h.s changes within range: current solution remains optimal,
shadow price tells us rate of change in the optimal objective
function value;;
If r.
r.h.s changes outside range: current solution is not optimal
anymore; we need to solve the optimization pb again !
December 15 2007
39
Avoid frequent mistakes!

mistakes!
Forgetting the non-negativity restrictions

Confusing Maximizing with Minimizing
Inconsistent and/or incorrect units
Reversinggth e signs
s g of the constraints
Wrong interpretation of the shadow prices.
prices
Change in R.H.S outside the allowable range
December 15 2007
40
TOPIC
PIC
9
9:
9:
Nonlinear Optimization
Optimization
December 15 2007
41
Some possible cases

objective
function level
objective
function level
optimal solution
Feasible
Region
g
Multiple optimal
solutions
Feasible
Region
g
objective
function level
linear objective,
nonlinear constraints
Corner solution
nonlinear objective,
linear constraints
objective
function level
objective
ffunction
ti level
l
l
optimal solution
Feasible
Region
December 15 2007
nonlinear constraints
optimal solution
Feasible
Region
linear constraints
42
Local vs global solutions

solutions
Op
O
ptima
ti
t mall soluti
lution:
l tion A feasibl
easible
ible sollution
t
that
h optiimiizes
the objective value among all feasible points.
Local optimal solution
solution: A feasible solution that optimizes
the objective value among all feasible points near it
Example:
Minimization in one variable over 2 <= x <= 7
Computer software for NLP can efficiently find local opt.
BUT! thi
this solluti
tion will
ill nott necessaril
ily b
be th
the global
globa
l b l opt.
t
f(x)
x = 2
is a local optimal solution.

solution
x = 3.5 is a local optimal solution.

x = 5
December 15 2007
2
5 6
is the global optimal solution
DMD
Fall 07 x
Final Review
7
43
Shadow prices in NLP

NLP
Review:
Shadow price of a constraint for LP:
LP:
Incremental change in the optimal objective function value

value
per unit increase

increase in the right
right--handhand-side (RHS) of the constraint.
constraint.
Shadow price of a constraint for NLP: (Lagrangian multiplier)

multiplier)
Approximate Incremental change in optimal objective function

ith small change in the RHS
RHS.
value with
Binding
Binding constraint :
when satisfied as equality at the optimum.
For nonbinding constraints,
constraints, shadow prices ar
aree zero!
December 15 2007
44
TOPIC
TOPIC 10
10:
10:
Discrete Optimization
Optimization
December 15 2007
45
Discrete optimization
optimization
Feasible region is a set
of discrete poin
points.
y
4
Cant be assured a
corner point or ev
even
boundary solution.
Not as easy
easy to solve
as LP.
1
Solving it as an L
LP
provides a relaxation
and a bound on the
solution.
December 15 2007
46
Modeling issues
issues
Decision variables are restricted to take only integer values

Great modeling flexibility using binary variables
xi = 1 , if event i occurs
xi = 0 ,
otherwise
Strategic planning (number of people to hire)

Allocation of resources (which project to fund)
Determination of productivity and distribution
December 15 2007
47
More on modeling issues

issues
If x1 = 0 then x2 = 0
x2 x1
If x1 = 1 then x2 = 1
x2 x1
If x1 = 1then x2 = 1 and vice versa
x2 = x1
If x1 = 1 then x2 = 1 or x3 = 1
x1 x2 + x3
10
Invest in at most 2 projects

projects
xx
d
2
2
i 1
Select 5 out of 10 projects
10
i 1
Key concept: Analyze logical implication of constraint in all

possible
ibl cases
December 15 2007
48
Partial taxonomy of optimization
Nonlinear
Optimization
Linear Optimization
objective and constraints are
linear expressions
Integer
Optimization variables
objective and/or constraints are

nonnon-linear expressions
are restricted to discrete

(integer) values
Mixed - Integer
Optimization
some variables are
continuous, some are
discrete
December 15 2007
49
P bl
Problems
ffrom 2005 fi
final
final
December 15 2007
50
Problem 1: True
True or False
False
(a) If the 95% confidence interval for the sample mean extends from 4 to
14 based on a random sample of size 60, then the sample mea
was 9.
Interval is centered around the sample mean:
TRUE
x-L =4
x+L=14
Midpoint:
Midpoint:
x =(4+14)/2
= 9
(b) If R2 = 0, it means that all the data points in an yy-vs-x

vs x regression
model must fall along the horizontal line
FALSE
y
December 15 2007
51
Problem 1: True
True or False
False
(c) A resident of Boston is chosen at random. Consider the 2 events:
I.
The person selected is a lawyer;
II.
The person selected is a lawyer and an environmental activist.
The probability of event II can never exceed that of event I.
Environmental
activists
TRUE
lawyers
Lawyers and environmental

activists
December 15 2007
52
Problem 1: True
True or False
False
d) If X has mean 1, standard deviation 2 and Y has mean 1, standard
deviation 4, then the standard deviation of Z=X+Y cannot exceed 6.
Var(Z) = Var(X) + Var(Y) + 2*X*Y*CORR(X,Y)
Max when CORR(X,Y) = 1 Var(Z) = 36, Z = 6
TRUE
e) Mendel asks a random number generator to create 10,000

independent selections from a N(0,1) distribution. The 10,000
selections turn out to have a sample mean of 0.0
0.08.
Assuming the random generator to work properly, the chance would
be less than 1% that the sample mean would fall at least as far as it
did from the true mean.
TRUE
n = 10,000, x = 0.08. By CLT X~N(0,1/n) (approximately).
P(X 0.08) = P(Z (0.08 0)/(1/100)) = P(Z 8) ~ 0 (8 standard
deviations from the mean)
December 15 2007
53
Problem 2 (a)
(a)
John has not been feeling well recently and he believes he has a bacterial
infection with probability 0.6.
He takes a test that is 99% reliable:
The
probability that the test is positive given that he has an infection is
99%;
The
probability that the test is negative given that he does not have an
inffectition is 99%.
99%
If the test result is positive, what is the probability that he has an infection?
P(INF) = 0
0.6
6
P(test+ | INF) = 0.99
P(!INF) = 0
0.4
4
P(test- | !INF) = 0.99
We want : P(INF | test+)

P(INF | test+) = P(INF and test+)
P(test+ | INF) = P(INF and test+)
P(test+)
December 15 2007
P(INF)
54
Problem 2 (a)
(a)
P(INF) = 0.6
P(test+ | INF) = 0.99
We want : P(INF | test+)
P(!INF) = 0.4
P(test- | !INF) = 0.99
P(INF | test+) = P(INF and test+)
P(test+)
P(test+
P(t
t+ | INF) = P(INF and
d ttest+)
t+)
P(t t+ | !INF) = P(!INF and

P(test+
d test+)
t t+)
P(INF)
P(INF and test+) = 0
0.99
99*0
0.6
6
= 0.594
P(!INF)
P(!INF and test+) = 0
0.01
01*0
0.4
4
= 0.004
P(test+) = P(INF and test+ ) + P(!INF and test+)
= 0.594 + 0.004 = 0.598
P( INF | test+) = 0.594/0.598 = 0.99

December 15 2007
55
Problem 2 (b)
(b)
Statistics show that the number of years a CEO spends in office is
normally distributed with mean 5.5 and standard deviation 1.2.
Given that a CEO has been in office for exactly 5 years so far
far, what is
is
the probability that she will still be in office 2 years from now?
X: # years in office : X~N((5.5,,1.2 )
Office tenure: t=0

t 0
now t=5
t 5
tt=7
7
We want : P(X 7 | X 5)
P( X 7 | X 5) = P(X 7 and X 5)
= P(X 7) = 1 - P(X 7)
7)
P(X 5)
P(X 5) 1- P(X 5)
Z~N(0,1):
P( X 7) = P(Z (7
(7-5.5)/1.2)
5.5)/1.2) = P(Z 1.25) = 0.8944
0.8944
Look up in Z-table!
P( X 5) = P(Z -0.417) = 0.3372
P(( X 7 | X 5)) = (1
( - 0.8944)/(1
) ( - 0.3372)) = 0.1593
December 15 2007
56
Problem 3
3
In a random poll of 100 randomly-selected business leaders, 77% say

that they support Bernanke as new chairman of the Fed.
(a) What is the 99% confidence interval for the percentage of al
all
business leaders who support Bernanke;
n = 100,, p = 77%
99% confidence interval for the sample proportion:
p (1 p )
p (1 p )
; p+c
p c
n
n
Where c is that number for which P( -c

c < Z < c) = 99%, Z~N(0,1)
Z N(0,1)
i.e c = 2.576
99% confidence interval: [0.66; 0.88]
December 15 2007
57
Problem 3
3
(b) Ezekiel- who has not seen the results of the poll- wants to find a
95% confidence interval for the percentage of business leaders who
supp
pport Bernanke. He also wants the interval to extend no more
than one percentage point in each direction around its midpoin
Make a sensible estimate of the number of business leaders he
should poll.
c2
4L2
Where L = 1%, and c is that number for which:
),i.e c = 1.960
P((-c<Z<c ) = 95%,,Z~N (0,,1),
n = 9,604 (round up non-integer values!)
December 15 2007
58
Problem 4
4
Mendel performs a linear regression analysis on the unemployment

rate in Massachusetts (UM) versus the current wholesale price of fuel
oil per gallon (P) in Massachusetts in inflation-adjusted dollars.
Using
U
i monthly
hl d
data ffor a recent six-year
i
period
i d (i
(i.e., using
i 72
observations), he reaches the least squares equation:
UM = 2.10 + 3.00P (P is in dollars and UM in per cent.)
The R^2 value for the regression is 0.66, and the upper end for the
95% confidence interval for the slope of P is 5.00. The sample
standard deviation of the monthly Massachusetts unemployme
unemployment
rates over the six-year period studied was 1.00 percent.
December 15 2007
59
Problem 4 (a)(a)-(c)
(a) If fuel oil is projected to cost $1.30 in a forthcoming month, what

is the estimate of the Massachusetts unemployment rate for that
month based on the regression result?
Um = 2.1 + 3 * (1.3) = 6%
(b) Does the 95% confidence interval for the slope of P include 0?
NO: CI is symmetric around mean 3 and upper bound is 5 [1, 5]
(c) What is the sum of squared residuals of the 72 data points

around the regression line?
Decem
60
Problem 4 (d)
(d)
(d) Consider one at a time the following possible patterns among the
residuals for this regression analysis. Briefly explain for each pattern
wh
heth
ther, b
by ititself
lf, it would
ld sub
bsttanti
tialllly red
duce your confid
fidence iin th
the
regression analysis:
II. The heavy majority of the residuals in the first three years studied
were positive, while the heavy majority of those in the second three
years were negative.
Autocorrelation: residuals are not casual but follow a time-based
time based
pattern.
(Another acceptable answer would be that the relationship might be
nonlinear.))
II. The residuals are consistently larger in the months when the fuel
prices are high than in those in which prices are low.
Heteroscedasticity: the residuals consistently get larger with larger
values of the independent variable P.
61
Problem 4 (contd)
(contd)
Fearful of an omitted variable in the regression above, Mendel
performs another linear regression on the same data. For each
month,
th th
the d
dependent
d t variable
i bl iis still
till UM,
UM while
hil the
th variables
i bl on the
th
right are P and UN, the average unemployment rate in the other 49
American states. He reaches the revised regression equation:
UM = 1.50 + 2.00P + 0.50UN
R 2 for the revised regression was .75,

R^2
75 while the upper ends of the
the
95% confidence intervals are 6.00 for the slope of P and 1.10 for the
slope of UN.
December 15 2007
62
Problem 4 (e)(e)-(f)
(e) Do the regression results provide statistically convincing evidence

that UN really belongs in the regression model? Briefly discuss.
NO: both 95% CIs contain 0: P [ -2, 6 ] and Un [-.1, 1.1]
(f) Suppose that UN and P exhibited strong positive correlation over
the six years studied. What general problem in regression analysis
might result from that circumstance? How might that problem have
affected the regression results?
Multi-collinearity: the independent variables are highly correlated
among
g themselves. This may
y neg
gatively
y affect the statistical
significance of both variables (like in this case).
December 15 2007
63
Problem 5
5
Recall the Filatoi Riuniti case and linear optimization model, where the firm
would like to determine its monthly outsourcing strategy for spun yarn among six
other spinning mills as well as their own internal production strategy for spun
yarn.
The objective function is to minimize the variable cost (including transportation
cost) for meeting demand for the four spun yarn sizes (Extrafine, Fine, Medium,
and Coarse).
There are four types of constraints in the model:
mode
1. Filatoi must meet monthly demand for each of the four spun yarn sizes.
2. None of the seven mills can exceed their monthly production capacity.
3. Neither Ambrosi nor De Blasi can produce Extrafine yarn.
4 All d
4.
deciisiion variiables
bl must b
be nonnegatiive.
Suppose that demand for spun yarns is the same as in the original case, as are
the production capacities and machine hour requirements
requirements.
December 15 2007
64
Problem 5
5
Suppose, however, that over time the variable production and transportation
costs have changed, and that the current data for Filatoi Riunitis production
problem for the coming month of January are shown in Table 1 below
below.
Decem
65
Problem 5
5
Roberto Cominetti has re-run the linear optimization model using this
new data, resulting in the optimal solution shown in Table 2 along with the
Sensitivity Report shown in Table 3
3. Please answer the following questions
based on the linear optimization model solution and Sensitivity Report.
December 15 2007
66
Problem 5
5
December 15 2007
67
Problem 5 (a)(a)-(b)
(a) What are binding constraints in the model? In the optimal plan for the coming
month, which spinning mills would use all of their spinning capacity to produce
spun yarn for Filatoi Riuniti?
All the constraints are binding, except for Capacity at Giuliani. This is the only
mill that has not its capacity fulfilled under the optimal strategy.
(b) What would be the cost impact of increasing the required production
of Extrafine yarn from 25,000 kg to 27,000 kg? What can you say, if anything,
about the cost impact of increasing the required production of Extrafine yarn
from 25,000 kg to 29,000 kg?
Shadow Price = 18.397 ($/kg). Max increment allowed +3,197.5 Kg
Additi
Additional
lC
Costs = +2,000
2 000 K
Kg * $18
$18.397/Kg
397/K = $36
$36,794
794 / month
h
Max Additional Costs = +3,197.5 Kg * $18.397/Kg = $58,824.4 (for additional
3,197.5 Kg). Nothing can be said for the remaining 802.5 Kg except that they
would cost at least $18.397/kg.
December 15 2007
68
Problem 5 (c)(c)-(d)
(c) Another local spinning mill by the name of Havarti has informed Filatoi
that they can produce Fine spun yarn for Filatoi for a delivered cost of
$14 25/kg Should Filatoi consider entering into an agreement with Havarti to
$14.25/kg.
produce Fine spun yarn at this price?
NO: The shadow price for the demand of fine is 14.018. Hence, if we were to
produce less fine yarn with the current machines and outsource it to Havarti, we
would save 14.018 per Kg, and the extra cost would be 14.25 per Kg, so it is not
worth it.
(d) According to the models data, monthly capacity at De Blasi is 2,600
spinning machine hours. However, Filatoi Riuniti has just received an email from
the outsourcing manager at De Blasi indicating that capacity for the coming
month will be curtailed to 2,200 spinning machine hours due to some
unanticipated machine maintenance. How much will this change the total
variable cost of producing and/or outsourcing spun yarn in the coming month?
Shadow Price = -.086 ($/hour)
Additional costs = (-400 hours) * (-$.086/hour) = $34.4
Problem 5 (e)
(e)
(e) How much do you think Giuliani would have to reduce the price they charge
Filatoi Riuniti for Fine spun yarn in order for Filatoi to want to discuss
outsourcing production of Fine spun yarn to them?
The shadow price for fine yarn is $14.02. De Blasi would have to reduce their
price below this level.
December 15 2007
70
Problem 6
6
Forest Capital (FC) has decided to appoint Sarah Edwards as the new portfolio
manager of its portfolio of technology and utility stocks in emerging markets,
which is currently comprised of various amounts in ten different companies.
compani
Table 4 below shows the current portfolio weights, the latest annualized
expected return and standard deviation estimates, and the classifications of
each of the ten companies.
December 15 2007
71
Problem 6
6
The estimated correlations among the returns of the ten companies are shown
in Table 5. Note in Table 5 that FC assumes for simplicity that returns among
stocks are uncorrelated except among stocks A
A, B
B, and C.
C
December 15 2007
72
Problem 6
6
Sarah has decided to use an optimization model to select the new weights of
the portfolio for the coming month. She would like to maximize the expected
return of the portfolio subject to the following constraint
constraints:
1. The standard deviation of the resulting portfolio should be at most 8%.
2. The amount of turnover of the portfolio should be at most 30%. As an
example of how turnover is calculated, if prior to trading a portfolio has 70%
of its funds in Stock 1 and 30% in Stock 2, and after the trade the weights are
60% for Stock 1 and 40% for stock 2,
2 the turnover of the portfolio is (|70
(|70
60)|+ |30-40|)= 20%.
3. Last month, the total portfolio weight in technology stocks was
0 08+0
0.08
0.07
07+0
0.17
17+0
0.09
09+0
0.08
08 = 0
0.49
49 = 49%
49%. S
Sarah
h would
ld lik
like to maiintaiin th
the
character of the portfolio as a balanced portfolio between technology and
utility stocks. For this reason, she would like the total weight of the portfolio
in technology stocks to be between 45% and 55%.
4. All portfolio weights need to be nonnegative. That is, short positions are not
allowed in the portfolio.
Problem 6 (a)
(a)
(a) Write down a formulation of a nonlinear optimization model to determine the

new weights of the portfolio.
wi = fraction of the resulting portfolio invested in stock i
Obj MAX (.08w1 + .12w2 + .15w3 + .11w4 + +.08w9 + .05w10)
Subject to:
w1 + w2 + w3 + w4 + + w9 + w10 = 1 (fractions)
[(.13)2(w1)2 + (.25)2(w2)2 + (.35)2(w3)2 + + (.07)2(w10)2 + 2(.13)(.25)(.4)(w1)(w2)

+ 2(
2(.13)(.35)(-.1)(w
13)( 35)( 1)(w1)(w3) + 2(
2(.25)(.35)(.1)(w
25)( 35)( 1)(w2)(w3)]1/2 .08
08
[|w1 - .12| + |w2 - .08| + |w3 - .07| + + |w10 - .08|] .3
w2 + w3 + w5 + w7 + w8 .55
55
w2 + w3 + w5 + w7 + w8 .45
wi 0 (for each i from 1 to 10)
December 15 2007
74
Problem 6 (b)
(b)
(b) Suppose that in order to trim the rather excessive transaction costs in
emerging markets
markets, Sarah would like to limit her portfolio to stocks in only six
different companies. How would you augment your formulation of the model
using binary variables to incorporate this requirement into the model?
December 15 2007
75
Problem 6 (c)
(c)
(c) Suppose that Sarah would like to limit the number of trades to at most
seven of the ten companies

companies. (Note that if a stocks
stock s weight does not change
change, it
does not produce a trade.) By defining binary variables, describe how you
would augment your model to incorporate this additional requirement as well.
December 15 2007
76
Good luck !!
There are things MBAs cant solve
For everything else, there is DMD !
December 15 2007
77
Additional Practice Problems

Problems
December 15 2007
78
TOPIC 2:
2:

Variables
December 15 2007
79
The Beer and Coke Example
Beer and
d Coke
k daily
d il salles att a soccer sttadium
di
Probability
X:# of Beer Cans
Y:# of Coke Cans
pi
xi
yi
0.15
0.27
0.15
0.26
0.17
35
78
81
30
16
41
10
0
13
42
S
Scatter
Pl
Plot of DailySales
D il S l off Beer
B and
d Coke
Ck
Coke Sa
ales
pi = P(X=xi and Y=yi)

50
40
30
20
10
0
0
December 15 2007
20
40
60
80
Beer Sales
100
S
Some
Q
Questions
ti
What
Wh t is
i the
th expected
t d numb
ber off beer
b
cans sold?
ld? off cokke cans sold?
ld?
What is the standard deviation of beer cans sold? of coke cans?
What is the covariance and the correlation of beer and coke cans sold?
What is the expected daily revenue?

What is the standard deviation of the daily revenue?
December 15 2007
81
Some Questions
The
Th expected
d numb
ber off b
beer cans sold
ld iis
Px= E(X) = 6i p(X=xi)xi
The variance of beer cans sold is
V2x=VAR(X)=6p(X=xi)(xi - Px)2
Here it turns out that :

P(X i)=p
P(X=x
) i, but
b t usually:
ll
P(X=xi)=j P(X=xi; Y=yj)
The standard deviation of beer cans sold is
is
Vx= VAR(X)
Summary of Daily Beer Sales
Prob.
pi
0.15
0 27
0.27
0.15
0.26
0.17
# Beer
Cans
xi
35
78
81
30
16
pi xi
5.25
21 06
21.06
12.15
7.80
2.72
Summary of Daily Coke Sales
pi ( xi - E(X))
29.32
227
227.38
38
153.79
93.66
184.91
Prob.
pi
0.15
0 27
0.27
0.15
0.26
0.17
E(X)= 48.98 VAR(X)=689.06

StdDev(X)=26.25Fall 07 Final Review
# Coke
Cans
yi
41
10
10
0
13
42
pi yi
6.15
22.70
2
70
0.00
3.38
7.14
pi ( yi - E(Y))
70.18
23 71
23.71
56.28
10.55
87.06
E(Y)= 19.37 VAR(Y)=247.77

StdDev(Y)=15.74
Scatter Plot of Daily Sales of Beer and Coke
The covariance of beer and coke cans sold is

COV(X,Y)=6 pi(xi - Px) (yi - Py)
Coke Sa
ales
Some Questions
50
40
30
20
10
0
20
40
60
80
Beer Sales
The correlation of beer and coke cans sold is

CORR(X,Y) = COV(X,Y)/( Vx Vy)
S u m m a ry o f D aily B e er a n d C o ke S ale s
P ro b .
pi
N um ber of
B ee r C an s
xi
N um ber of
C o k e C an s
yi
p i ( x i E (X )) (y i - E (Y ))
0 .1 5
0 .2 7
0.15
0 .2 6
0 .1 7
35
78
81
30
16
41
10
0
13
42
-4 5 .3 6
-7 3 .4 2
-9
9 3 .0 3
3 1 .4 3
-1 2 6 .8 8
E (X )= 48.98
E (Y )= 19.37
C O V (X,Y ) = -3 0 7 .2 5
December 15 2007
C o rre lation = -0.7 4
S td D ev(X )= 26.25
S td D ev(Y )= 15.74
100
Some More Questions About Beer and Coke

X= number of cans of beer sold; Y= number of cans of coke sold
Revenues : $3 per can of beer, $2 per can of coke
Daily revenue (in $) = 3X+2Y
What is the expected daily revenue?

E( 3 X + 2 Y ) = 3 E(X) + 2 E(Y)
= $3 * 48.98 + $2 * 19.37
= $185
68
$185.68
E(X)=48.98
E(Y)=19.37
What is the standard deviation of the daily revenue?
StdDev(X)=26.25
StdDev(Y)=15.74
Cov(X,Y)= - 307.25
( ) + 22 * VAR(Y)
( )
VAR(( 3 X + 2 Y ) = 32 * VAR(X)
+ 2 * 3 * 2 * COV(X,Y)
= 9 * 689+ 4 * 248+ 12 * ((-307))
= 3509
December 15 2007
Fall 07 Final Review
STD DEV(3X+2Y) = DMD
3509
= $59.23
84
TOPIC 4:
4:
4:
Continuous Random Variables

Variables
December 15 2007
85
The amazon.com example
The time, in minutes, spent surfing amazon.com last

month by people in this auditorium is normally distributed:
X N(170 10)
X~N(170,10)
What if we triple the time spent of a randomly chosen student?
Y=3X
Y=3x=3(170) = 510
Y2=Var(3X)=32x2=9(100) = 900, Y=30
L
Lets
t ttake
k 3 iindependent
d
d t students
t d t att random
d
and
d combine
bi
the time they spent on amazon.com last month
Y X1+X2+X3
Y=X
December 15 2007
Y=3x=3(170) = 510
DMD Fall +X
07 Final
Review
86
Y2=Var(X
1
2+X3) =3(100)=300, Y= 17.32
Th amazon.com example
l
The
What is the probability that a randomly selected student has

spent between 160 and 180 minutes on amazon.com last
month
th ?
X~N(170,10)
P[[160 <X < 180]] = ?
P [(160-170)/10 < (X-P)/V<(180-170)/10]=
P [[-1<Z<1]
1<Z<1] = F(1)
F(1)-F(
F(-1)
1) = 00.8413-0.1587=0.6826!
8413 0 1587=0 6826!
What is the probabilityythat three inde
indeppendent students
together have spent more than 460 minutes?
minutes
Y=X1+X2+X3 ~ N(510, 17.32)
P(Y>460)=P(Y-510/17.32>460-510/17.32)=P(Z> -2.89)
December 15 2007
1-P(Z<-2.89) = 1-0.0019 = 0.9981!
87
TOPIC 5:
5:
Statistical Samplin
Sampling
Sampling
December 15 2007
88
Annual income example

After having managed to successfully survey 100 families we have
found that the observed sample mean of the annual income is
$19,763 while the observed sample standard deviation is $4,000.
What is the distribution of the sample mean
(i l di the
(including
h fform off the
h di
distribution,
ib i iits mean and
d standard
d d
deviation)?
a)
The sample mean X follows a normal distribution

with mean P and standard deviation V/n : N(P, V/n)
December 15 2007
89

b) What
is the probability that the sample mean will be within $784

of the population mean?
mea
_
P((- $784 < X - P <$_784))
= P( -$784/(V/n) < (X - P/(V/n) < $784 /(V/n) )
~ P( -$784/(s/n) < Z < $784 /(s/n) )
= P( -$784/(4000/
$784/(4000/100)
100) < Z < $784 /(4000/
/(4000/100)
100) )
)
= P(-1.96 < Z < 1.96)
= P(Z < 1.96) - P(Z < -1.96)
= 0.975 - 0.025
= 0.95
December 15 2007
90

c) What
is a number L such that the probability that the sample

mean is within L of the population mean is 99%
99 ?
A 99% confidence
interval
for the sample mean is given by:
_
_
[x - c*s/n
s/n , x + c*s/
c s/n]
n]
_
(where c = 2.576 (E=99%), s= 4000, n= 100,and x = 19,763)
Therefore L=c
Therefore,
L=c*s/
s/ n
n =1030
1030.44
So the 99% confidence interval is given by:
[19 763-22,576
[19,763
576*4000/100
4000/100, 19,763+2,576
19 763+2 576*4000/100]
4000/100]
= [18,732.6, 20,793.4]
December 15 2007
91

d) How
many families should we successfully survey so that the

probability that the sample mean is within $200 of the
population mean is 95% ?
To construct
T
t t a 95% interval
i t
l that
th t is
i within
ithi $200 off the
th
population mean, the required sample size n is given by:
n = c2s2/L2
= 1.962 * 40002 / 2002
= 1536.64 ~ 1537
December 15 2007
92
The Room Service Example

A hotel manager would like to find out the mean time guests have to wait for
room service. For a sample of 45 guests the observed sample mean turned
out to be 32 minutes while the observed standard deviation 11

11 minutes.
minutes
minutes.
What is the 95% confidence interval for the mean time guests have to
wait for room service?
We assume the mean time guests have to wait for room service is
approximately Normal.
A_95% confidence
interval for the mean time guests have to wait is given by:
_
[ x-c*s/n, x+ c*s/n ]
_
where c = 1.96 (E=95%), s = 11, and x = 32
So the 95% confidence interval is given by:

[ 32-1.96*11/ 45, 32+1.96*11/ 45 ] = [28.79, 35.21]
December 15 2007
93
TOPIC 7:
7:
Regression
Regression
December 15 2007
94
An Ice Cr
Cream
eam Example
The fat content in a gallon of chocolate ice cream is believed to depend on
Cream,
Cream, Chocolate and Sugar according to:
Fat =A +B*Cr
+B*Cream
eam +C*Chocolate +D*Sugar
A multiple regression was run on data from 20 differ
differeent batches of chocolate ice cream:
R Square:
0.8433
Standard Error:
13.73
Observations:
20
df
Regression:
Residual:
16
Total:
19
Coefficients Standard Error
Intercept
t-Stat.
Lower 95%
Upper 95%
-8.94
19.95
-0.45
-51.24
33.35
Cream (ounces)
0.93
0.12
7.80
0.67
1.18
Choc. (ounces)
2.07
0.60
???
???
???
December 15 2007
Sugar
(ounces)
2.47
1.33
1.86
- 0.34
5.29 95
An Ice Cr
Cream
eam Example
Correlation between different variables:
Fat (g
(gm))
Cream ((ounces))
Fat (gm)
Cream (ounces)
0.769
Choc (ounces)
Choc.
00.486
486
0.025
0 025
Sugar (ounces)
0.280
-0.099
Choc. ((ounces))
Sugar
g ((ounces))
1
0.409
Compute the 95% CI for Choc. coefficient

Critique
itique mod
model
December 15 2007
96
An Ice Cr
Cream
eam Example
Compute the 95% CI for Choc. Coefficient
Interceptth
t-Stat.
Lower 95%
Upper 95%
-8.94
19.95
-0.45
-51.24
33.35
Cream (ounces)
0.93
0.12
7.80
0.67
1.18
Choc. (ounces)
2.07
0.60
???
???
???
Sugar (ounces)
2.47
1.33
1.86
- 0.34
5.29
1<Z<1] = F(1)
1) = 0 8413 0 1587=0 6826!
The 95% confidence interval for the Choc. coefficient

using c=2.120 from the T-table, will be:
[2.07 2.120*0.60, 2.07 + 2.120* 0.60]
= [0.798,
[0 798 33.342]
342]
December 15 2007
97
An Ice Cr
Cream
eam Example
Critique model
Signs of Regression
Regression Coefficients
p
Intercept
t-Stat.
Lower 95%
Upper 95%
-8.94
19.95
-0.45
-51.24
33.35
Cream (ounces)
0.93
0.12
7.80
0.67
1.18
Choc. (ounces)
2.07
0.60
3.45
0.80
3.34
S
Sugar
((ounces))
22.47
47
11.33
33
11.86
86
- 0.34
0 34
55.29
29
The coefficients for Cream, Choc and Sugar appear to make sense.
Significance test:
0 is in the confidence interval for Sugar coeff.
so Sugar should be
excluded from the regression
regression.
December 15 2007
98
R2 - The value for R2 is 0.8433 which indicates that the model has a high level
of prediction.
Multicollinearity:
Fat (gm)
Cream (ounces)
Fat (gm)
Cream (ounces)
0.769
Choc. (ounces)
0.486
0.025
Sugar (ounces)
0.280
-0.099
Choc
Choc. (ounces)
Sugar (ounces)
1
0.409
There is a high correlation between chocolate and sugar

(>0.4) hence we should eliminate one of these variables
- suga
sugar because of
o thee low
ow t-statistic.
s a s c.
December 15 2007
99
Heter
Hetero
oscedasticity:
Residuals
Cream Residual Plot

0
C
Cream
(ounces)
(
)
Residuals
Chocolate Residual Plot

0
Chocolate (ounces)
There appears tto bbe no hheteroscedasticity

Th
t
d ti it
December 15 2007
100
Reesidual Valuee
Autocorrelation:
Residuals vs. Sample
p Number
0
Sample Number
There appears to be no autocorrelation

Residual Distribution:
Frequenncy
Residual Frequency
Residual
December 15 2007

The residuals appear to be normally
distributed
101
TOPIC 8:
Linear Optimization
Optimizatio
Optimization
December 15 2007
102
Different Modes of Driving Example

Different Modes of Driving manufacturer of cars & trucks.
Vehicles are processed in the paint and body shops.

Painting trucks takes 1.5 times as much time as painting cars. If the paint shop only
paints trucks, then it paints 40 trucks/day. If it only paints cars, then 60 cars/day.
Body work on cars and trucks takes the same amount of time.
time If the body shop only
produces trucks, then 50/day. If only produces cars, then 50/day.
Trucks contribute $500 and cars contribute $400 to profit.
Determine daily production schedule to maximize profits.
Decision Variables : C=# cars, T=# trucks
Objective Function: Max 400 C+ 500 T
Constraints:
Paint Shop: T/40+C/60 <=1 day

Bodyy Shop:
p T/50+C/50 <=1 day
y
T,C >=0 vehicles

December 15 2007
103
Trucks
Different Modes of Driving Example...

Which are the Binding Constraints?
Optimal
O
ti l Solution
S l ti
50
T/50+C/50 <=1
40
20
Total Profit: $$22,000/Day

,
y
Cars 30, Trucks 20
Profit: $10,000/Day
Feasible
Profit: $5,000/Day
$5 000/Day
Region
T/40+C/60 <=1
T >=0
0
December 15
2007
C>=0
25
50
60
Cars
104
Different Modes of Driving Example...

Adjustable Cells
Cells
Final Reduced Objective Allowable Allowable

Cell
Name
Value
Cost
Coefficient Increase
Decrease
$B$2 Cars Decision Variables
30
0
400
100 66.66666667
$B$3 Trucks Decision Variables
20
0
500
100
100
Constraints
Cell
Name
$B$7 Paint Shop Constraints
$B$8 Body Shop Constraints
December 15 2007
Final Shadow Constraint Allowable Allowable

Value Price
R.H. Side Increase
Decrease
1
12000
1
0.25 0.166666667
1
10000
1
0.2
0.2
105
p
Economic Interpretation
An outside contractor offers to paint 8 more trucks (or 12 more cars)
per day for $2,000. Should we accept the offer?
Yes, based on the shadow prices, this expansion is worth:
$12,000 * 8/40 - $2,000 = $400
and, the increased capacity of 8/40 or 0.2 is within the allowable increase.
If the DMD company was given extra labor to increase productivity

in the body shop by 5 cars (or trucks),
trucks) what would DMDs profits become?
become
Increased profit is $10,000 * 5/50 = $1,000
and, the increased capacity of 5/50 or 0.1 is within the allowable increase.
December 15 2007
106
Value of Opt. Obj
Careful of the range!
25 K
22 K
20 K
Sl
Slope
=0
Slope = 12,000
Slope = 24,000
0K
0.83
1.00
1.25
Value of Paint Shop

RHS
In this range, every unit change in the RHS results in a $12,000 unit
change in the objective function
function.
December
2007
DMD price
Fall 07 Final
Review
107
This
value15is
called the shadow
of the
constraint over this range.
TOPIC 9:
Nonlinear Optimization
Optimizatio
Optimization
December 15 2007
108
A Production Example
You are producing three products A, B and C. You need to satisfy production
limits and resource availability constraints: (1) You can produce at most 1000,
800 and 700 units of A, B and C respectively; (2) The data for resource
availability
il bilit is
i as follows:
f ll
A
Resources (in hours)
machine 1
35
3.5
1000
machine 2
0.2
0.8
1.2
350
Production levels influence market price of each product:

PA=200 - XA + 0.5 XB,
December 15 2007
PB =100 - 2XB + 0.25 XA, PC = 500 - XC
We want to Maximize revenue

109
Formulation
Decision Variables
X1A = product A to be produced by machine 1
X1B = product B to be produced by machine 1
X1C= product C to be produced by machine 1
X2A = product A to be produced by machine 2
X2B = product B to be produced by machine 2
X2C = p
product C to be p
produced by
y machine 2
Objective Function
Max PA * (X1A + X2A) + PB * (X1B + X2B) + PC * (X1C + X2C)
December 15 2007
110
More Formulation...
Subject to:
Price:
Resource:
PA= 200 - (X1A + X2A) + 0.5 * (X1B + X2B),

PB = 100 - 2 * (X1B + X2B) +0.25 * (X1A + X2A) ,
PC = 500 - (X1C + X2C)
Machine 1: 2 X1A + X1B + 3.5 X1C <= 1000
Machine 2: 0.2 X2A + 0.8 X2B + 1.2 X2C <= 350
Production Limit:
Non-negativity: X1A ,X2A ,X1B ,X2B ,X1C ,X2C , PA , PB , PC >= 0
December 15 2007
A: X1A + X2A <= 1000

B: X1B + X2B <= 800
C: X1C + X2C <= 700
111
Excel Solution
hours/unit
B
A
Machine 1
Machine 2
2
0.2
1
0.8
3.5
1.2
Capacity Limit
1000
units
800
units
700
units
Decision Variables:
(units)
58.82
58
82
58.82
23.53
23
53
23.53
125.00
125
00
125.00
Price A
Price B
Price C
Objective Function:
Constraints:
machine 1 capacity
machine 2 capacity
product A limit
product B limit
Decemberproduct
15 2007 C limit
Machine Limit
1000 hours
350 hours
$ 105.88
$ 35.29
$ 250.00
$ 76,617.65 MAX
maximize revenues
LHS
RHS
578.68
<=
1000
180.59
<=
350
117 65
117.65
<=
1000
47.06
<=
800
250.00
DMD Fall <=
07 Final Review700
112
Sensitivity Report
Report
Microsoft
Mi
ft E
Excell 10
10.0
0S
Sensitivity
iti it R
Reportt
Worksheet: [Book1]Products
Report Created: 12/9/2004 10:19:06 PM
Adjustable Cells
Cell
$B$8
$C$8
$D$8
$B$9
$C$9
$D$9
Name
units
units
i
units
units
units
units
Final
Reduced
Value
Gradient
58.82
0
23.53
23
53
0
125.00
0
58.82
0
23.53
0
125.00
0
All Lagrange
Multipliers are zero!
All constraints are non
binding around the close
proximity of the optimal
solution.
Constraints
Cell
Name
$B$19 machine 1 capacity LHS
$B$20 machine 2 capacity LHS
$B$21 product A limit LHS
$B$22 product B limit LHS
$B$23 product C limit LHS
$B$11 Price A units
$B$12 Price B units
December 15 2007
$B$13 Price C units
Final
Lagrange
Value
Multiplier
578.68
0
180.59
0
117.65
0
47.06
0
250.00
250
00
0
$
105.88 $
$
35.29 $

$
250.00 $
Optimal solution occurs

in the interior of the
feasible region.
113
TOPIC 10:
Optimizatio
Optimization
December 15 2007
114
Lets play!
An electrical utility company each day is deciding which generators to start up.
It has three generators (see below).

There are two periods in a day,
day and the number of megawatts needed in the
first period is 2900. The second period requires 3900 megawatts. Unused
electricity left over from period 1 can be used in period 2.
It wants to minimize total cost.
Formulate and solve as MIP !
Generator
Fixed costs
per period ($)
Cost per period
Max capacity
per megawatt used ($)
in each period (MW)
3000
2100
2000
1800
1000
3000
December 15 2007
115
TOPIC 10:
Optimizatio
Optimization
December 15 2007
114
More Formulation...
Objective Function
minimize 3000 (XA1 + XA2) + 2000 (XB1 + XB2) + 1000 (XC1 + XC2)
5 ((YA1 + YA2) + 4 ((YB1 + YB2) + 7 ((YC1 + YC2)
Subject to:
Capacity:
Machine A: YA1 <= 2100 XA1 ; YA2 <= 2100 XA2
Machine B: YB1 <= 1800 XB1 ; YB2 <= 1800 XB2
Machine C: YC1 <= 3000 XC1 ; YC2 <= 3000 XB2
Demand:
Period 1: YA1 + YB1 + YC1 >= 2900
Period 2: YA2 + YB2 + YC2 +YA1 + YB1 + YC1 - 2900 >= 3900
Binary: XA1, XA2, XB1, XB2, XC1, XC2 = {1 if used; 0 otherwise}
Non-negativity:
YA1, YA2, YB1, YB2, YC1, YC2 >= 0
December 15 2007
117
Excel Solution
Objective Function:
Fixed
10000
Variable
30400
A
3000
5
B
2000
4
C
1000
7
Total
40400
Cost:
Fixed Cost per period
Cost per megawatt
Period 2 Period
d1
Decision Variables and Constraints:

Xij (0 or 1)
1
1
0
1
1
0
A
B
C
A
B
C
Other constraints:
Xij
Xij, Yij
binary
>=
December 15 2007
Yij
2100
1800
0
1100
1800
0
<=
<=
<=
<=
<=
<=
Limit * Xij
2100
1800
0
2100
1800
0
Limit
2100
1800
3000
2100
1800
3000
Total
Demand
3900
2900 + 1000
3900
>=
2900
>=
3900
118

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15.

060 Data, Models, Decisions

DMD Fall 07 Final Review

Date: Monday, December 17

DMD Fall 07 Final Review

Topic 1 : Decision Analysis

DMD Fall 07 Final Review

You are NOT responsible for:

DMD Fall 07 Final Review

Discrete Random Variables

DMD Fall 07 Final Review

Discrete Random Variables

A probability distribution for a discrete random variable X consists of

x1, x2, . . . , xn,

so that: P(X = x1) = p1, P(X = x2) = p2, . . . , P(X = xn) = pn .

Probabilities are non-negative, must sum to 1,

DMD Fall 07 Final Review

1. Expected Value or Mean: (measured in units of X)

2. Variance: (in units of X squared)

3. Standard Deviation: (in units of X)

DMD Fall 07 Final Review

You are NOT responsible for:

The Binomial distribution

DMD Fall 07 Final Review

DMD Fall 07 Final Review

Measures the extent to which two random variables

DMD Fall 07 Final Review

Suppose X and Y are two random variables with

Joint distribution of X and Y

DMD Fall 07 Final Review

Sums of random variables

E(aX  bY  c) = aE( X )  bE(Y )  c

V ( X  bY  c)) = a 2Var(( X )  b 2Var(Y

DMD Fall 07 Final Review

DMD Fall 07 Final Review

Continuous random variables

A continuous r.v can take any value in some interval

DMD Fall 07 Final Review

Probability density function:

f(t): gives a picture of

(think of a smoothed histogram)

under the curve between 2

values a and b: P(a

area under the curve = 1

Cumulative density function:

DMD Fall 07 Final Review

The normal distribution

Computing probabilities with the Normal distribution:

2 Use the standard normal probabilit

DMD Fall 07 Final Review

DMD Fall 07 Final Review

Sum of i.i.d random variables:

DMD Fall 07 Final Review

DMD Fall 07 Final Review

Sample mean of a population

Estimator of the mean of a

DMD Fall 07 Final Review

Sample standard deviation

S2 is an unbiased estimator of the variance, i.e. E[S

DMD Fall 07 Final Review

Confidence interval for sample mean

How confident are we that X is a good estimate of the true mean of

What sample size do we need to be sure that the % confidence

E(aX bY c) = aE( X ) bE(Y ) c

V ( X bY c)) = a 2Var(( X ) b 2Var(Y