11-08-2020

Ch-3: Optimization
Techniques

Optimization Techniques
• Methods for maximizing or minimizing
an objective function
• Examples
– Consumers maximize utility by purchasing
an optimal combination of goods
– Firms maximize profit by producing and
selling an optimal quantity of goods
– Firms minimize their cost of production by
using an optimal combination of inputs

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Expressing Economic Relationships

Equations: TR = 100Q - 10Q2

Tables: Q
TR
0
0
1
90
2
160
3
210
4
240
5
250
6
240

Graphs:

Total, Average, and Marginal Cost

The relationship between Total, Average, and Marginal
Cost is important in optimisation analysis.
Table shows a hypothetical example of relation ship
between output(Q) and Cost(C)

Q TC AC MC
AC = TC/Q 0 20 - -
1 140 140 120
MC = TC/Q 2 160 80 20
3 180 60 20
4 240 60 60
5 480 96 240

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Total, Average, and

Marginal Cost

Profit Maximization

Q TR TC Profit
0 0 20 -20
1 90 140 -50
2 160 160 0
3 210 180 30
4 240 240 0
5 250 480 -230

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Profit Maximization

Steps in Optimization
• Define an objective mathematically as a
function of one or more decision variables.
• Define one or more constraints on the
values of the objective function and/or the
decision variables.
• Determine the values of the decision
variables that maximize or minimize the
objective function while satisfying all of the
constraints.

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Concept of the Derivative

The derivative of Y with respect to X is

equal to the limit of the ratio Y/X as
X approaches zero.

dY Y
 lim
dX X 0 X

Rules of Differentiation
Constant Function Rule: The derivative
of a constant, Y = f(X) = a, is zero for all
values of a (the constant).

Y  f (X )  a

dY
0
dX

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Rules of Differentiation
Power Function Rule: The derivative of
a power function, where a and b are
constants, is defined as follows.

Y  f (X )  aX b

dY
 b  a X b 1
dX

Rules of Differentiation
Sum-and-Differences Rule: The derivative
of the sum or difference of two functions
U and V, is defined as follows.
U  g( X ) V  h( X ) Y  U V

dY dU dV
 
dX dX dX

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Rules of Differentiation
Product Rule: The derivative of the
product of two functions U and V, is
defined as follows.
U  g( X ) V  h( X ) Y  U V

dY dV dU
U V
dX dX dX

Rules of Differentiation
Quotient Rule: The derivative of the
ratio of two functions U and V, is
defined as follows.
U
U  g( X ) V  h( X ) Y
V

dY V

 dU dX   U  dV dX 
2
dX V

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Rules of Differentiation
Chain Rule: The derivative of a function
that is a function of X is defined as follows.

Y  f (U ) U  g( X )

dY dY dU
 
dX dU dX

Optimization With Calculus

Given, Y = f(X)
Find X such that dY/dX = 0
Second derivative rules:
If d2Y/dX2 > 0, then X is a minimum.
If d2Y/dX2 < 0, then X is a maximum.

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New Management Tools for

Optimisation
1. Benchmarking -
2. Total Quality Management –> “how can we do
this cheaper, better or faster”? It’s about
maximising quality and minimising costs or
constantly improving quality to deliver
increasing value to customers.
3. Reengineering–> seeks to completely
reorganise the firm; if you were to start all over
again, how would you do it?
4. The Learning Organization- continuous
learning- both collective and individual.

Quadratic Formula

b2  4ac