CHAPTER 4: NETWORK MODELS
A few issues can be described graphically as a network (the set of nodes and
arcs). Typical circumstance is a transportation network: cities (nodes) are
connected with one another by roads (arcs).
Solved with utilization of the network models, the most significant value is unit
cost and the objective is to find the minimal total cost.
Network - it is a set of nodes and arcs that diagrams the relationships between
objects of the real system.
Network models can represent e.g. a transportation system where nodes are
the cities and arcs are the connections between them (roads).
NETWORK TERMINOLOGY
Network – set of nodes and arcs
Arc – connector between a pair of nodes and can be directed (oriented) or
undirected.
Directed Arc – specifies which node is considered as the point of origin. The
orientation of the arc is marked with the arrowhead.
Directed Network – when a network contains directed arcs.
Undirected Network – does not contain directed arcs
Path – specific sequence of arcs in which the initial node of each arc is
identical with the terminal node of the preceding arc in the sequence.
Closed path - If the path starts and ends in the same node it is termed a circuit
(cycle).
Connected - If there is a path connecting every pair of nodes in the network.
The network shown above is connected.
Tree - the connected network without any circuit. If we denote the total
number of nodes in the network as n it is evident that the tree involving all
nodes must contain exactly (n – 1) arcs. If we add any arc to the tree, the circuit
will appear.
Spanning tree is a tree including all the nodes from the original network.
Removing of any arc from the spanning tree changes the tree into unconnected
network.
BASIC NETWORK APPLICATIONS
1. Shortest Path Problem
2. Travelling Salesperson Problem
3. Minimal Spanning Tree
4. Maximum Flow Problem
Shortest-path problem is a specific network model that has gotten a lot of
consideration for both practical and theoretical reasons. The essence of the
problem can be specified as follows: Given a network with distance ci j (or travel
time, or cost, etc.) related with each arc, discover a path through the network
from a particular origin (source) to a particular destination (sink) that has the
shortest total distance.
MINIMAL SPANNING TREE
Spanning tree is such sub-network that comprises exactly (n-1) arcs and no
circuits. If we have the evaluated network (e.g. by distances), the minimal
spanning tree is a spanning tree with the minimal sum of values.
CHAPTER 5: PROJECT MANAGEMENT
Program Evaluation Review Technique (PERT) Description
While in CPM only one estimate of each activity’s duration is deliberated, PERT
(Program Evaluation Review Technique) uses three estimates to form a
weighted average of the expected completion time:
 aij = optimistic estimate of duration – the shortest possible time, in
which the activity (i, j) can be accomplished (if execution goes
extremely well),
 bij = pessimistic estimate of duration – the longest time that the
activity (i, j) could take (when everything goes wrong),
 mij = most likely estimate of duration – the time that would occur most
often (if the activity (i, j) were repeated under exactly the same
conditions many times), or the time estimated by experts.
Project Management comprises of a set of techniques that helps management
accomplish large-scale projects; projects that usually involve coordination of
numerous jobs throughout the organization.
A project consists of interrelated activities which are to be executed in a
certain order before the entire task is completed.
The activities are interrelated in a logical sequence which is known as
precedence relationship.
Project is represented in the form of a network for the purpose of analytical
treatment to get solutions for scheduling and controlling its activities.
There are two basic methods for solving those problems:
 CPM (Critical Path Method)
 PERT (Program Evaluation Review Technique).
The two methods require the network representation of the problem. Both are
developed independently but are now often used interchangeably
PHASES OF PROJECT MANAGEMENT
Planning
 Dividing the project into distinct activities
 Estimating time requirement for each activity
 Establishing precedence relationships among the activities
 Construction of the arrow diagram (network)
Scheduling
 Determines the start and end time of each and every activity
Controlling
 Uses the arrow diagram and time chart for continuous monitoring and
progress reporting
GUIDELINES FOR NETWORK CONSTRUCTION
The starting event and ending event of an activity are called tail event and head
event.
The network should have a unique starting node (tail event)
The network should have a unique completion node (head event)
No activity should be represented by more than one arc in the network
No two activities should have the same starting node and the same ending
node.
Dummy activity is an imaginary activity indicating precedence relationship
only. Duration of a dummy activity is zero.
CRITICAL PATH METHOD is defined in the Project Management Body of
Knowledge (PMBOK) as the sequence of scheduled activities that determines
the duration of the project.
 It is the longest path (in time) from Start to Finish that indicates the
minimum time necessary to complete the entire project
 This method is fundamentally an algorithm for decision making. This
algorithm takes a task's start time, its duration, and finish time to figure
out which activities deserve the most attention (i.e. are "critical" for
the project).
 These scheduled activities must be performed if the project is to be
considered a success. Moreover, they must be completed in a specific
order.
DETERMINING PROJECT COMPLETION TIME EVENT (Event Analysis)
The critical path of a project network is the longest path in the
network.
This can be identified by simply listing out all the possible paths from
the start node of the project to then end node of the project and then
selecting the path with the maximum sum of activity times on that
path.
Two Phases:
I. Determine earliest event time (ET) of all the nodes. This is called
forward pass.
II. Determine the latest event time (ET) of all the nodes. This is called
backward pass.
 Decision under certainty – all the information available is perfect
(deterministic decision)
Decision under risk – the information available is partial
Decision under uncertainty – the information available is incomplete

Decisions under Uncertainty

I. Laplace Criterion / Equal Probability / Rationality – (Bayes Criterion)
II. Criterion of Optimism
- Maximax Criterion
- Minimin Criterion
III. Criterion of Pessimism
- Maximin Criterion
- Minimax Criterion
IV. Minimax Regret Criterion (Savage Criterion)
- Maximization Problem
- Minimization Problem
V. Hurwicz Criterion (Criterion of Realism)
- Maximization Problem
- Minimization Problem

Decision Tree
- can be used instead of a table to show alternatives, outcomes and payoffs.
Trees are much powerful than tables, which are limited to two dimensions, e.g.,
alternatives and outcomes
- shows the order of decisions and outcomes.
- can be used to determine optimal decisions.

Decision node (denoted by a square) represents a time when a decision is

CHAPTER 6: DECISION ANALYSIS made.
Decision-making Event node (denoted by a circle) represents a time when the outcomes occur.
 is an integral part of any business organization. A branch of a decision tree is a terminal branch if no nodes come out of the
 is a continuous process which involves selecting the best among branch.
several decisions.
Folding back a decision tree:
TYPES OF DECISION A process of identifying the optimal decision in a decision tree.
The process begins after a complete decision tree has been developed.
Moving from right to left, calculate the expected payoff at each outcome node. ordering of smaller quantities results in a higher cost during the period than
At each decision node, we then select the best decision alternative (based on less frequent ordering of larger quantities.
expected payoff calculated at each outcome node).
- largest payoff for maximization problem 2. Unit purchasing cost is the variable cost associated with purchasing a single
- lowest cost for minimization problem unit. This item becomes an important factor in case the price of the single unit
depends on the size of the order (quantity discount – unit price decreases with
CHAPTER 7: INVENTORY MODELS increasing order quantity).
Inventory represents the goods or material that must be held by a company for
use sometime in the future. The usual examples of inventories are: 3. Holding or carrying cost includes:
 Raw material  storage cost (maintaining the storage space),
 Finished goods  store keeping operations (taking physical inventory),
 Semi-finished products  insurance and taxes on inventory,
 Spare parts  interest (paid on the capital invested in inventories),
 the opportunity cost (e.g., the interest gained from money saved in the
The key reasons for maintaining inventory are: bank, the return from money invested in shares or bonds, or the yield
 protection against fluctuating demand, gained by possible alternative use of funds),
 protection against delayed supply,  cost due to the possibility of spoilage or obsolescence.
 savings on ordering cost,
 benefits on large quantities, 4. Shortage (or stockout) cost is significant if shortage of items affects the
 protection against inflation, etc. company’s activities, revenue, profit, employment inside the company etc. In
general, shortage leads to unsatisfied demand for the required items.
All these reasons (and many others) lead to following two questions for a Following examples of such cost can be considered:
company’s management: cost of idled production, cost of idled machines (in case of the spare-parts
1. How much to order? storage), cost of placing special expensive expediting order to restore the
2. When to order? inventory, loss of customers due to late deliveries of the finished goods,
other cost, often incalculable.
INVENTORY TERMINOLOGY AND MODELS CLASSIFICATION
Since the objective in the inventory model is typically the minimization of the Inventory Level - this is the available size of the inventory, i.e. the number of
total cost, we need to identify the most important types of partial inventory stocked items (the number of units) or the amount of stocked material (in
cost: kilograms, liters, meters, etc.).

1. Ordering and setup cost are all the necessary expenses of placing an order. Reordering, Reorder Point, and Lead Time
This item represents the fixed charge that includes e.g., the cost of paperwork, Since the inventory is being depleted, stocked items must be replenished
billing cost and supplier’s fixed cost associated with the order. More frequent periodically. When the inventory level is reduced to a signal level called the
reorder point, the replenishment order must be placed to restore the inventory
on time. The time period between placing the order and receiving the shipment
is called the lead time. This period can be constant or variable.
Shortages, Surpluses and Safety Stock
Shortage (its full elimination or partial reduction) company’s management can
keep a buffer in the form of safety stock that is used in case where shortage
event would occur. This issue is the most significant in the models with
probabilistic demand or lead time.
Average Inventory
Concept of an average inventory is used in almost all the inventory models.
CLASSIFICATION OF INVENTORY MODELS
Deterministic Models – the rate of demand (and the inventory depletion rate)
is known with certainty
Probabilistic Models - the rate of demand (and the inventory depletion rate) is
probabilistic (described as a random variable).
DETERMINISTIC MODELS
In deterministic models the rate of demand (and the inventory depletion rate)
is known with certainty. As an example, we can consider the production
process with the constant production rate.
This rate (e.g., number of units produced per day) determines the constant rate
of demand for the inventory (e.g., semi-products) and hence, the uniform
decrease in the inventory level. These are some of such models:
 Basic economic order quantity model (EOQ model).
 EOQ model with back orders allowed (with planned shortages).
 Economic production lot size model.
 EOQ model with quantity discounts.
PROBABILISTIC MODELS
In probabilistic models the rate of demand (and the inventory depletion rate)
is probabilistic (described as a random variable). To illustrate such models let
us consider a large supermarket with complex inventory system. Demand for
any goods offered in the supermarket is obviously random. It is evident that
monitoring and analyzing the demand fluctuation in time is a complex and
never-ending process for a highly experienced team of managers and database
analysts.
Two basic models will be described later:
 Probabilistic model with continuous demand.
 Single-period decision model.
1. In case of a static demand, its rate is known with certainty (deterministic
model) and in addition, it does not change from one time period to the next.
This type of demand is
considered in the simplest inventory models.
2. Although in case of a dynamic demand its rate is known with certainty, it is
not constant throughout time. Thus, we know the demand value (or its rate)
for each period.
3. A stationary probabilistic demand corresponds to a random variable with
the probability density function, remaining unchanged over the time.
4. In a non - stationary case of demand, the corresponding probability density
function varies within time period. Considering this type of demand leads to
the most complex inventory models in which the simulation process is often
used as the last chance of successful inventory managing.
DETERMINISTIC INVENTORY MODELS THE ECONOMIC ORDER QUANTITY
MODEL (EOQ)
EOQ model is the simplest of all the inventory models. Two basic questions
associated with the inventory management (how much and when to order) can
be extended to the following list of questions:
1. How much (optimum quantity) should be ordered?
2. When (in optimum reorder point) should the order be placed?
3. What is the total cost?
4. What is the average inventory level?
5. What is the maximum inventory level?
 Lead Time – The time between placing an order and receiving the shipment
PROBABILISTIC INVENTORY MODELS (delivery).
In most probabilistic models three following basic questions should be
Ordering Cost – Fixed cost of placing one order.
discussed:
1. When to order? Probabilistic Inventory Model – Inventory model in which demand fluctuates
2. How much to order? throughout time period and it is described as a random variable.
3. How much to store in a safety stock?
Production Rate – Number of items being possibly produced within specific

Safety stock is a buffer stock, built up to avoid the inventory shortages that can time period.
occur in the situations with uncertain demand or fluctuating depletion rate. Quantity Discount – A discount on the unit purchasing cost offered by supplier
to a buyer willing to buy in large lots.

PROBABILISTIC INVENTORY MODELS Reorder Point – The inventory level at which a new order is placed.
Single-Period Decision Model Safety Stock – Inventory maintained specifically to reduce shortages.
- refers to the situation in which only one order is placed for the Setup Cost – Fixed cost associated with preparation of a production run (lot).
considered time period and the inventory is out of stock or there is
surplus of units at the end of that period. Shortage (Stockout) – Inability to provide the units from stock. Available
- Concern seasonal or perishable items that cannot be kept for future inventory is insufficient to meet demand.
periods. Shortage (Stockout) Cost – Variable cost associated with shortage of inventory.
- Known as Newsboy Problem
Surplus – Available inventory exceeds demand.
Unit Purchasing Cost – Variable cost associated with purchasing a single unit of
Cycle Time – The length of time between the placing of two consecutive orders.
the inventory (unit price).
Demand Rate – Inventory demanded within a specific time period.
Depletion – The process of reduction of the inventory, or reduction of the
inventory to a zero point.
Deterministic Inventory Model – Inventory model in which demand within a
time period is known with certainty.
Economic Order Quantity (EOQ) – An order quantity that minimizes the annual
holding cost plus annual ordering cost.
Holding Cost – Variable cost associated with storing inventory.
Inventory Level – The current (available) amount of inventory.