Now, suppose 𝑐𝑐 = 2, 𝑟𝑟 = 4, 𝑠𝑠 = 1. What would be the optimal order quantity?

0.65
P(z)==
=

3
=

table
~from
P 4x0.43
=
10
+

=
11.72 =
12

Discrete demand distribution

Let us now assume that the demand is a discrete random variable. The expected profit is:

𝐸𝐸[Π(𝑁𝑁)] = R. E (min (D,N] + SECIN-D1+] -

CN

(N-d) PID d) N
1)] S2
-

[NP(D
=

d)
+

R(EndP(D
+
=

↓EN
=

d > N

PID d) cN
EndP(D
d) RN(1-F(N)
S.NFCN)-SENd
=
-

R +
+
=
=

(R-S).N.F(N)
=(R CN (R S)
EndP(D d)
=
- -

- +

What if we order an additional unit? Replace N with (N+1)

𝐸𝐸[Π(𝑁𝑁 + 1)] =
d) 1R-S)(N+1) F(N+1)
(R c) (N +1) (R- s) ENP(D
=

- +

As in the continuous case, we want to find the maximum for the expected profit. However, since
the demand is now a discrete random variable, we cannot differentiate. In this case, the
optimum order level, 𝑁𝑁 ∗ , must satisfy the following two conditions (explain why):

𝐸𝐸[Π(𝑁𝑁 + 1)] − 𝐸𝐸[Π(𝑁𝑁)] ≤ 0 and 𝐸𝐸[Π(𝑁𝑁)] − 𝐸𝐸[Π(𝑁𝑁 − 1)] > 0

**is optimum order level in other

words, order level for profit
defined as
4
meximization (for proof see the
prev. ICE). So
by definition Expected profit
is
higher than all the other levels
including (N*+1) and IN*-1)
 So, let us find the difference:

𝐸𝐸[Π(𝑁𝑁 + 1)] − 𝐸𝐸[Π(𝑁𝑁)] =

=(R c) (N + 1
-
-
N) (R-S) (N+1P(D N+ 1)
+
= -

(R-S) [IN+1) F(N+1) -

NF(N)]

=(R C)-

(1) (R-S)(N+1P(D N+1)

+
= -

(R-S) [NCFCN+-FCNC) + FCNA]

=(R -

c)(1) (R
+ -

s)(N+1P(+1) -(R S)((

N+1) -
= +

F)]
(R-3) P(+1) F(N)

(R
=
-

2) -

(R S)-

F (N*) 0 =

What about the second condition? Just substitute 𝑁𝑁 by 𝑁𝑁 − 1 in the result above:

𝐸𝐸[Π(𝑁𝑁)] − 𝐸𝐸[Π(𝑁𝑁 − 1)] = 𝐶𝐶𝑢𝑢 − (𝐶𝐶𝑢𝑢 + 𝐶𝐶𝑜𝑜 )𝐹𝐹(𝑁𝑁 ∗ − 1) >0

-
Then, the optimal order quantity must satisfy these conditions: de

*
(R-2) -

(R-S) F(N*) 0
=

- -

Cu
(xu c0)
+

FIN*-) <
FIN*)
c 1
critratio
r-S
⎧ �3 , if 𝑑𝑑 = 1
F(d)
⎪ =E
𝑓𝑓𝐷𝐷 (𝑑𝑑) = 1�3 , if 𝑑𝑑 = 2 . Let 𝑐𝑐 = 1, 𝑟𝑟 = 2, 𝑠𝑠 = 0.
Example 3: Assume 𝑁𝑁 = 2 and 𝑃𝑃(𝐷𝐷 = 𝑑𝑑) = -2
⎨
⎪⑤1� , if = 1
⎩ 3
-0 2 0
=0.5
-

Π(2) = 2 min(d, 2) +
0(2-d) t-1.2 2min(d,2)-2
=

2(5.1 5.2 5.2) 2 1

=

𝐸𝐸[Π(2)] =
-

5
 Example 4: We need to determine the optimal order quantity for next year’s calendars; we
estimate that next year’s demand for the calendar follows the probability distribution given
below. The unit ordering cost is $2, sales price is $4.5, and the salvage value is $0.75. How
many calendars should we order?

Number of Probability Sales Leftover Shortage

CDF
calendars sold (pmf) 𝐦𝐦𝐦𝐦𝐦𝐦 (𝑵𝑵, 𝑫𝑫) (𝑵𝑵 − 𝑫𝑫)+ (𝑫𝑫 − 𝑵𝑵)+
100 0.30 0.3 100 100 I

150 0.20
· 200
150 50 !

200 0.30 0
0

0
250 0.15 0.95 200 I&
300 0.05 1 200 0
100

critical ratio:
Is 0.67 =

4.5 0.75
-

What is the expected number of sales if 𝑁𝑁 = 𝑁𝑁 ∗ ? -> N* + 200

↓ P(D
E(min (D, NIS
EIN d) NP(D d)
=
= =

↓> N

10.15
+ 0.05) 160 calendars
0.2x10
=

0.3x100 + + 0.8x200 +
200

What is the expected number of leftover calendars if 𝑁𝑁 = 𝑁𝑁 ∗ ?

Elmax (N-D, 0)] IN-dP(D d)
EEN
=

(200-200) 40 cal.
0.3(200-100) 0.2(200-150) 0.3
=
+
+

What is the expected shortage if 𝑁𝑁 = 𝑁𝑁 ∗ ?

-N)P(D d)
E(max(D -N,0)) w(d
=

0.05/300-2001 cel
12.5
0.3 (200 200) 0.15(250-100
=

- +
+

Variation 1: Newsvendor Problem with Upper and Lower Bounds on the Order Quantity

Let us consider the optimization model below.

Maximize 𝐸𝐸[Π(𝑁𝑁)]

Subject to 𝑁𝑁 ≤ 𝑁𝑁 ∗ ≤ 𝑁𝑁

What are the possible cases?