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probabilities of future occurrences by analysing

presently known probabilities.

including market share analysis, bad debt prediction, future

breakdown of machine, etc.

Markov analysis makes the assumption that the system starts

in an initial state or condition.

Predicting these future states involves knowing the system

likelihood or probability of changing from one state to another.

These probabilities can be collected and placed in a matrix or

table.

that the system will change from one time period to next.

This is the Markov process and it enables us to predict future

states or conditions.

States are used to identify all possible conditions of a process

or a system.

For example

a machine can be in one of two states at any point of time. It can be

either functioning correctly or not functioning correctly.

If there are only three grocery stores in a small town, a resident can be

customer of any one of the three at any point in time. Therefore there

are three states corresponding to the three grocery stores.

collectively exhaustive and mutually exclusive.

Our discussion of Markov analysis assumes that there is a

finite number of states for any system.

Collectively exhaustive means that we can list all of the

possible states of a system or process.

Mutually exclusive means that a system can be in one state at

any point in time.

determine the probability that the system is in this state.

Such information is then placed into a vector of state

probabilities.

(i) = vector of state probabilities for period i

= (1, 2, 3, ..........., n)

probability of being in state 1, state 2, ....... state n

There could be a total of 100000 people that shop at the three

grocery stores during any given month. 40000 people may be

shopping at American Food Store. 30000 people may be

shopping at Food Mart and 30000 may be shopping at Atlas

Foods. The probability that a person will be shopping at one of

these three grocery stores is as follows:

State 1: 1 = 40000/100000 = 0.4 = probabilities that a person

will shop at American Food

State 2: 2 = 30000/100000 = 0.3 = probabilities that a person

will shop at Food Mart

State 1: 3 = 30000/100000 = 0.3 = probabilities that a person

will shop at Altas Foods

These probabilities can be placed in the vector of state

probabilities i.e. (0) = (0.4, 0.3, 0.3), which represent the

market shares for these three stores for the first period.

American Food

# 1 : 0.4

Food Mart

#2: 0.3

Atlas Foods

# 3: 0.3

#1: 0.8

0.4x0.8 = 0.32

#2: 0.1

0.4x0.1 = 0.04

#3: 0.1

0.4x0.1 = 0.04

#1: 0.1

0.3x0.1 = 0.03

#2: 0.7

0.3x0.7 = 0.21

#3: 0.2

0.3x0.2 = 0.06

#1: 0.2

0.3x0.2 = 0.06

#2: 0.2

0.3x0.2 = 0.06

#3: 0.6

0.3x0.6 = 0.18

Solution

Tree diagram and the calculations could be used to find the

state probabilities for the next month and the month after that

the tree would soon get very large. Rather than use a tree

diagram it is easier to use a matrix of transition probabilities,

which is a matrix of conditional probabilities of being in a

future state given a current state.

Pij = conditional probability of being in state j in the future

given the current state of i

P = matrix of transition probabilities

P11

P21

P12

P22

.

.

P1n

P2n

Pm1

Pm2

Pmn

P=

Solution

The three grocery stores to determine4 what percentage of the

customers would switch each month.

Put these transitional probabilities into the following matrix:

0.8 0.1 0.1

P = 0.1 0.7 0.2

0.2 0.2 0.6

When current period is 0, calculating the state probabilities for

the next period can be accomplished as (1) = (0) P

Similarly, calculating the state probabilities for the n + 1

period can be accomplished as (n + 1) = (n) P

Solution

When current period is 0, calculating the state probabilities for

the next period can be accomplished as (1) = (0) P

= (0.4 0.3

0.3)

0.8

0.1

0.2

0.1

0.7

0.2

0.1

0.2

0.6

(0.3)(0.2), (0.4)(0.1) + (0.3)(0.2) + (0.3)(0.6)]

=(0.41, 0.31, 0.28)

Market share for American Food and Food Mart has increased

while the market share for Atlas Foods has decreased.

Solution

Will this trend continue in the next period and the one after

that?

Consider two time periods from now: (2) = (1) P

Since we know that (1) = (0) P

So, (2) = (0) P P = (0) P2

In general (n) = (0) Pn

Machine Operator

Paul Tolsky, owner of Tolsky Works, has recorded the

operation of his milling machine for several years. Over the

past two years 80% of the time the milling machine functioned

correctly during the current month if it had functioned

correctly in the preceding month. This also means that only

20% of the time did the machine not function correctly for a

given month when it was functioning correctly during the

preceding month. In addition, it has been observed that 90% of

the time the machine remained incorrectly adjusted for any

given month. Only 10% of the time did the machine operate

correctly in a given month when it did not operate correctly

during the preceding month. In other words, this machine can

correct itself when it has not been functioning correctly in the

past and this happens 10% of the time.

Machine Operator

0.8 0.2

Matrix of transition probabilities for this machine is P =

0.1 0.9

Probabilities of functioning and non functioning (0) = (1, 0)

(1) = (0) P = (1, 0) 0.8 0.2

0.1 0.9

= [(1)(0.8) + (0)(0.1), (1)(0.2) + (0)(0.9) = (0.8, 0.2)

Probability that the machine will be functioning correctly two

months from now.

0.8 0.2

(2) = (1) P = (0.8, 0.2)

0.1 0.9

[(0.8)(0.8) + (0.2)(0.1), (0.8)(0.2) + (0.2)(0.9)] = (0.66, 0.34)

Period

State 1

1

1

2

0.8

3

0.66

4

0.562

5

0.4934

6

0.44538

7

0.411766

8

0.388236

9

0.371765

10

0.360235

11

0.352165

12

0.346515

13

0.342560

14

0.339792

15

0.337854

State 2

0

0.2

0.34

0.438

0.5066

0.55462

0.588234

0.611763

0.628234

0.639754

0.647834

0.653484

0.657439

0.660207

0.662145

Machine Operator

The machine starts off functioning correctly in the first period.

In period 5, there is only a 0.4934 probability that the machine

is still functioning correctly and by period 10, this probability

is only 0.360235.

In period 15, the probability that the machine is still

functioning correctly is about 0.34.

Probability that the machine will be functioning correctly at a

future period is decreasing but it is decreasing at a decreasing

rate.

Machine Operator

From table, it appears there will be an equilibrium at

0.333333.

An equilibrium condition exists if the state probabilities do not

change after a large number of periods.

At equilibrium the state probabilities for a future period must

be the same as the state probabilities for the current period.

(next period) = (this period) P or (n+1) = (n) P

At equilibrium (n + 1) = (n) or (n) = (n) P

or = P

Machine Operator

0.8 0.2

(1, 2) = (1, 2)

0.1 0.9

(1, 2) = [(1)(0.8) + (2)(0.1), (1)(0.2) + (2)(0.9)]

1 = 0.81 + 0.12

(1)

2 = 0.21 + 0.92

(2)

(3)

1 + 2 = 1

From the above three equations arbitrarily drop any one of the

above two and solve the simultaneous equation, we get

Machine Operator

2 = 0.21 + 0.92

1 + 2 = 1

From the above three equations arbitrarily drop any one of the

above two and solve the simultaneous equation, we get

1 =1/3 = 0.333333

2 = 2/3 = 0.666666

state 2 is 0.66666

Receivable Application

Generally it assume that it is possible for the process or system

to go from one state to any other state between any two

periods.

In some cases, if you are in a state you can not go to another

state in the future i.e. when you are in a given state you are

absorbed by it and you will remain in that state.

Any state that has this property is called an absorbing state.

An account receivable system normally places debts or

receivables from its customers into one of several categories

or states depending on how overdue the oldest unpaid bill is.

company. Four typical states or categories for an accounts

receivable application follow:

State 1 (1): paid, all bill

State 2 (2): bad debt, overdue more than three month

State 3 (3): overdue less than one month

State 4 (4): overdue between one and three month

The matrix of transition probabilities for these four states will

reflect the propensity of customers to move among the four

accounts receivable categories from one month to next. The

probability of being in the paid category for any item or bill in

a future month given that a customer is in the paid category for

a purchased item this month is 100% or 1.

product one month and owe money on it in a future month.

Another absorbing state is the bad debt state. If a bill is not

paid in three months we are assuming that the company will

completely write it off and not try to collect it in the future.

Thus once a person is in the bad debts category, that person

will remain in that category forever. For any absorbing state,

the probability that a customer will be in this state in the future

is 1 and the probability that a customer will be in any other

state is 0. For a person in the less than one month category,

there is a 0.6 probability of being in the paid category, a 0

probability of being in the bad debt category, a 0.2 probability

of remaining in the less than one month category and a

probability of 0.2 of being in the one to three month category

in the next month.

category the next month because it is impossible to get from

state 3, less than one month, to state 2, more than three months

overdue, in just one month. For a person in the one to three

month category, there is a 0.4 probability of being in the paid

category, a 0.1 probability of being in the bad debt category, a

0.3 probability of being in the less than one month category

and a 0.2 probability of remaining in the one to three month

category in the next month.

This Month

Paid

Bad Debt

1< Month

1 to 3 Month

Paid

1

0

0.6

0.4

Next Month

Bad Debt 1< Month 1 to 3 Month

0

0

0

1

0

0

0

0.2

0.2

0.1

0.3

0.2

categories or states for any given period, we can determine the

fraction of the people in these four states or categories for any

future period. These fraction are placed in a vector of state

probabilities and multiplied times the matrix of transition

probabilities.

In long run everyone will be either in the paid or bad debt

category. This is because the categories are absorbing states.

But how many people or how much money will be in each of

these categories? Knowing the total amount of money that will

be in either the paid or bad debt category will help a company

mange its bad debts and cash flow. This analysis requires the

use of the fundamental matrix.

the matrix of transition probabilities P.

I

1

0

0

0

0

1

0

0

0.6 0 0.2 0.2

0.4 0.1 0.3 0.2

A

B

P=

I=

1

0

0

1

A = 0.6 0

0.4 0.1

0=

0

0

B = 0.2

0.3

0

0

0.2

0.2

I = an identity matrix

0 = a matrix with all 0

Fundamental matrix can be computed as F = (I B)-1

-1

F= 1 0

- 0.2 0.2

0 1

0.3 0.2

F=

F=

a

c

b

d

0.8 -0.2 -1

-0.3 0.8

-1

=

d

-b

ad-bc ad-bc

-c

a

ad-bc ad-bc

F=

0.8

-0.3

-0.2

0.8

-1

=

0.8 -(-0.2)

0.58 0.58

-(-0.3) 0.8

0.58 0.58

1.38

0.52

0.34

1.38

debt money that expect in the long run is to multiply the

fundamental matrix F times the matrix A

FA = 1.38 0.38

0.52 1.38

0.6

0.4

0

0.1

0.97 0.03

0.86 0.14

It indicates the probability that an amount in one of the nonabsorbing states will end up in one of the absorbing states.

amount in the less than one month category will end up in the

paid and the bad debt category.

The probability that an amount that is less than one month

overdue will be paid is 0.97

The probability that an amount that is less than one month

overdue will end up as a bad debt is 0.03

The second row has similar interpretation for the other non

absorbing state which is the one to three month category.

0.86 is the probability that an amount that is one to three

months overdue will eventually be paid

0.14 is the probability that an amount that is one to three

months overdue will never be paid but will become a bad debt.

category and $5000 in the one to three month category. Then

M = (2000, 5000), where M is the amount of money that is in

each of the non-absorbing states

Amount of money that will end up as being paid and the

amount that will end up as bad debts = MFA

=

(2000, 5000)

0.97

0.86

0.03

0.14

(6240, 760)

Out of the total $7000 ($2000 in the less than one month

category and $5000 in the one to three month category), $6240

will be eventually paid and $760 will end up as bad debt.

concerned about declining enrolments. Bradley School is a

technical college that specialize in training computer

programmes and computer operators. Over the years, there has

been a lot of competition among Bradley School ,

International Technology and Career Academy. The tree

schools compete in providing education in the areas of

programming, computer operations and basic secretarial skills.

To gain a better understanding of which of these schools is

emerging as a leader, George decided to conduct a survey. His

survey looked at the number of students who transferred from

one school to the other during their academic careers. On the

average, Bradley School was able to retain 65% of those

students it originally enrolled. Twenty percent of the students

originally enrolled transferred to Career Academy and 15%

transferred to International Technology.

students remained at Career Academy for their full academic

programme. George estimated that about half the students who

left Career Academy went to Bradley School and other half

went to International Technology. International Technology

was able to retain 80% of its students after they enrolled. 10%

of the originally enrolled students transferred to Career

Academy and other 10% enrolled in Bradley School.

Currently, Bradley School has 40% of the market. Career

Academy a much newly school has 35% of the market. The

remaining market share 25% consists of students attending

International Technology. George would like to determine the

market share for Bradley for the next year. What are the

equilibrium market shares for Bradley School, International

Technology and Career Academy?

Solution:

State 1: initial share = 0.4 = Bradley School

State 2: initial share = 0.35 = Career Academy

State 3: initial share = 0.25 = International Technology

Transition matrix values are

Bradley

Bradley

0.65

Career

0.05

International

0.1

Career International

0.2

0.15

0.9

0.05

0.1

0.8

Solution:

To determine market share for Bradley School, he has to

multiply current market share and transition matrix

probability.

0.65

0.2

0.15

(0.4, 0.35, 0.25)

0.05

0.1

0.9

0.1

0.05

0.8

(0.25)(0.10) = 0.303

Market share for Career Academy = (0.4)(0.2) + (0.35)(0.90) +

(0.25)(0.10) = 0.420

Market share for International Technology = (0.4)(0.15) +

(0.35)(0.05) + (0.25)(0.8) = 0.278

or current market share times the matrix of transition

probabilities.

Market share for Bradley School = X1

Market share for Career Academy = X2

Market share for International Technology = X3

0.65

0.2

(X1, X2, X3) = (X1, X2, X3)

0.05

0.9

0.1

0.1

X2 = 0.2X1 + 0.9X2 + 0.1X3

X1 = 0.15X1 + 0.05X2 + 0.8X3

X1 + X2 + X3 = 1

0.15

0.05

0.8

one of the top three equation, then solve by simultaneous

equation procedure to get the equilibrium market share of

Bradley School, Career Academy and International

Technology.

Market share for Bradley School = X1 = 0.158

Market share for Career Academy = X2 = 0.579

Market share for International Technology = X3 = 0.263

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