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You are on page 1of 75

DBM

Quantitative Techniques in Management

Semester - 1

Session - 8

Generic Example

Consider the following problem with

three decision alternatives and three

states of nature with the following payoff

table representing costs: COST PAYOFF TABLE

States of Nature

s1

s2

s3

d1

4.5

Decisions d2

0.5

d3

Optimistic Approach

An optimistic decision maker would use the optimistic

(maximax) approach. We choose the decision that

has the best single value in the payoff table.

Maximax

d1

decision

d2

Best

Decision

2

0.5

d3

Cost

Maximax

payof

Conservative Approach

A conservative decision maker would use the

conservative (maximin) approach. List the

worst payoff for each decision. Choose the

decision with the best of these worst payoffs.

Decision

Payoff

Maximin

payof

d1

4.5

Maximin

ddecision

4

2

d3

Decision

States of Nature

s1 s2

s3

d1

4.5

Decisions d2

0.5

d3

table, entries in

the regret table

represent

overpayments

(i.e. higher costs

incurred).

Example

Minimax Regret Approach (continued)

For each decision list the maximum regret. Choose

the decision with the minimum of these values.

States of Nature

s1

Max

s2

s3

Regret

d1

Decisions d2

0.5

d3

Probabilities

Expected Value Approach

If probabilistic information regarding the states of nature is

available, one may use the expected value (EV) approach.

Here the expected return for each decision is calculated by

summing the products of the payoff under each state of

nature and the probability of the respective state of nature

occurring.

The decision yielding the best expected return is chosen.

E

V

(d)(

P

s)V

Alternative

N

ij1jij

sum of weighted payoffs for the decision alternative.

The expected value (EV) of decision alternative di

is defined as:

where:

N = the number of states of nature

P(sj ) = the probability of state of nature sj

Vij = the payoff corresponding to decision

alternative di and state of nature sj

Burger Prince Restaurant is contemplating

opening a new restaurant on Main Street. It

has three different models, each with a different

seating capacity. Burger Prince estimates that

the average number of customers per hour will

be 80, 100, or 120. The payoff table (profits) for

the three models is on the next slide.

Payoff Table

Average Number of Customers Per Hour

s1 = 80

s2 = 100

s3 = 120

Model A

Model B

Model C

$10,000

$ 8,000

$ 6,000

$15,000

$18,000

$16,000

$14,000

$12,000

$21,000

Expected Value Approach

Calculate the expected value for each

decision. The decision tree on the next

slide can assist in this calculation. Here

d1, d2, d3 represent the decision

alternatives of models A, B, C, and s1, s2,

s3 represent the states of nature of 80,

100, and 120.

Payofs

Decision Tree

d1

1

d2

d3

s1

s2

s3

.4

.2

.4

s1

.4

s2

s3

.2

s1

s2

s3

.4

.4

.2

.4

10,000

15,000

14,000

8,000

18,000

12,000

6,000

16,000

21,000

Expected Value For Each Decision

Model A

d1

Model B d2

Model C

d3

= $12,600

= $11,600

= $14,000

Information

improve the probability estimates for the states of

nature.

The expected value of perfect information (EVPI)

is the increase in the expected profit that would

result if one knew with certainty which state of

nature would occur.

The EVPI provides an upper bound on the

expected value of any sample or survey

information.

Information

EVPI Calculation

Step 1:

Determine the optimal return corresponding to each state of

nature.

Step 2:

Compute the expected value of these optimal returns.

Step 3:

Subtract the EV of the optimal decision from the amount

determined in step (2).

Expected Value of Perfect Information

Calculate the expected value for the

optimum payoff for each state of nature

and subtract the EV of the optimal

decision.

EVPI= .4(10,000) + .2(18,000) + .

4(21,000) - 14,000 = $2,000

Sensitivity Analysis

Some of the quantities in a decision analysis, particularly the

probabilities, are often intelligent guesses at best.

It is important to accompany any decision analysis with a

sensitivity analysis.

Sensitivity analysis can be used to determine how changes

to the following inputs affect the recommended decision

alternative:

probabilities for the states of nature

values of the payoffs

If a small change in the value of one of the inputs causes a

change in the recommended decision alternative, extra

effort and care should be taken in estimating the input value.

Sensitivity Analysis

One approach to sensitivity analysis is to arbitrarily

assign different values to the probabilities of the states of

nature and/or the payoffs and resolve the problem. If the

recommended decision changes, then you know that the

solution is sensitive to the changes.

For the special case of two states of nature, a graphical

technique can be used to determine how sensitive the

solution is to the probabilities associated with the states

of nature.

OPERATION RESEARCH

Introduction to

Operations Research

Introduction to Operations

Research

which seeks to determine how best to design and

operate a system, usually under conditions requiring

the allocation of scarce resources.

Kimball & Morse: a scientific method of providing

executive departments with a quantitative basis for

decisions regarding the operations under their

control.

Introduction to Operations

Research

Provides rational basis for decision making

Solves the type of complex problems that turn up

in the modern business environment

Builds mathematical and computer models of

organizational systems composed of people,

machines, and procedures

Uses analytical and numerical techniques to make

predictions and decisions based on these models

Introduction to Operations

Research

Draws upon

engineering, management, mathematics

sciences"

applied mathematics, computer science,

economics, industrial engineering and

systems engineering

The Seven Steps to a Good OR Analysis

Identify the Problem

or Opportunity

Understand the System

Formulate a

Mathematical Model

Verify the Model

Present the Results of

the Analysis

Implement and Evaluate

Feedback loops

at all levels!

The Seven Steps to a Good OR Analysis

What are the objectives?

Identify the Problem

or Opportunity

Understand the System

too narrow?

Is it too broad?

Formulate a

Mathematical Model

Verify the Model

Present the Results of

the Analysis

Implement and Evaluate

The Seven Steps to a Good OR

Analysis

What data should

Identify the Problem

or Opportunity

Understand the System

Formulate a

Mathematical Model

Verify the Model

Present the Results of

the Analysis

Implement and Evaluate

be collected?

How will data be

collected?

How do different

components of the

system interact with

each other?

The Seven Steps to a Good OR Analysis

Identify the Problem

or Opportunity

Understand the System

Formulate a

Mathematical Model

Verify the Model

Present the Results of

the Analysis

Implement and Evaluate

be used?

Is the model accurate?

Is the model too complex?

The Seven Steps to a Good OR Analysis

Identify the Problem

or Opportunity

Understand the System

Formulate a

Mathematical Model

Verify the Model

Present the Results of

the Analysis

Implement and Evaluate

observations for current

inputs?

Are outputs reasonable?

Could the model be

erroneous?

The Seven Steps to a GoodWhat

ORif Analysis

there are conflicting

Identify the Problem

or Opportunity

Understand the System

Formulate a

Mathematical Model

Verify the Model

Present the Results of

the Analysis

Implement and Evaluate

objectives?

Inherently the most difficult

step.

This is where software tools

will help us!

The Seven Steps to a Good OR Analysis

Identify the Problem

or Opportunity

Must communicate

results in laymans

terms.

Formulate a

Mathematical Model

Verify the Model

Present the Results of

the Analysis

Implement and Evaluate

friendly!

The Seven Steps to a Good OR Analysis

Identify the Problem

or Opportunity

Understand the System

Formulate a

Mathematical Model

Verify the Model

Present the Results of

the Analysis

Implement and Evaluate

the new system.

System must be observed

over time to ensure it works

properly.

Introduction

Our world is filled with limited resources.

Oil

Land

Human

Time

Business

Resource (Budget)

Manufacturing

m/c , number of worker

Restaurant

Space available for seating

Introduction

How best to used the limited resources

available ?

How to allocate the resource in such a

way as to maximize profits or minimize

costs ?

Introduction

Mathematical Programming(MP) is a field

of management science or operations

research that fines most efficient way of

using limited resources/ to achieve the

objectives of a business.

Optimization

Characteristics of Optimization

Problems

One or more decisions

Restrictions or constraints

e.g. Determining the number of products to

manufacture

a limited amount of raw materials

a limited amount of labor

Objective

The production manager will choose the mix of

products that maximizes profits

Minimizing the total transportation cost

mathematically

Decision variables

X1 , X2 , X3 , , Xn

Index n = the number of product types

Constraints

a less than or equal to constraint :

f(X1 , X2 , X3 , , Xn) < b

a greater than or equal to constraint :

f(X1 , X2 , X3 , , Xn) > b

an equal to constraint :

f(X1 , X2 , X3 , , Xn) = b

Objective

MAX(or MIN) : f(X1 , X2 , X3 , , Xn)

Mathematical formulation of an

optimization problem

MAX(or MIN) : f(X1 , X2 , X3 , , Xn)

Subject to:

f(X1 , X2 , X3 , , Xn) < b1

.

f(X1 , X2 , X3 , , Xn) > bk

.

f(X1 , X2 , X3 , , Xn) = bm

note : n variables , m constraints

The function in model : f(x)

-Linear

-Nonlinear

Decision variable

-Integer value e.g. 1,2,3,4..

-Binary e.g. 0,1

1.

2 x1 x2 3 x3 50

2.

2 x1 x2 60

3. 4 x1 (1 / 3) x2 75

2

3

x

4.

1 7 x 2 45

3 x1 2 x2 3 x3

0.9

5.

x1 x2 x3

Problem

Blue Ridge Hot Tubs manufactures and sells two models of hot tubs :

Aqua Spa and the Hydro-Lux.

Howie Jones, the owner and manager of the company, needs to

decide how many of each type of hot tubs to produce

200 pumps available

Howie expects to have 1,566 production labor hours and

2,880 feet of tubing available.

Aqua-Spa requires 9 hours of labor and 12 feet of tubing

Hydro-Lux require s 6 hours of labor and 16 feet of tubing

Assuming that all hot tubs can be sold

To maximize profits, how many Aqua-Spas and Hydra-Luxs should be

produce?

Formulating LP Models

1. Understand the problem

2. Indentify the decision variable

3. State the objective as a linear combination of decision variables

Max : 350x1 + 300x2

4. State the constraints as linear combinations of the decision variable

4.1 Pumps available

4.2 labor available

4.3 Tubing available

5. Identify any upper or lower bounds on the decision variable

x1 > 0

x2 > 0

Subject to:

x1 + x2

9x1 + 6x2

< 1,566 , Labors available

x1

x2

>0

>0

MAX(or MIN) : C1X1+ C2X2+ , , CnXn

Subject to:

a11X1+ a12X2+ , , a1nXn

< b1

> bk

Notations

n

< b1

a

i 1

x b1

1i i

X1+ X2+ , ,+ Xn

= b1

x

i 1

b1

x

i 1

= b1

= b2

ij

b j , j

Graphical Method:

Solving LP Problems

Graphical Method

x1+x2 200

(1)

Graphical Method

x1+x2 200

(1)

Note :

X1 = 0 , x2 = 1566/6 = 261

X2 = 0 , x1 = 1566/9 =174

Graphical Method

x1+x2 200

(1)

12x1+ 16x2 2,880 (3)

Note :

X1 = 0 , x2 = 2880/16 = 180

X2 = 0 , x1 = 2880/12 = 240

Graphical Method

MAX

350x1 + 300x2

MAX

350x1 + 300x2

e.g. Obj = 35,000

2. Finding points (x1,x2) which has obj =

35,000

x1 = 100 , x2 = 0

x1 = 0

, x2 = 116.67

Graphical Method

MAX

350x1 + 300x2

x1+x2 200

(1)

(2)

12x1+ 16x2 2,880 (3)

x1+x2

= 200

3x1+ 1,200

=

3x1

=

Optimal Solution =

x1

=

X2

(1)

(2)

1,566

1,566

366

122

= 78

1.

- having more than one optimal solution

MAX

x1+x2

450x1 + 300x2

200 (1)

9x1+ 6x2

1,566 (2)

12x1+ 16x2 2,880 (3)

2. Redundant Constraints

region of the problem.

x1+x2

225

(1)

9x1+ 6x2

1,566 (2)

12x1+ 16x2 2,880 (3)

3. Unbounded Solutions

MAX x1 + x2

x1+ x2

400 (1)

-x1+ 2x2

x1

x2

0

0

400

(2)

4. Infeasibility

MAX

x1 + x2

x1+ x2

x1+ x2

x1

x2

0

0

150

200

(1)

(2)

Modeling LP Problems

1. Make vs. Buy Decisions

- The Electro-Poly corporation received a $750,000 order

for various quantities of 3 types of slip rings.

- Each slip ring requires a certain amount of time to wire

and hardness.

Model1 Model2 Model3

Number ordered

3,000

2,000

900

1.5

The company has only 5,000 hours of harnessing

capacity.

(Continue)

The company can sub contract to one of its competitors.

Cost($)

Model1

Model2

Model3

Cost to make

50

83

130

Cost to buy

61

97

145

to buy in order to fill the customer order at the least

possible cost

Defining the decision variables

mi = number of model i slip rings to make in-house

bi = number of model i slip rings to buy from competitor

Defining the objective function

To minimize the total cost

Min : 50m1 + 83m2 + 130m3 + 61b1+ 97b2 + 145b3

Subject to:

1m1 + 2m2

< 5,000

+ m3

, harness constraint

m1 + b1 = 3,000

m2 + b2 = 2,000

m3 + b3 = 900

Parameters

of wiring , Hours of harnessing

Decision Variable

- number of model i slip rings to buy from

competitor

Objective

Total Cost

Constraint

wiring constraint

harness constraint

Required order of each model

A transportation problem

Supply

R/M Area

Capacity

Processing Plant

i1

j1

275,000

200,000

i2

j2

400,000

600,000

i3

300,000

j3

225,000

Distance : (mile)

j1

j2

j3

i1

21

50

40

i2

35

30

22

I3

55

20

25

A transportation problem

How many product should be shipped from r/m area to the processing

plant, the trucking company charges a flat rate for every mile.

Min the total distance ~ Min total cost of transportation

Defining the decision variable

xij = number of R/M to ship from node i to node j

Defining the objective function

Min : 21x11+50x12 +40x13+35 x21 +30x22 +22x23 +55x31 +20x32 +25x33

Defining the constraints

x11 + x21 + x31 < 200,000

capacity restriction for j1

x12 + x22 + x32 < 600,000

capacity restriction for j2

x13 + x23 + x33 < 225,000

capacity restriction for j3

x11 + x12 + x13 = 275,000

supply restriction for i1

x21 + x22 + x23 = 400,000

supply restriction for i2

x31 + x32 + x33 = 300,000

supply restriction for i3

xij > 0 , for all i and j

A transportation problem

Parameters

Decision Variable

Objective

Constraint

capacity restriction

supply restriction

A transportation problem

A Blending problem

Agri-Pro stocks bulks amounts of four

types of feeds that can mix to meet a

given customers specifications.

Nutrient(%)

feed1

feed2

feed3

feed4

Corn (i=1)

30%

5%

20%

10%

Grain(i=2)

10%

30%

15%

10%

Minerals(i=3)

20%

20%

20%

30%

0.25

0.30

0.32

0.15

A Blending problem

Agri-Pro has just received an order from a local chicken farmer for

8,000 pounds of feed.

The farmers wants this feed to contain at least 20% corn, 15% grain ,

and 15% minerals.

What should Agri-Pro do to fill this order at minimum cost?

Defining the decision variable

xi = pounds of feed (j) to use in the mix

Defining the objective function

Min : 0.25x1 +0.30x2 +0.35x3+0.15 x4 , total cost

Defining the constraints

x1 + x2 + x3 + x4 = 8,000

0.3x1 +0.05 x2 + 0.20x3 + 0.10x4 > 0.20 8,000

--- Corn

0.1x1 +0.30 x2 + 0.15x3 + 0.10x4 > 0.15 8,000

--- Grain

0.2x1 +0.20 x2 + 0.20x3 + 0.30x4 > 0.15 8,000

--- Mineral

x1 , x2 , x3 , x4 > 0

A Blending problem

Parameters

Nutrient(%) of each feed

Order quantity ,

Required Nutrient(%)

Decision Variable

Objective

Minimize Cost

Constraint

A Blending problem

planning

problem

Upton Corporation

is trying to plan

its production and inventory

levels for the next 6 months

m1

m2

m3

m4

m5

m6

240

250

265

280

280

260

Unit Demanded(Dm)

1000

4500

6000

5500

3500

4000

Maximum Production(Maxp

m)

4000

3500

4000

4500

4000

3500

The owner like to keep at least 1,500 units in inventory any months

as safety stock

The company wants to produce at no less than half of its maximum

production capacity each month.

Estimate that the cost of carrying a unit in any given month is equal

to 1.5% of the unit production cost in the same month.

planning

problem

The number of units carried in inventory using the

month

Current inventory 2,750 units

To minimize production and inventory costs, the

company wants to identify the production and inventory

plan.

Defining the decision variable

pm = the number of units to product in month m

bm = the beginning inventory for month m

planning problem

6

6

Min : Cm pm (0.015 cm )(bm ,bm 1 ) / 2

m 1

m 1

Subject to

pm Maxpm

, m

pm (1 / 2) Maxpm

, m

bm pm Dm 6,000

, m

bm pm Dm 1,500

, m

bm1 bm pm Dm

, m

planning problem

Parameters

Maximum Production(Maxp),

Unit production cost(Cm) ,

Unit Demanded(Dm)

Decision Variable

the beginning inventory for month m, bm

Objective

Minimize Cost

Constraint

inventory , Balance constraint

planning problem

To: sjain@amity.edu

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