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PAN African e Network Project

DBM
Quantitative Techniques in Management

Semester - 1
Session - 8

Dr. Sarika Jain

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

Generic Example : Optimistic Decision


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

Generic Example: Conservative Approach


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

Generic Example: Minimax Regret


Decision

Minimax Regret Approach

States of Nature
s1 s2
s3
d1

4.5

Decisions d2

0.5

d3

Best cost for each state of nature.

For a cost payoff


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

Decision Making with


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

Expected Value of a Decision


Alternative

N
ij1jij

The expected value of a decision alternative is the


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

Example: Burger Prince


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.

Example: Burger Prince


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

Example: Burger Prince


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.

Example: Burger Prince

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

Example: Burger Prince


Expected Value For Each Decision

Model A

d1

Model B d2

Model C

d3

EMV = .4(10,000) + .2(15,000) + .4(14


= $12,600

EMV = .4(8,000) + .2(18,000) + .4(12,0


= $11,600

EMV = .4(6,000) + .2(16,000) + .4(21,0


= $14,000

Choose the model with largest EV, Model C.

Expected Value of Perfect


Information

Frequently information is available which can


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.

Expected Value of Perfect


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).

Example: Burger Prince


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

Operations research/management science

Winston: a scientific approach to decision making,


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

Closely related to the "decision


sciences"
applied mathematics, computer science,
economics, industrial engineering and
systems engineering

Methodology of Operations Research*


The Seven Steps to a Good OR Analysis
Identify the Problem
or Opportunity
Understand the System
Formulate a
Mathematical Model
Verify the Model

Select the Best Alternative


Present the Results of
the Analysis
Implement and Evaluate

Feedback loops
at all levels!

Methodology of Operations Research*


The Seven Steps to a Good OR Analysis
What are the objectives?
Identify the Problem
or Opportunity
Understand the System

Is the proposed problem


too narrow?
Is it too broad?

Formulate a
Mathematical Model
Verify the Model

Select the Best Alternative


Present the Results of
the Analysis
Implement and Evaluate

Methodology of Operations Research*


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

Select the Best Alternative


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?

Methodology of Operations Research*


The Seven Steps to a Good OR Analysis
Identify the Problem
or Opportunity
Understand the System
Formulate a
Mathematical Model
Verify the Model

Select the Best Alternative


Present the Results of
the Analysis
Implement and Evaluate

What kind of model should


be used?
Is the model accurate?
Is the model too complex?

Methodology of Operations Research*


The Seven Steps to a Good OR Analysis
Identify the Problem
or Opportunity
Understand the System
Formulate a
Mathematical Model
Verify the Model

Select the Best Alternative


Present the Results of
the Analysis
Implement and Evaluate

Do outputs match current


observations for current
inputs?
Are outputs reasonable?
Could the model be
erroneous?

Methodology of Operations Research*


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

Select the Best Alternative


Present the Results of
the Analysis
Implement and Evaluate

objectives?
Inherently the most difficult
step.
This is where software tools
will help us!

Methodology of Operations Research*


The Seven Steps to a Good OR Analysis
Identify the Problem
or Opportunity

Must communicate
results in laymans
terms.

Understand the System


Formulate a
Mathematical Model
Verify the Model

Select the Best Alternative


Present the Results of
the Analysis
Implement and Evaluate

System must be user


friendly!

Methodology of Operations Research*


The Seven Steps to a Good OR Analysis
Identify the Problem
or Opportunity
Understand the System
Formulate a
Mathematical Model
Verify the Model

Select the Best Alternative


Present the Results of
the Analysis
Implement and Evaluate

Users must be trained on


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

Expressing optimization problems


mathematically
Decision variables
X1 , X2 , X3 , , Xn

e.g. the quantities of different products


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

Mathematical programming techniques


The function in model : f(x)

-Linear
-Nonlinear

Decision variable

-Fractional value e.g. 2.33


-Integer value e.g. 1,2,3,4..
-Binary e.g. 0,1

Test : Linear functions?


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

Max : 350x1 + 300x2


Subject to:

x1 + x2
9x1 + 6x2

< 200 , Pumps available


< 1,566 , Labors available

12x1 + 16x2 < 2,880 , Tubing available


x1
x2

>0
>0

General Form of an LP model


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

Subject to:
a11X1+ a12X2+ , , a1nXn

< b1

ak1X1+ ak2X2+ , , aknXn

> bk

am1X1+ am2X2+ , , amnXn = bm

Notations
n

a11X1+ a12X2+ , , a1nXn

< b1

a
i 1

x b1

1i i

X1+ X2+ , ,+ Xn

= b1

x
i 1

b1

x
i 1

X11 + X21+ X31

= b1

X12 + X22+ X32

= b2

ij

b j , j

Graphical Method:
Solving LP Problems

Graphical Method
x1+x2 200

(1)

Graphical Method
x1+x2 200

(1)

9x1+ 6x2 1,566 (2)

Note :
X1 = 0 , x2 = 1566/6 = 261
X2 = 0 , x1 = 1566/9 =174

Graphical Method
x1+x2 200

(1)

9x1+ 6x2 1,566 (2)


12x1+ 16x2 2,880 (3)

Note :
X1 = 0 , x2 = 2880/16 = 180
X2 = 0 , x1 = 2880/12 = 240

Graphical Method
MAX

350x1 + 300x2

Using level curves


MAX

350x1 + 300x2

1. Set a number of objective


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)

9x1+ 6x2 1,566


(2)
12x1+ 16x2 2,880 (3)

Finding the optimal solution


x1+x2

= 200

9x1+ 6x2 = 1,566

9x1+ 6(200 x1) =


3x1+ 1,200
=
3x1
=
Optimal Solution =
x1
=
X2

(1)
(2)

1,566
1,566
366
122
= 78

Special Conditions in LP Models


1.

Alternate Optimal Solutions


- having more than one optimal solution

MAX
x1+x2

450x1 + 300x2
200 (1)

9x1+ 6x2
1,566 (2)
12x1+ 16x2 2,880 (3)

Special Conditions in LP Models


2. Redundant Constraints

A constraint that plays no role in determining the feasible


region of the problem.

MAX 350x1 + 300x2


x1+x2
225

(1)

9x1+ 6x2
1,566 (2)
12x1+ 16x2 2,880 (3)

Special Conditions in LP Models


3. Unbounded Solutions

The objective function can be made infinitely large.

MAX x1 + x2
x1+ x2
400 (1)
-x1+ 2x2
x1
x2

0
0

400

(2)

Special Conditions in LP Models


4. Infeasibility

No ways to satisfy all of the constraints

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

Hours of wiring required per unit

1.5

Hours of harnessing required per unit

The company has only 10,000 hours of wiring capacity.


The company has only 5,000 hours of harnessing
capacity.

Make vs. Buy Decisions


(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

Determine the number of slip rings to make and the number


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

Make vs. Buy Decisions (Continue)


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:

2m1 + 1.5m2 + 3m3

< 10,000 , wiring constraint

1m1 + 2m2

< 5,000

+ m3

, harness constraint

m1 + b1 = 3,000

, Required order of model1

m2 + b2 = 2,000

, Required order of model2

m3 + b3 = 900

, Required order of model3

m1 , m2 ,m3 , b1 , b2 ,b3 , > 0

Make vs. Buy Decisions


Parameters

Cost to buy, Cost to make, Number ordered, Hours


of wiring , Hours of harnessing

Decision Variable

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


- 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

Distance from I to j, no supply , no capacity

Decision Variable

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

Objective

Min the total distance

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%

Cost per Pound($)

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

Cost per Pound($),


Nutrient(%) of each feed
Order quantity ,
Required Nutrient(%)

Decision Variable

pounds of feed (j) to use in the mix

Objective

Minimize Cost

Constraint

Satisfy the Required Nutrient(%)

A Blending problem

A production and inventory


planning
problem
Upton Corporation
is trying to plan
its production and inventory
levels for the next 6 months

m1

m2

m3

m4

m5

m6

Unit production cost (Cm)

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

Given the size of Uptons warehouse, a maximum of 6,000 units


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.

A production and inventory


planning
problem
The number of units carried in inventory using the

averaging the beginning and ending inventory for each


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

A production and inventory


planning problem

Defining the objective function


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

A production and inventory


planning problem
Parameters

Maximum Production(Maxp),
Unit production cost(Cm) ,
Unit Demanded(Dm)

Decision Variable

the number of units to product in month m , pm


the beginning inventory for month m, bm

Objective

Minimize Cost

Constraint

Upper bound and Lower bound of the production and


inventory , Balance constraint

A production and inventory


planning problem

Please forward your query


To: sjain@amity.edu