DSME 6620

Decision Models and Applications

Lecture Seven

Advanced Topics
in Mathematical Programming I

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DSME 6620
Decision Models and Applications

Agenda

• Piecewise linearity
– Microcomputer problem revisited

• Optimization in presence of uncertainty

– Walton bookstore problem
– Production and pricing problem revisited

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DSME 6620
Decision Models and Applications

Why Piecewise Linearity?

• Mathematically, a piecewise linear function is one

that is composed of several linear sections.

• In reality, we may face situations in which some

business parameter value varies when it goes beyond
some threshold
– For example, there can be price discounts when the
order quantity gets sufficiently large.

• More importantly, a nonlinear function can be

approximated by a piecewise linear function.
– That way, we may circumvent the deficiency caused
by nonlinear programming, namely, no guarantee of
global optimal solution with nonlinear programming

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DSME 6620
Decision Models and Applications

Microcomputer Problem Revisited

Original problem description:

The manufacturer produces two microcomputers, Type 1 and
Type 2 Microcomputers:
Resources Type 1 Type 2 Amount
available
Assembly time 4 hours 10 hours 100 hours
Inspection time 2 hours 1 hour 22 hours
Storage space 3 cubic feet 3 cubic feet 39 cubic feet
The unit profit of Type 1 Microcomputer is $60, while that of
Type 2 is $50.

Original LP formulation and optimal solution:

Max p = 60x1 + 50x2
subject to
4x1 + 10x2 ≤ 100
2x1 + x2 ≤ 22
3x1 + 3x2 ≤ 39
x1 ≥ 0, x2 ≥ 0
The optimal solution is (x1, x2) = (9, 4) and the optimal profit
is 740. 4
DSME 6620
Decision Models and Applications

Microcomputer Problem Revisited

Suppose the data in the manufacturer’s problem is

exactly the same as before, with the following
exception:

Due to some reason associated with the product

distribution, each of the first 5 units of Type 1
Microcomputer sold contributes $60 (as before), and
any units in excess of 5 have a contribution of $55
each. In this case, how should the manufacturer make
its decision on the production quantities?

Profit collected from

Type 1 Microcomputer
slope =
$55/unit

slope =
$60/unit

5
0 5 Units sold
DSME 6620
Decision Models and Applications

Problem Formulation

Approach one

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DSME 6620
Decision Models and Applications

Problem Formulation

Approach two

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DSME 6620
Decision Models and Applications

Problem Formulation

Approach three

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DSME 6620
Decision Models and Applications

Problem Formulation

Due to some reason associated with the product

distribution, each of the first 5 units of Type 1
Microcomputer sold contributes $60, each of the next 3
units sold contributes $55, and any units in excess of 8
have a contribution of $50 each. In this case, how should
the manufacturer make its decision on the production
quantities? Modify the formulations as appropriate.

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DSME 6620
Decision Models and Applications

Optimization in Presence of
Uncertainty

• Uncertainty is inevitable in the business world, as

many business parameters are highly fluctuating and
hardly predictable. This brings much difficulty to
decision making.

• The uncertainty can be partially resolved by some

probability knowledge, if the business situation
allows. If that is the case, the difficulty may be
somehow alleviated.

• We can use mathematical programming to treat

some problems that are of one-shot decision making
and contain probabilistic information about
uncertainty.

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DSME 6620
Decision Models and Applications

Walton Bookstore Problem

Walton Bookstore must decide how many of next year’s

nature calendars to order. Each calendar costs the
bookstore $7.50 and sells for $10. After January, all
unsold calendars will be returned to the publisher for a
refund of $2.50 per calendar.

We assume the demand D for calendar (at the full price) is

given by the probability distribution shown in the table
below.

Demand Probability
100 0.30
150 0.20
200 0.30
250 0.15
300 0.05
Walton wants to decide how many calendar to order.
Assume Walton is an expected-value decision maker.

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DSME 6620
Decision Models and Applications

Walton Bookstore Problem

Analysis & Formulation

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DSME 6620
Decision Models and Applications

Production & Pricing Problem

Revisited
A company makes two products, product one and product
two, from two resources, materials and labor. At the
beginning of each month, the company sets the production
quantities of the two products and determines their selling
prices.

A unit of product one costs $50 to make, while a unit of

product two costs $20. The utilization of materials and labor
and the available quantities of resources are shown in the
table I.

The company believes that either product’s demand depends

on its selling price and is estimated to be linearly decreasing
in that price, plus some noise. The company will use the
latest ten months’ information on pricing and demand
(shown in Table II) to estimate that relationship.

Assume produced units in a month can be used to meet the

demand of that month. Leftovers at the end of a month will
be wasted, hence the company won’t want to produce more
than the estimated demand for either product.

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DSME 6620
Decision Models and Applications

Production & Pricing Problem

Revisited
Table I: Utilization and availability of resources
Materials (lbs) Labor (hour)
Product One (per unit) 8 4
Product Two (per unit) 2 2
Availability 20,000 12,000

Table II: Price and demand during latest ten months

Product One Product Two
Month Price Demand Price Demand
1 284 2339 130 1172
2 287 2301 143 1052
3 277 2385 124 1302
4 285 2342 132 1116
5 293 2203 138 1105
6 298 2214 133 1097
7 303 2215 118 1353
8 272 2475 127 1271
9 308 2148 125 1199
10 277 2384 123 1283
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DSME 6620
Decision Models and Applications

Production & Pricing Problem

Revisited
Analysis

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