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random variable: ai
probability: pi
3 0.05
4 0.12
5 0.20
6 0.24
7 0.17
8 0.14
9 0.08
How many bouquets should he make each morning to maximize the expected profit?
CASE 1: Make 3 bouquets probability( demand 3) = 1 Exp. Profit = 3x50 3x35 = $45
CASE 2: Make 4 bouquets if demand = 3, then revenue = 3x $50 = $150 if demand = 4 or more, then revenue = 4x $50 = $200
Compute expected profit for each case number of bouquets probability Expected profit 3 0.05 45 4 0.12 57.5 5 0.20 64 6 0.24 60.5 7 0.17 45 8 0.14 21 9 0.08 -10
3 0.05
4 0.12
5 0.20
6 0.24
7 0.17
8 0.14
9 0.08
Probability density function (area under curve = integral over entire range = 1)
P( a x b) = ab f(x) dx
-4
-3
-2
-1
a
Property:
normally distributed random variable x, mean = Q, standard deviation = W, Corresponding standard random variable: z = (x Q)/ W z is normally distributed, with a Q = 0 and W = 1.
Assumptions: - Plan for single period inventory level - Demand is unknown - p(y) = probability( demand = y), known - Zero setup (ordering) cost
Example: Mrs. Kandells Christmas Tree Shop Order for Christmas trees must be placed in Sept
$55 before Dec 25 $15 after Dec 25
If she orders too few, the unit shortage cost is cu = 55 25 = $30 If she orders too many, the unit overage cost is co = 25 15 = $10 Past Data
Sales Probability 22 .05 24 .10 26 .15 28 .20 30 .20 32 .15 34 .10 36 .05
D total demand before Christmas F(x) the demand distribution, D > Q stockout, at a cost of: cu (D Q)+ = cu max{D Q, 0}
1. Uncertain demand 2. One chance to order (long) before demand 3. ( order > demand OR order < demand) COST
Model development
Stockout cost = cu max{D Q, 0} Overstock cost = co max{Q D, 0} Total cost = G(Q) = cu (D Q)+ + co (Q D)+ Expected cost, E( G(Q) ) = E(cu (D Q)+ + co (Q D)+) = cu E(D Q)+ + co E(Q D)+
!
[cu ( x Q) co (Q x) ]P( x) !
x !0
E (G (Q )) !
[c ( x Q )
u x !Q
]P ( x) [co (Q x) ]P ( x)
x !0
g 0
g (Q) ! E ( G (Q )) !
x !0
(Q x) P ( x) dx
x !Q
( x Q) P ( x) dx
Model solution
Q g 0
g (Q ) ! E ( G (Q )) !
x !0
(Q x ) P( x ) dx
x !Q
( x Q ) P( x ) dx
Minimize g(Q)
d g (Q ) !0 dQ
g Q d 0c0 (Q x) P( x) dx x!Qcu ( x Q) P( x) dx ! 0 dQ x !
g(Q) is a convex function: it has a unique minimum when g(Q) is at minimum value, F(Q) = cu/(cu + co)
co = 25 15 = $10
24 0.1 0.15 26 0.15 0.3 28 0.2 0.5 30 0.2 0.7 32 0.15 0.85 34 0.1 0.95 36 0.05 1
optimum 31
NOTE:
24 0.1 0.15
26 0.15 0.3
28 0.2 0.5
30 0.2 0.7
32 0.15 0.85
34 0.1 0.95
36 0.05 1
optimum: 31
F
F
Summary
When demand is uncertain, we minimize expected costs newsvendor model: single period, with over- and under-stock costs Critical ratio determines the optimum order point Critical ratio affects the direction and magnitude of order quantity
Drive to reduce inventory costs was main motivation for Supply Chain Management
next: Quality Control