Quantitative Analysis - All in One

Introduction to
Quantitative Analysis
• LEARNING OBJECTIVES
• After completing this chapter, students will be
able to:
1. Describe the quantitative analysis approach.
2. Understand the application of quantitative
analysis in a real situation.
3. Describe the use of modeling in quantitative
analysis.
4. Discuss possible problems in using
quantitative analysis.
5. Perform a break-even analysis.
CHAPTER OUTLINE
1.1 Introduction
1.2 What Is Quantitative Analysis?
1.3 The Quantitative Analysis Approach
1.4 How to Develop a Quantitative Analysis Model
1.5 Possible Problems in the Quantitative Analysis
Approach
1.6 Implementation—Not Just the Final Step
1.1 Introduction
People have been using mathematical tools to
help solve problems for thousands of years
 the formal study and application of
quantitative techniques to practical decision
making is largely a product of the twentieth
century.
Introduction
• The techniques we study in this course have
been applied successfully to an increasingly
wide variety of complex problems in
• Business
• government
• health care, education, and many other areas.
1.2 What Is Quantitative Analysis?
 Quantitative analysis is the scientific approach

to managerial decision making.
 opinion, emotions, and guesswork are not part of
the quantitative analysis approach.
 The approach starts with data. Like raw material
for a factory, these data are manipulated or
processed into information that is valuable to
people making decisions.
This processing and manipulating of raw data
into meaningful information is the heart of
quantitative analysis.
 Computers have been instrumental in the
increasing use of quantitative analysis.
• In solving a problem, managers must consider
both qualitative and quantitative factors.
• For example, we might consider several
different investment alternatives, including
certificates of deposit at a bank, investments in
the stock market, and an investment in real
estate
1.3 The Quantitative Analysis
Approach
 The quantitative analysis approach consists of
1. defining a problem
2. developing a model
3. acquiring input data
4. developing a solution
5. testing the solution
6. analyzing the results
7. and implementing the results
Defining the Problem
The first step in the quantitative approach is
 to develop a clear, concise statement of the
problem.
This statement will give direction and meaning
to the following steps.
In many cases, defining the problem is the
most important and the most difficult step.
Defining the Problem
It is essential to go beyond the symptoms of
the problem and identify the true causes.
One problem may be related to other
problems; solving one problem without regard
to other related problems can make the entire
situation worse.
Developing a Model
 Once we select the problem to be analyzed, the next
step is to develop a model.
 Simply stated, a model is a representation (usually
mathematical) of a situation.
• types of models.
• Architects sometimes make a physical model of a
building that they will construct.
• Engineers develop scale models of chemical plants,
called pilot plants
• A schematic model is a picture, drawing, or
chart of reality. Automobiles, lawn mowers,
gears, fans, typewriters, and numerous other
devices have schematic models (drawings and
pictures) that reveal how these devices work.
• A mathematical model is a set of
mathematical relationships.
• In most cases, these relationships are
expressed in equations and inequalities, as they
are in a spreadsheet model that computes
sums, averages, or standard deviations.
• A variable, as the name implies, is a measurable
quantity that may vary or is subject to change.
• Variables can be controllable or uncontrollable.
• A controllable variable is also called a decision
variable.
• An example would be how many inventory items
to order.
• A parameter is a measurable quantity that is
inherent in the problem.
• The cost of placing an order for more
inventory items is an example of a parameter.
• In most cases, variables are unknown
quantities, while parameters are known
quantities.
Acquiring Input Data
 Once we have developed a model, we must obtain the
data that are used in the model (input data).
 Obtaining accurate data for the model is essential;
even if the model is a perfect representation of reality,
improper data will result in misleading results.
 This situation is called garbage in, garbage out.
 For a larger problem, collecting accurate data can be
one of the most difficult steps in performing quantitative
analysis.
• There are a number of sources that can be used
in collecting data.
• In some cases, company reports and
documents can be used to obtain the necessary
data.
• Another source is interviews with employees
or other persons related to the firm.
Developing a Solution
 Developing a solution involves manipulating the
model to arrive at the best (optimal) solution to
the problem.
 In some cases, this requires that an equation be
solved for the best decision.
 In other cases, you can use a trial and error
method, trying various approaches and picking
the one that results in the best decision.
1.4 How to Develop a Quantitative
Analysis Model
Developing a model is an important part of the
quantitative analysis approach.
 Let’s see how we can use the following
mathematical model, which represents profit:
Profit = Revenue - Expenses
Profit = Revenue - (Fixed cost + Variable cost)
 Profit = (Selling price per unit)(Number of units sold) –
[(Fixed cost + (Variable cost per unit)(Number of units
sold)]
Profit = sX – [f + vX]
Profit = sX - f – vX
Where,
s = selling price per unit
f = fixed cost
n = variable cost per unit
X = number of units sold
1.5 Management Science Techniques
• Linear Programming
• Linear programming is a problem-solving
approach developed for situations involving
maximizing or minimizing a linear function
subject to linear constraints that limit the
degree to which the objective can be pursued.
• Integer Linear Programming Integer linear
programming is an approach used for
problems that can be set up as linear
programs, with the additional requirement
that some or all of the decision variables be
integer values.
• Distribution and Network Models
• Nonlinear Programming
• Project Scheduling: PERT/CPM
• Inventory Models
• Waiting-Line or Queueing Models
• Decision Analysis
• Goal Programming
Example
1. Micromedia offers computer training seminars on a
variety of topics. In the seminars each student works
at a personal computer, practicing the particular
activity that the instructor is presenting. Micromedia is
currently planning a two-day seminar on the use of
Microsoft Excel in statistical analysis. The projected fee
for the seminar is birr 300 per student. The cost for the
conference room, instructor compensation, lab
assistants, and promotion is birr 4800. Micromedia
rents computers for its seminars at a cost of birr 30 per
computer per day.
a. Develop a model for the total cost to put on the
seminar. Let x represent the number of students
who enroll in the seminar.
b. Develop a model for the total profit if x students
enroll in the seminar.
c. Micromedia has forecasted an enrollment of 30
students for the seminar. How much profit will be
earned if their forecast is accurate?
d. Compute the breakeven point.
Example 2
2. Eastman Publishing Company is considering
publishing a paperback textbook on
spreadsheet applications for business. The fixed
cost of manuscript preparation, textbook design,
and production setup is estimated to be birr
80,000. Variable production and material costs are
estimated to be birr 3 per book. Demand over the
life of the book is estimated to be 4000 copies.
The publisher plans to sell the text to college and
university bookstores for birr 20 each.
a. What is the breakeven point?
b. What profit or loss can be anticipated with a demand
of 4000 copies?
c. With a demand of 4000 copies, what is the minimum
price per copy that the publisher must charge to break
even?
d. If the publisher believes that the price per copy could
be increased to $25.95 and not affect the anticipated
demand of 4000 copies, what action would you
recommend? What profit or loss can be anticipated?
Chapter two Linear Programming
Models
LEARNING OBJECTIVES
 After completing this chapter, students will be able to:
1. Understand the basic assumptions and properties of
linear programming (LP).
2. Formulate a real-world problem as a mathematical
programming model and solve the model
3. Graphically solve any LP problem that has only two
variables by both the corner point and isoprofit line
methods.
4. Perform sensitivity analysis to determine the
direction and magnitude of change of a
model’s optimal solution as the data change
CHAPTER OUTLINE
2.1 An Introduction to Linear Programming
2.2 Problem Formulation
2.3Linear Programming Applications
2.4 Maximization Problem
2.5 Minimization Problem
2.6 Methods to Solve Linear Programming
2.6.1 GRAPHICAL SOLUTIONPROCEDURE
2.6.2 Simplex Method
2.7 SPECIAL CASES
2.8Linear Programming: Sensitivity Analysis and Interpretation of
Solution
2.1 An Introduction to
LinearProgramming
Linear programming is a problem-solving
approach developed to help managers make
decisions.
Numerous applications of linear programming
can be found in today’s competitive business
environment.
Linear programming is a powerful quantitative
tool used by managers to obtain optimal
solutions to problems that involve restrictions
or limitations, such as the available materials,
budgets, and labor and machine time
These problems are referred to as constrained
optimization problems.
1. A manufacturer wants to develop a production
schedule and an inventory policy that will
satisfy sales demand in future periods.
 Ideally, the schedule and policy will enable
the company to satisfy demand and at the same
time minimize the total production and
inventory costs.
2. A financial analyst must select an investment
portfolio from a variety of stock and bond
investment alternatives.
The analyst would like to establish the
portfolio that maximizes the return on
investment
3. A marketing manager wants to determine how
best to allocate a fixed advertising budget
among alternative advertising media such as
radio, television, newspaper, and magazine.
The manager would like to determine the
media mix that maximizes advertising
effectiveness.
4. Company has warehouses in a number of
locations.
 For a set of customer demands, the company
would like to determine how much each
warehouse should ship to each customer so
that total transportation costs are minimized
Linear Programming Models
• components and assumptions
• Four components provide the structure of a
linear programming model:
1. Objective.
2. Decision variables.
3. Constraints.
4. Parameters
 Linear programming algorithms require that a
single goal or objective, such as the maximization
of profits, be specified.
 The two general types of objectives are
maximization and minimization.
 The objective function is a mathematical
expression that can be used to determine the total
profit (or cost, etc., depending on the objective)
for a given solution.
• Decision variables represent choices available to
the decision maker in terms of amounts of either
inputs or outputs.
• For example, some problems require choosing a
combination of inputs to minimize total costs
• while others require selecting a combination of
outputs to maximize profits or revenues.
Constraints are limitations that restrict the
alternatives available to decision makers.
• The three types of constraints are
• less than or equal to
• greater than or equal to
• and simply equal to (=).
 In order for linear-programming models to be used
effectively, certain assumptions must be satisfied. These are:
1. Linearity: the impact of decision variables is linear in
constraints and the objective function.
2. Divisibility: noninteger values of decision variables are
acceptable.
3. Certainty: values of parameters are known and constant.
4. Nonnegativity: negative values of decision variables are
unacceptable.
2.2 MODEL FORMULATION
An understanding of the components of linear
programming models is necessary for model
formulation.
This helps provide organization to the process
of assembling information about a problem
into a model.
• A firm that assembles computers and computer
equipment is about to start production of two new types
of microcomputers. Each type will require assembly
time, inspection time, and storage space. The amounts
of each of these resources that can be devoted to the
production of the microcomputers is limited. The
manager of the firm would like to determine the
quantity of each microcomputer to produce in order to
maximize the profit generated by sales of these
microcomputers.
• Additional information:
• In order to develop a suitable model of the
problem, the manager has met with design and
manufacturing personnel. As a result of those
meetings, the manager has obtained the
following information:
Type 1 type 2
Profit per unit $ 60 $50

assembly time 4 hours 10 hours
per unit
inspection time 2 hours 1 hour
per unit
storage space per 3 cubic feet 3 cubic feet
unit
the manager also has acquired information on the availability of company
resources .these( daily) amounts are:
Resource Amount available
100 hours
assembly time
22 hours
inspection time
39 cubic feet
storage space
• An appliance manufacturer produces two models of
microwave ovens: H and W. Both models require
fabrication and assembly work; each H uses four hours
of fabrication and two hours of assembly, and each W
uses two hours of fabrication and six hours of assembly.
There are 600 fabrication hours available this week and
480 hours of assembly. Each H contributes $40 to
profits, and each W contributes $30 to profits. What
quantities of Hand W will maximize profits?
A manager has the option of purchasing one, two and three
machines. Fixed costs and potential volumes are as follows.
Number of Total annual Corresponding

machines Fixed costs range of outputs
1 $ 9600 0 to 300
2 15,000 301 t0 600
3 20,000 601 to 900

• Variable cost is $10 per unit and revenue is $
40 per unit
1. Determine the break even for each range
2. If projected annual demand is between 580
and 660 units ,how many machines should the
manager purchase
example
• A company produces two products that are processed
on two assembly lines. Assembly line 1 has 100
available hours, and assembly line 2 has 42 available
hours. Each product requires 10 hours of processing
time on line 1, while on line 2 product 1 requires 7
hours and product 2 requires 3 hours. The profit for
product 1 is $6 per unit, and the profit for product 2 is
$4 per unit.
a. Formulate a linear programming model for this
problem.
• The Jimma Furniture Company produces chairs and tables
from two resources labor and wood. The company has 80
hours of labor and 36 pounds of wood available each day.
Demand for chairs is limited to 6 per day. Each chair
requires 8 hours of labor and 2 pounds of wood, whereas a
table requires 10 hours of labor and 6 pounds of wood. The
profit derived from each chair is $400 and from each table,
$100. The company wants to determine the number of
chairs and tables to produce each day in order to maximize
profit.
• a. Formulate a linear programming model for this problem.
• Creative Sports Design (CSD) manufactures a standard-size racket
and an oversize racket. The firm’s rackets are extremely light due to
the use of a magnesium-graphite alloy that was invented by the firm’s
founder. Each standard size racket uses 0.125 kilograms of the alloy
and each oversize racket uses 0.4 kilograms; over the next two-week
production period only 80 kilograms of the alloy are available. Each
standard-size racket uses 10 minutes of manufacturing time and each
oversize racket uses 12 minutes. The profit contributions are $10 for
each standard-size racket and $15 for each oversize racket, and 40
hours of manufacturing time are available each week. Management
specified that at least 20% of the total production must be the
standard-size racket. How many rackets of each type should CSD
manufacture over the next two weeks to maximize the total profit
contribution? Assume that because of the unique nature of their
products, CSD can sell as many rackets as they can produce.
• The XYZ Cereal Company makes a cereal from several
ingredients. Two of the ingredients, oats and rice, provide
vitamins A and B. The company wants to know how many
ounces of oats and rice it should include in each box of
cereal to meet the minimum requirements of 48 milligrams
of vitamin A and 12 milligrams of vitamin B while
minimizing cost. An ounce of oats contributes 8 milligrams
of vitamin A and 1 milligram of vitamin B, whereas an
ounce of rice contributes 6 milligrams of A and 2
milligrams of B. An ounce of oats costs $5, and an ounce of
rice costs $3.
• a. Formulate a linear programming model for this problem.
• The Electrocomp Corporation manufactures two
electrical products: air conditioners and large fans. The
assembly process for each is similar in that both require
a certain amount of wiring and drilling. Each air
conditioner takes 3 hours of wiring and 2 hours of
drilling. Each fan must go through 2 hours of wiring and
1 hour of drilling. During the next production period,
240 hours of wiring time are available and up to 140
hours of drilling time may be used. Each air conditioner
sold yields a profit of $25. Each fan assembled may be
sold for a $15 profit. Formulate as LP
• A candidate for mayor in a small town has allocated $40,000
for last-minute advertising in the days preceding the
election. Two types of ads will be used: radio and television.
Each radio ad costs $200 and reaches an estimated 3,000
people. Each television ad costs $500 and reaches an
estimated 7,000 people. In planning the advertising
campaign, the campaign manager would like to reach as
many people as possible, but she has stipulated that at least
10 ads of each type must be used. Also, the number of radio
ads must be at least as great as the number of television ads.
How many ads of each type should be used? How many
people will this reach?
A city hospital has the following
minimal daily requirements for nurses.
Period Clock time (24 Minimum
hours day) number of nurses
required
1 6 a.m. – 10 a.m. 2
2 10 a.m. – 2 p.m. 7
3 2 p.m. – 6 p.m. 15
4 6 p.m. – 10 p.m. 8
5 10 p.m. – 2 a.m. 20
6 2 a.m. – 6 a.m. 6
• Nurses report at the hospital at the beginning of
each period and work for 8 consecutive hours.
The hospital wants to determine the minimal
number of nurses to be employed so that there
will be a sufficient number of nurses available for
each period.
• Formulate this as a linear programming problem
by setting up appropriate constraints and objective
function.
• Solve the following LPP by graphical method
• Minimize Z = 20X1 + 40X2
• Subject to constraints
36X1 + 6X2 ≥ 108
3X1 + 12X2 ≥ 36
20X1 + 10X2 ≥ 100
X1 X2 ≥ 0
Simplex Method
• the following three steps are necessary to
prepare a linear programming problem for
solution using the simplex method:
Step 1. Formulate the problem.
Step 2. Set up the standard form by adding slack
and/or subtracting surplus variables.
Step 3. Set up the tableau form.
Basic Solution
• To determine a basic solution, set n - m of the
variables equal to zero, and solve the m linear
constraint equations for the remaining m
variables.
• Criterion for Entering a New Variable into the
Basis
• Look at the net evaluation row (cj - zj), and select
the variable to enter the basis that will cause the
largest per-unit improvement in the value of the
objective function.
• In the case of a tie, follow the convention of
selecting the variable to enter the basis that
corresponds to the leftmost of the columns.
• Criterion for Removing a Variable from the
Current Basis (Minimum Ratio Test)
Chapter 3
Distribution: Transportation Problem
Objectives of the chapter
By the end of this unit you will be able to:

 Define transportation problem
 Define a balanced and unbalanced transportation problem
 Formulate transportation model of both categories
 Develop an initial solution of a transportation problem using the Northwest
Corner Rule, least cost rule, and Vogel approximation method
 Use the Stepping Stone and modified distribution( UV) methods to find an optimal
solution of a transportation problem
 Define assignment problem
 Formulate special linear programming problems using the assignment model
 Solve assignment problems with the Hungarian method.
Transportation Model
• Transportation problem deals with the distribution of goods
from several points of supply to a number of points of demand.
They arise when a cost-effective pattern is needed to ship items
from origins that have limited supply to destinations that have
demand for the goods.
• Resources to be optimally allocated usually involve a given

capacity of goods at each source and a given requirement for
the goods at each destination.
• Most common objective of the transportation problem is to

schedule shipments from sources to destinations so that
transportation costs and time are minimized
Transshipment Model
 An extension of transportation problems is called
transshipment problem in which a point can have
shipments that both arrive as well as leave.
 Example would be a warehouse where shipments

arrive from factories and then leave for retail outlets
 It may be possible for a firm to achieve cost savings

(economies of scale) by consolidating shipments from
several factories at a warehouse and then sending
them together to retail outlets.
Assignment Model
• Assignment problem refers to a class of LP problems that
involve determining most efficient assignment of:
People to projects,
Salespeople to territories,
Contracts to bidders,
Jobs to machines, and so on
• Objective is to minimize total cost or total time of performing
tasks at hand, although a maximization objective is also
possible.
Transportation Model
Problem definition
• There are m sources. Source i has a supply capacity of Si.
• There are n destinations.The demand at destination j is D j.
• Objective:
 To minimize the total shipping cost of supplying the
destinations with the required demand from the
available supplies at the sources.
The Transportation Model
Characteristics
A product is to be transported from a number of sources

to a number of destinations at the minimum possible
cost.
Each source is able to supply a fixed number of units of
the product, and each destination has a fixed demand for
the product.
The linear programming model has constraints for supply
at each source and demand at each destination.
All constraints are equalities in a balanced transportation
Balanced Transportation Model- Example 1
In a balanced transportation model in which supply
equals demand, all constraints are equalities
Balanced Transportation Model Example 1
Transportation Costs Per Desk

Transportation Model Example 1
LP Transportation Model Formulation
Objective: Minimize total shipping costs =
5 XDA + 4 XDB + 3 XDC + 3 XEA + 2 XEB +
1 XEC + 9 XFA + 7 XFB + 5 XFC
Where: Xij = number of desks shipped from factory i to warehouse j
i = D (for Des Moines),
E (for Evansville), or
F (for Fort Lauderdale).
j = A (for Albuquerque),
B (for Boston), or
C (for Cleveland).
Transportation Model Example 1
Supply Constraints
XDA + XDB + XDC = 100 (Des Moines capacity)

XEA + XEB + XEC = 300 (Evansville capacity)
XFA + XFB + XFC = 300 (Fort Lauderdale capacity)
Demand Constraints
XDA + XEA + XFA = 300 (Albuquerque demand) and

XDB + XEB + XFB = 200 (Boston demand)
XDC + XEC + XFC = 200 (Cleveland demand)
Example 2
Problem: How many tons of wheat to transport from each grain

elevator to each mill on a monthly basis in order to minimize the
total cost of transportation?
Grain Elevator Supply Mill Demand
Data: 1. Kansas City 150 A. Chicago 200
2. Omaha 175 B. St. Louis 100
3. Des Moines 275 C. Cincinnati 300
Total 600 tons Total 600 tons
Transport Cost from Grain Elevator to Mill ($/ton)
Grain Elevator A. Chicago B. St. Louis C. Cincinnati
1. Kansas City $ 6 $ 8 $10
2. Omaha 7 11 11
3. Des Moines 4 5 12
Example 2
Model Formulation
Minimize Z = 6x1A + 8x1B + 10x1C + 7x2A + 11x2B + 11x2C +

4x3A + 5x3B + 12x3C
subject to:
x1A + x1B + x1C = 150
x2A + x2B + x2C = 175
x3A + x3B + x3C = 275
x1A + x2A + x3A = 200
x1B + x2B + x3B = 100
x1C + x2C + x3C = 300
xij  0
xij = tons of wheat from each grain elevator, i, i = 1, 2, 3, to each
Eexercise
Carlton Pharmateuticals
• Carlton Pharmaceuticals supplies drugs and other
medical supplies.
• It has three plants in: Cleveland, Detroit, Greensboro.
• It has four distribution centers in:

Boston, Richmond, Atlanta, St. Louis.
• Management at Carlton would like to ship cases of a

certain vaccine as economically as possible.
• Data
– Unit shipping cost, supply, and demand
To
From Boston Richmond Atlanta St. Louis Supply
Cleveland $35 30 40 32 1200
Detroit 37 40 42 25 1000
Greensboro 40 15 20 28 800
Demand 1100 400 750 750
1. Show the network

2. Develop the model
Unbalanced transportation problem
• In an unbalanced transportation model, supply is greater than demand or demand is greater than
supply
• It is a more likely occurred
When demand is greater than supply

 One of the demand constraints will not be met because there is not enough total supply to meet total demand.
The demand constraints will be ≤
In our above example 2, if the demand at Cincinnati is increased from 300 tons to 350 tons, a situation is created in which total
demand is 650 tons and total supply is 600 tons.
• This will result in the following change in our linear programming model of this Problem
Unbalanced transportation model
The model is:
Minimize Z = 6x1A + 8x1B + 10x1C + 7x2A + 11x2B + 11x2C +
4x3A + 5x3B + 12x3C
subject to:
x1A + x1B + x1C = 150
x2A + x2B + x2C = 175
x3A + x3B + x3C = 275
x1A + x2A + x3A ≤ 200
x1B + x2B + x3B ≤ 100
x1C + x2C + x3C ≤ 350
xij  0
Balancing transportation problem:
when demand is greater than supply
Formulate linear programming model of the above

transportation problem
When supply is greater than demand
If supply exceeds demand, then the supply constraints will be ≤ because there
is surplus.
In our above example 2, if the supply at Des Moines is increased from 275 tons to 300 tons, a
situation is created in which total supply is 625 tons and total demand is 600 tons.
Thus, the model will be:
Minimize Z = 6x1A + 8x1B + 10x1C + 7x2A + 11x2B + 11x2C + 4x3A +
5x3B + 12x3C
subject to:
x1A + x1B + x1C ≤ 150
x2A + x2B + x2C ≤175
x3A + x3B + x3C ≤ 300
x1A + x2A + x3A = 200
x1B + x2B + x3B =100
x1C + x2C + x3C = 350
xij  0
Balancing transportation problems
• If the demand exceeds supply, we introduce a dummy source (i.e. a
fictitious factory) which has that capacity.
• The amount shipped from this dummy source to a destination represents
the shortage quantity at that destination.
• Since the source does not exist, no shipping from the source will occur, so
the unit transportation costs can be set to zero.
• If supply exceeds demand then a dummy destination is added which

absorbs the surplus units. Any units shipped from a source to a dummy
destination represent a surplus at that source. In this case the supply
constraints will be =
• Since no shipping takes place, the unit transportation costs can be set to
zero
Solving transportation problem
 The transportation problem is solved in two phases:

•Phase I -- Obtaining an initial feasible solution
•Phase II -- Moving toward optimality
Solving transportation problem
• Transportation models do not start at the origin where all decision
values are zero; they must instead be given an initial feasible solution.
• Initial feasible solution determination methods include:
1. Northwest Corner Method
2. Minimum Cell Cost Method
3. Vogel’s Approximation Method
• Methods for solving the transportation problem include: Also called
methods of testing optimality
1. Stepping-Stone Method
2. Modified Distribution Method.
Initial feasible solution of Transportation Model
:Example
Problem: How many tons of wheat to transport from each grain
elevator to each mill on a monthly basis in order to minimize the
total cost of transportation?
Grain Elevator Supply Mill Demand
Data: 1. Kansas City 150 A. Chicago 200
2. Omaha 175 B. St. Louis 100
3. Des Moines 275 C. Cincinnati 300
Total 600 tons Total 600 tons
Transport Cost from Grain Elevator to Mill ($/ton)
Grain Elevator A. Chicago B. St. Louis C. Cincinnati
1. Kansas City $ 6 $ 8 $10
2. Omaha 7 11 11
3. Des Moines 4 5 12
1st : write in tableau Format
• Transportation problems are solved manually within a tableau
format.
• Each cell in a transportation tableau is analogous to a decision
variable that indicates the amount allocated from a source to
a destination.
• The supply and demand values along the outside rim of a
tableau are called rim values.
Tableau form
MB, BECO, Jimma University 89

1. Northwest corner method
• Steps:
1. Allocate as much as possible to the cell in the upper left-hand
corner, subject to the supply and demand conditions.
2. Allocate as much as possible to the next adjacent feasible cell.
3. Repeat step 2 until all rim requirements are met.
The Northwest Corner Method
The Northwest Corner Method
• The initial solution is complete when all rim requirements

are satisfied.
• Transportation cost is computed by evaluating the
objective function:
• Z = $6x1A + 8x1B + 10x1C + 7x2A + 11x2B + 11x2C + 4x3A +
5x3B + 12x3C
• Z = 6(150) + 8(0) + 10(0) + 7(50) + 11(100) + 11(25) + 4(0)
+ 5(0) + !2(275)
= $5,925
The Minimum Cell Cost Method
Step:
1. Allocate as much as possible to the feasible cell with the
minimum transportation cost, and adjust the rim requirements.
2. Repeat step 1 until all rim requirements have been met.
 The minimum cell cost method will provide a solution with a
lower cost than the northwest corner solution because it
considers cost in the allocation process.
The Minimum Cell Cost Method
The complete initial minimum cell cost solution; total

cost = $4,550.
Vogel’s Approximation Method (VAM)
• Begin with computing each row and column a penalty.

• The penalty will be equal to the difference between the two
smallest shipping costs in the row or column.
• Identify the row or column with the largest penalty. Find the
first basic variable which has the smallest shipping cost in that
row or column.
• Then assign the highest possible value to that variable, and
cross-out the row or column as in the previous methods.
• Compute new penalties and use the same procedure
Step 1: Compute the penalties.
-
Step 2: Identify the largest penalty and allocates as much as
possible to the minimum cost cell in the row or column with the
largest penalty cost
- After each VAM cell allocation, all row and column penalty costs are recomputed.
The Second
AM Allocation

The initial VAM solution; total cost = $5,125

VAM and minimum cell cost methods both provide better initial solutions than does
the northwest corner method.
The Initial VAM

Solution
Summary of Steps
1. Determine the penalty cost for each row and column.

2. Select the row or column with the highest penalty cost.
3. Allocate as much as possible to the feasible cell with the
lowest transportation cost in the row or column with the
highest penalty cost.
4. Repeat steps 1, 2, and 3 until all rim requirements have been
met.
 In addition to the initial feasible solution, it gives more
information about the penalties that otherwise we incur
Exercise
W1 W2 W3 W4 Supply
F1 10 0 20 11 20
F2 12 7 9 20 25
F3 0 14 16 18 15
Demand 10 15 15 20
Find the initial basic feasible solution using:
1. Northwest corner method =640
2. least cost method=480
3. VAM method =480 MB, BECO, Jimma University 102
Exercise
• A company has factories at A, B and C which supply warehouses
at D, E and F. Weekly factory capacities are 200, 160 and 90 units
respectively. Weekly warehouse requirements (demands) are 180,
120 and 150 units respectively. Unit shipping costs are as follows:
• Find the initial feasible solution using northwest corner method,

least cost method, and VAM method

Exercise
• What is the initial feasible solution of the above example

using west-corner method, least cost method, and Vogel’s
approximation method
When demand is not equal to supply
Find the initial feasible solution of the following

transportation problem using north west corner method, least
cost method, and VAM Method

When demand is not equal to supply

Exercise
• Formulate the transportation model of the following
problem and the initial basic feasible solution using
Northwest, least cost, and VAM methods

Summery of basic feasible solution
Basic feasible solution to a transportation problem

satisfies the following conditions:
• The row-column( supply-demand )conditions are
satisfied
• The non-negativity constraints are satisfied
• The allocations are independent and do not form a
loop
• There are m+n-1 allocations

Methods for solving the transportation problem:
optimization
• Also called testing initial feasible solution for optimality
• We can proceed to find out whether initial solution is
optimal or not
• The following are two methods of testing
1. Stepping-Stone Method and
2. Modified Distribution Method.

The Stepping-Stone Solution Method
The stepping-stone method determines if there is a cell with no

allocation that would reduce cost if used.
Step 1: proceed row by row and select a water square( a cell with out
any allocation). A cell with allocation is a stone square
Step 2: form a closed path starting from selected water square via stone
square and then back to the same water square
Step 3: assign alternative plus and minus sign on the closed path
starting with a plus sign on the water square
Step 4: calculate net cost change for the path. The net cost change is
obtained by summing up the unit cost of each cell. Evaluate the solution
for optimality test by observing the net cost change

The Stepping-Stone Solution Method
• Negative sign indicates a cost reduction can be made by

making the change
• Positive sign indicates an increase in cost if the change
is made
• if all the sign are positive, then that means that the
optimal solution has been reached
• If more than one square has a negative sign then the
water square with the largest negative net cost change
is selected for quicker solution

Example 1
• Solve the following using Stepping stone method. The initial
solution used as a starting point in this problem is the
minimum cell cost method solution

Example 1--------
1A →1B → 3B → 3A:
6 -8 +5 -4 = -1
Example 1----

Example 1
The answer is 4525

Exercise1
• Find initial feasible solution using Northwest cost method and test
optimality using steeping stone method

Exercise
• Find the initial basic feasible solution of the following
transportation problem and test the value for optimality
W1 W2 W3 W4 Supply
F1 10 0 20 11 20
F2 12 7 9 20 25
F3 0 14 16 18 15
Demand 10 15 15 20

The Modified Distribution Method (MODI)
• MODI is a modified version of the stepping-stone method in which math

equations replace the stepping-stone paths
• In the table, the extra left-hand column with the ui symbols and the extra
top row with the vj symbols represent values that must be computed.
• Computed for all cells with allocations: ui + vj = cij = unit

transportation cost for cell ij.

MODI method example
The minimum cell method was used to find the initial basic
feasible solution
MODI method example
Formulas for cells containing

allocations:
x1B: u1 + vB = 8
x1C: u1 + vC = 10
x2C: u2 + vC = 11
x3A: u3 + vA = 4
x3B: u3 + vB = 5
Five equations with 6 unknowns, therefore
let u1 = 0 and solve to obtain:
vB = 8, vC = 10, u2 = 1, u3 = -3, vA= 7

MODI example
- Use following to evaluate all empty cells:

cij - ui - vj = kij
where kij equals the cost increase or
decrease that would occur by allocating to
a cell.
- For the empty cells in the previous Table:
x1A: k1A = c1A - u1 - vA = 6 - 0 - 7 = -1
x2A: k2A = c2A - u2 - vA = 7 - 1 - 7 = -1
x2B: k2B = c2B - u2 - vB = 11- 1 - 8 = +2
x3C: k3C = c3C - u3 -vC = 12 - (-3) - 10 = +5

The Modified Distribution Method (MOD)
After each allocation to an empty cell, the
ui and vj values must be recomputed.
Again as follows cij - ui - vj = kij: empty cell
- Formulas for cells containing allocations:
- Use following to evaluate all empty cells:
x1B: u1 + vA = 6
cij - ui - vj = kij
x1C: u1 + vC = 10 where kij equals the cost increase or decrease that
would occur by allocating to a cell.
x2C: u2 + vC = 11
• For the empty cells in the previous Table :
x3A: u3 + vA = 4 x1B: k1B = c1A - u1 - vB = 8 - 0 - 7 = 1
x3B: u3 + vB = 5 x2A: k2A = c2A - u2 - vA = 7 - 1 - 6 = 1
Five equations with 6 unknowns, therefore let u1 = x2B: k2B = c2B - u2 - vB = 11- 1 - 7 = +3
0 and solve to obtain: x3C: k3C = c3C - u3 -vC = 12 - (-2) - 10 = +4
vB = 7, vC = 10, u2 = 1, u3 = -2, vA= 6 All result of cij - ui - vj are positive and no need of further
improvement. Therefore , the optimum solution is in the
next slide

MODI----

Exercise1
• Find initial feasible solution using Northwest cost method and test
optimality using UV method

Exercise
The ruck Rental firm has accumulated extra trucks at three of its
truck leasing outlets, as shown in the following table:
The firm also has four outlets with shortages of rental trucks, as follows:

Exercise continue---
The firm wants to transfer trucks from those outlets with extras to those with
shortages at the minimum total cost. The following costs of transporting these
trucks from city to city have been
determined:
To( cost in Birr )

From A B C D
1 70 80 45 90
2 120 70 30 75
3 110 60 70 80
a. Find the initial basic feasible solution using list cost method
b. Find the optimal solution using stepping stone and UV methods

Chapter one
MANAGEMENT SCIENCE:
INTRODUCTION
MANAGEMENT SCIENCE: Introduction
Contents to be covered are:
• Definition of management science

• Problem Solving and Decision Making
• Quantitative Analysis and Decision Making
• Quantitative Analysis
• Models of Cost, Revenue, and Profit
• Quantitative Methods in Practice
• The Management Scientist
Management science
• Quantitative methods for business involve

rational approaches to decision making based
on the scientific method of problem solving.
• Also called operations research or decision
science.
• It had its early roots in World War II and is
flourishing in business and industry with the
aid of computers.
Problem Solving and Decision Making
• Problem solving can be defined as the process of identifying a

difference between the actual and the desired state of affairs and
then taking action to resolve the difference
• the problem solving process involves the following seven steps:

Problem Solving and Decision Making
(First 5 steps are the process of decision making)

– Identify and define the problem.
– Determine the set of alternative solutions.
– Determine the criteria for evaluating the alternatives.
– Evaluate the alternatives.
– Choose an alternative.
---------------------------------------------------------------------
– Implement the chosen alternative.
– Evaluate the results.
Example of decision making process
1. For the moment assume that you are currently
unemployed and that you would like a position that will
lead to a satisfying career. Suppose that your job search has
resulted in offers from companies in Jimma, AA, Adama,
and Diredawa,
2. Thus, the alternatives for your decision problem can be

stated as follows: next----
Example-----
1. Accept the position in Jimma.
2. Accept the position in AA.
3. Accept the position in Adama.
4. Accept the position in Dire Dawa
Example
3. determining the criteria that will be used to evaluate the four
alternatives.
Example, if salary is the only criteria of some importance, the

alternative selected as ―best‖ would be the one with the highest starting
salary.
Problems in which the objective is to find the best solution with respect
to one criterion are referred to as single-criterion decision problems.
Example
• Problems that involve more than one criterion are referred
to as multicriteria decision problems. For example
starting salary, potential for advancement, and location
4. The next step of the decision-making process is to
evaluate each of the alternatives with respect to each
criterion.
Example
Alternative Starting salary potential for Location
advancement
Jimma 48,000 Average Average

AA 46,000 Good Good
Adama 46,000 Good Excellent
Dire Dawa 47,000 Average Good
The relationship between problem
solving and decision making
Quantitative Analysis and Decision Making
• the first three steps of the decision-making process is

―Structuring the Problem‖
• the latter two steps under the heading ―Analyzing the
Problem.”
• the analysis phase of the decision-making process may
take two basic forms: qualitative and quantitative.
• Qualitative analysis is based primarily on the manager’s

judgment and experience; it includes the manager’s
intuitive ―feel‖ for the problem and is more an art than a
science.
The role of qualitative and quantitative analysis
Potential Reasons for a Quantitative Analysis Approach to

Decision Making
– The problem is complex, and the manager cannot develop a
good solution without the aid of quantitative analysis.
– The problem is especially important (e.g., a great deal of

money is involved), and the manager desires a thorough
analysis before attempting to make a decision.
– The problem is new, and the manager has no previous

experience from which to draw.
– The problem is repetitive, and the manager saves time and

Quantitative Analysis process
– Model Development
– Data Preparation
– Model Solution
– Report Generation
Model Development
• Models are representations of real objects or situations.
• Three forms of models are iconic, analog, and
mathematical.
1. Iconic models are physical replicas (scalar

representations) of real objects.
– The model airplane and toy truck are examples of

models that are physical replicas of real objects
Model Development
– Analog models are physical in form, but do not

physically resemble the object being modeled.
The speedometer of an automobile is an analog model;

the position of the needle on the dial represents the speed
of the automobile. A thermometer is another analog model
representing temperature
Model Development
Mathematical models represent real world problems through a
system of mathematical formulas and expressions based on key
assumptions, estimates, or statistical analyses.
• For example, the total profit from the sale of a product can be determined by
multiplying the profit per unit by the quantity sold. If we let x represent the
number of units sold and P the total profit, then, with a profit of $10 per unit,
the following mathematical model defines the total profit earned by selling x
units:
P = 10x
Advantages of Models
• value, of any model is that it enables us to make
inferences about the real situation by studying and
analyzing the model
• Generally, experimenting with models (compared to
experimenting with the real situation):
– requires less time
– is less expensive
– involves less risk
Mathematical Models
• Points that should be considered in mathematical
model are:
• Decision variables
• Objective function
• Constraints
• Stochastic( probabilistic) model
• Deterministic model
• Optimal solution
• Etc --
Mathematical Models
• Relate decision variables (controllable inputs to the model)
with fixed or variable parameters (uncontrollable inputs).
• Are said to be stochastic( probabilistic) if any of the
uncontrollable inputs is subject to variation, otherwise are
said to be deterministic.
• Generally, stochastic models are more difficult to analyze.
• The values of the decision variables that provide the
mathematically-best output are referred to as the optimal
solution for the model.
Transforming Model Inputs into
If they are known with
certainty and fixed the Output If they are vary and
uncertain the model is
model is called called Stochastic model
Deterministic model Uncontrollable Inputs
(Environmental Factors) Example: demand
Example: corporate
income tax
Controllable
Mathematical Output
Inputs
Model (Projected Results)
(Decision Variables)
Decision
alternatives
Example of simple mathematical
model of production: linear
programming
Objective function
• A mathematical expression that describes the problem’s
objective.
• It can be profit maximization or cost minimization
For example, the profit equation P =10x would be

an objective function for a firm attempting to
maximize profit.
Example
Constraints
• A production capacity constraint would be
necessary if, for instance, 5 hours are required to produce each unit and
only 40 hours of production time are available per week. Let x indicate the
number of units produced each week. The production time constraint is
given by
5x ≤ 40
The value of 5x is the total time required to produce x units; the symbol ≤
indicates that the production time required must be less than or equal to the
40 hours available
Example
• The decision problem or question is the following: How many
units of the product should be scheduled each week to
maximize profit?
• A complete mathematical model for this simple production

problem is
Example
• The x ≥ 0 constraint requires the production quantity x to be greater
than or equal to zero, which simply recognizes the fact that it is not
possible to manufacture a negative
number of units
• The optimal solution to this model can be easily calculated and is

given by x ꞊ 8, with an associated profit of $80
Example: Project Scheduling
Consider a construction company building a 250-
unit apartment complex. The project consists of
hundreds of activities involving excavating, framing,
wiring, plastering, painting, landscaping, and more.
Some of the activities must be done sequentially and
others can be done simultaneously. Also, some of the
activities can be completed faster than normal by
purchasing additional resources (workers, equipment,
etc.).
What is the best schedule for the activities and for
which activities should additional resources be
purchased?
• Question:
How could management science be used to
solve this problem?
• Answer:
Management science can provide a
structured, quantitative approach for determining
the minimum project completion time based on
the activities' normal times and then based on
the activities' expedited (reduced) times.
• Question:
What would be the uncontrollable inputs?
• Answer:
– Normal and expedited activity completion times
– Activity expediting costs
– Funds available for expediting
– Precedence relationships of the activities
• Question:
What would be the decision variables of the
mathematical model? The objective function? The
constraints?
• Answer:
– Decision variables: which activities to expedite and by how
much, and when to start each activity
– Objective function: minimize project completion time
– Constraints: do not violate any activity precedence relationships
and do not expedite in excess of the funds available.
• Question:
Is the model deterministic or stochastic?
• Answer:
Stochastic. Activity completion times, both
normal and expedited, are uncertain and subject to
variation. Activity expediting costs are uncertain.
The number of activities and their precedence
relationships might change before the project is
completed due to a project design change.
• Question:
Suggest assumptions that could be made to
simplify the model.
• Answer:
Make the model deterministic by assuming
normal and expedited activity times are known
with certainty and are constant. The same
assumption might be made about the other
stochastic, uncontrollable inputs.
Data Preparation
• Data in this sense refer to the values of the uncontrollable
inputs to the model.
• All must be specified before we can analyze the model and

recommend a decision or solution for the problem.
Two alternatives
1. Prepare the data and develop the model are considered as

one step as of the production model specified
• In the production model above , the values of the

uncontrollable inputs or data were $10 per unit for profit, 5
Data Preparation
2. in many mathematical modeling situations, the data or
uncontrollable input values are not readily available.
Rather than attempting to collect the required data as the model

is being developed, the analyst will usually adopt a general
notation for the model development
step, and then a separate data preparation step will be performed
to obtain the uncontrollable input values required by the model.
Data Preparation
• A separate data preparation step to identify the values for c, a, and b would then be necessary
to complete the model.
Model Solution
• Involves identifying the values of the decision
variables that provide the “best” output for
the model.
• One approach is trial-and-error.
– might not provide the best solution
– inefficient (numerous calculations required)
Computer Software
• A variety of software packages are available
for solving mathematical models.
– Spreadsheet packages such as Microsoft Excel
– The Management Scientist, developed by the
textbook authors
Model Testing and Validation
• Often, the goodness/accuracy of a model cannot be
assessed until solutions are generated.
• Small test problems having known, or at least expected,
solutions can be used for model testing and validation.
• If the model generates expected solutions:
– use the model on the full-scale problem.
• If inaccuracies or potential shortcomings inherent in the
model are identified, take corrective action such as:
– collection of more-accurate input data
– modification of the model
Report Generation
• A managerial report, based on the results of the
model, should be prepared.
• The report should be easily understood by the
decision maker.
• The report should include:
– the recommended decision
– other pertinent information about the results (for
example, how sensitive the model solution is to the
assumptions and data used in the model)
Implementation and Follow-Up
• Successful implementation of model results is of
critical importance.
• Secure as much user involvement as possible
throughout the modeling process.
• Continue to monitor the contribution of the
model.
• It might be necessary to refine or expand the
model.
MODELS OF COST, REVENUE, AND PROFIT
Cost and Volume Models
The cost of manufacturing or producing a product is a function of the

volume produced.
This cost can usually be defined as a sum of two costs: fixed cost and
variable cost.
Fixed cost is the portion of the total cost that does not depend on the
production volume; this cost remains the same no matter how much is
produced.
Variable cost, on the other hand, is the portion of the total cost that is
dependent on and varies with the production volume.
Cost model
• Suppose that the setup cost to produce CD-50 is $3000. This setup cost is a
fixed cost that is incurred regardless of the number of units eventually
produced. In addition, suppose that variable labor and material costs are $2
for each unit produced. The cost-volume model for producing x units of the
CD-50 can be written as
C(x)=3000+2x
For example, the decision to produce x=1200 units would result in a

total cost of C(1200) = 3000 + 2(1200) = $5400.
Cost model
• Marginal cost is defined as the rate of change of the total
cost with respect to production volume. That is, it is the cost
increase associated with a one-unit increase in the production
volume.
• In the cost model we see that the total cost C(x) will increase
by $2 for each unit increase in the production volume. Thus,
the marginal cost is $2.
Revenue and Volume Models
Suppose that each CD-50 storage unit sells for $5. The model for
total revenue can be written as
R(x) = 5x
x =sales volume in units
R(x) = total revenue associated with selling x units
Marginal revenue is defined as the rate of change of total

revenue with respect to sales volume.
That is, it is the increase in total revenue resulting from a one-

unit increase in sales volume. we see that the marginal revenue
is $5.
Profit and Volume Models
• Total profit, denoted P(x), is total revenue minus total cost;
therefore, the following model provides the total profit
associated with producing and selling x units:
P(x) = R(x) - C(x)

= 5x - (3000 + 2x) = -3000 + 3x
Breakeven Analysis
MANAGEMENT SCIENCE TECHNIQUES
• Linear Programming
• Distribution and Network Models
• Project Scheduling: PERT/CPM
• Inventory Models
• Waiting-Line or Queueing Models
• Simulation
• Decision Analysis
• Forecasting
• Markov Process Models
LINEAR PROGRAMMING: SENSITIVITY
ANALYSIS
SENSITIVITY ANALYSIS
 In all LP models the coefficient of the objective function and the
constraints are supplied as input data or as parameters to the model ·
 The optimal solutions obtained is based on the values of these
coefficients·
 In practice the values of these coefficients are seldom known with
absolute certainty. That means
 Optimal solutions to LP problems have been examined under deterministic
assumptions. However, conditions in most real world situations are
dynamic and changing.
 After an optimal solution to a problem is found, input data values are
varied to assess optimal solution sensitivity.
 This process is also referred to as sensitivity analysis or post-
optimality analysis.
Sensitivity analysis
 Sensitivity analysis (or post-optimality analysis) is used to
determine how the optimal solution is affected by changes, within
specified ranges, in:
 the objective function coefficients
 the right-hand side (RHS) values
 Sensitivity analysis is important to the manager who must
operate in a dynamic environment with imprecise estimates of
the coefficients.
 Sensitivity analysis allows him to ask certain what-if questions

about the problem
SENSITIVITY ANALYSIS
 Changes may be reactions to anticipated uncertainties in the
parameters or the new or changed information concerning the
model
 Each variation in the values of the data coefficients changes the
LP problem which may in turn affect the optimal solution found
earlier· Sensitivity analysis helps to study how the optimal
solution will change with changes in the input coefficients
The Role of Sensitivity Analysis of the Optimal Solution
Possible reasons for asking this question:

Parameter values used were only best estimates.
Dynamic environment may cause changes.
“What-if” analysis may provide economical and
operational information.
Sensitivity Analysis of Objective Function Coefficients.
Ranges of Optimality: The Objective Function Coefficients

The value of the objective function will change if the
coefficient multiplies a variable whose value is nonzero.
The optimal solution will remain unchanged as long as:
an objective function coefficient lies within its range of
optimality
there are no changes in any other input parameters.
• The optimality range for an objective coefficient is the
range of values over which the current optimal solution
point will remain optimal
• For two variable LP problems, the optimality ranges of

objective function coefficients can be found by setting
the slope of the objective function equal to the slopes of
each of the binding constraints
Sensitivity Analysis Using Graphs
Example 1
Maximize Z = $40x1 + $50x2

subject to: 1x1 + 2x2  40
4x2 + 3x2  120
x1, x2  0
Sensitivity Analysis Using Graphs that shows change of the optimal solution because
of change in coefficient (c1)of objective function beyond the range of optimality
Example

4x2 + 3x2  120
x1, x2  0
Sensitivity Analysis Using Graphs that shows change of the optimal solution
because of change in coefficient (c2)of objective function beyond the range of
optimality
Example

4x1 + 3x2  120
x1, x2  0
How to determine Range of Optimality values over which the current optimal
solution point will remain optimal
• Graphically, the limits of a range of optimality are

found by changing the slope of the objective function line
within the limits of the slopes of the binding constraint
lines.
The slope of an objective function line, Max= c1x1 + c2x2,
is -c1/c2, and the slope of a constraint, a1x1 + a2x2 = b, is -
a1/a2
How?
Range of Optimality for c1
• The slope of the objective function line is -c1/c2
• The slope of the first binding constraint, 1x1 + 2x2 = 40, is -1/2
• The slope of the second binding constraint, 4x1 + 3x2 =120, is -4/3
• Find the range of values for c1 (with c2 staying 50 ) such that the objective function line slope lies between that
of the two binding constraints: -1/2 ≥ -c1/50 ≥ -4/3
Multiplying through by -50 (and reversing the inequalities):
25  c1  66.67
How?
Range of Optimality for c2
• Find the range of values for c2 ( with c1 staying 40) such that the
objective function line slope lies between that of the two binding
constraints:
-1/2 ≥-40/c2 ≥ -4/3
Multiplied by -2, 1 ≤ 80/c2 ≤ 8/3
80 ≥ c2 ≥ 30
30  c2  80
With in this optimality range of c2 while c1 and other binging constraints are
constant, the original optimality value is not affected
Example2
Max z = 5x1 + 7x2
s.t. x1 < 6
2x1 + 3x2 < 19
x 1 + x2 < 8
x1, x2 > 0
1. Find the optimal solution?

2. Find range of optimality
Sensitivity-----
Sensitivity----------------
Sensitivity-------------
Sensitivity Analysis of Right Hand Side
Values
Sensitivity Analysis of
Right-Hand SideValues: shadow price
• The focus of sensitivity analysis for constraint quantity values is

to determine the range over which the constraint quantity values
can change without changing the solution variable mix,
specifically including the slack variables.
 Any change in the right hand side of a binding constraint
will change the optimal solution.
Ranges of Optimality: Shadow Price
 A shadow price for a right hand side value (or resource limit)
is the amount the objective function will change per unit
increase in the right hand side value of a constraint.
 Graphically, a shadow price is determined by adding +1 to
the right hand side value in question and then resolving for
the optimal solution in terms of the binding constraints.
 The shadow price is equal to the difference in the values of
the objective functions between the new and original
problems.
 The shadow price for a non-binding constraint is 0.
Shadow price
 Mathematically, the shadow price is the rate of improvement in the
objective value per unit increase in a constraint right hand side(RHS).
 Economically, the shadow price measures the marginal benefit of

having one additional unit of a scarce resources.
 Therefore, depending on the cost per unit of the limited resource, you
use the shadow price to decide whether to buy one additional unit of
that resource
Example
Max z = 5x1 + 7x2
s.t. x1 < 6
2x1 + 3x2 < 19
x1 + x2 < 8
x1, x2 > 0
Example: Sensitivity Analysis:
shadow price
x2
• Graphical Solution
x +x < 8
8 1 2
Max 5x1 + 7x2
7
6 x1 < 6
5 Optimal x1 = 5, x2 = 3
4 z = 46
3
2x1 + 3x2 < 19
2
1 x1
1 2 3 4 5 6 7 8 9 10
Example: Sensitivity Analysis: shadow
price
Constraint 1: Since x1 < 6 is not a binding constraint,
its shadow price is 0.
Constraint 2: Change the RHS value of the second
constraint to 20 and resolve for the optimal point
determined by the last two constraints:
2x1 + 3x2 = 20 and x1 + x2 = 8.
The solution is x1 = 4, x2 = 4, z = 48. Hence, the
shadow price = znew - zold = 48 - 46 = 2.
Example: Sensitivity Analysis: shadow price
Constraint 3: Change the RHS value of the third

constraint to 9 and resolve for the
optimal point determined by the last two
constraints:
2x1 + 3x2 = 19 and x1 + x2 = 9.
The solution is: x1 = 8, x2 = 1, z = 47. Hence,
the shadow price is znew - zold = 47 - 46 = 1.
Example
Example
Example
Example
Example
Example
Chapter 4
Decision Analysis
MB, BECO, Jimma University Supplement 1-207

Components of decision making
States of nature
– Events that may occur in the future
– Examples of states of nature:
• high or low demand for a product
• good or bad economic conditions
Payoff table
 is a means of organizing a decision situation, including
the payoffs from different decisions, given the various
states of nature.

Components of decision making
Payoff
– outcome of a decision
States Of Nature
Decision a b
1 Payoff 1a Payoff 1b
2 Payoff 2a Payoff 2b
Decision-making Environment
• The decision-making problems can be discussed

under the following heads on the basis of their
environments:
Decision-making under certainty
Decision-making under uncertainty
Decision-making under risk

The decision-maker
 knows with certainty the consequences of every alternative or decision
choice.
 presumes that only one state of nature is relevant for his purpose.
 identifies this state of nature, takes it for granted and presumes
complete knowledge as to its occurrence.
 will choose the alternative that will maximize his/her well-being or will result
in the best outcome.

Example
let’s say that you have $1,000 to invest for a 1-year period.
One alternative is to open a savings account paying 6%
interest and another is to invest in a government Treasury
bond paying 10% interest. If both investments are secure and
guaranteed, there is a certainty that the Treasury bond will
pay a higher return. The return after one year will be $100 in
interest.

Decision Making under uncertainty
Did you decide before without any means to arrive at

probability values to the likelihood of outcomes
occurrence?

Decision Making under uncertainty
• When the decision-maker faces multiple states of nature but he/she

has no means to arrive at probability values to the likelihood of
occurrence of these states of nature,
Example, when a new product is introduced in the market or a new

plant is set up. In business, there are many problems of this ‘nature’.
• the choice of decision largely depends on
the personality of the decision-maker

Decision Making Criteria Under Uncertainty
The following are some of the available criteria in such

environment:
1. Maximax Criterion
2. Maximin Criterion
3. Hurwicz Alpha Criterion (Criterion of Realism)
4. Laplace Criterion (Criterion of equally likelihood)
5. Minimax Criterion
6.

Example to analyze the criteria
• All the above criteria will be conceptualized based on an investor
decision case
An investor is to purchase one of three types of real estate, The investor must decide
among an apartment building, an office building, and a warehouse. The future
states of nature that will determine how much profit the investor will make are good
economic conditions and poor economic conditions. The profits that will result from
each decision in the event of each state of nature are shown in next Table

Maximax Criterion
• The decision maker selects the decision that will result in the maximum
of the maximum payoffs.
• this is how this criterion derives its name—a maximum
of a maximum.
• The maximax criterion is very optimistic.
– The decision maker assumes that the most favorable state of nature
for each decision alternative will occur.
• Thus, for example, using this criterion, the investor would optimistically
assume that good economic conditions will prevail in the future

Maximax Criterion
• The decision maker first selects the maximum

payoff for each decision. All three maximum
payoffs occur under good economic conditions

Maximax Criterion
• Although the decision to purchase an office building will

result in the largest payoff ($100,000), such a decision
completely ignores the possibility of a potential loss of
$40,000.
• If the payoff table consisted of costs, the opposite selection
would be indicated: the minimum of the minimum costs, or
a minimin criterion.
.

Example two
State of nature
Decisions S1 S2 S3
A 220 160 140

B 180 190 170
C 100 190 200
Maximum under each decision are (220, 190, 200). The maximum of these three
maximums is 220. Consequently, according to the maximax criteria the decision to
be adopted is A

The Maximin Criterion
• In the maximin criterion the decision maker is
pessimistic about the future state of nature
• For each decision alternative, the decision maker
assumes that the minimum payoff will occur. Of
these minimum payoffs, the maximum is selected


• The minimum payoffs for our example are 30,000, -40,000 and
$10,000. The maximum of these three payoffs is $30,000; thus, the
decision arrived at by using the maximin criterion would be to
purchase the apartment building.
• If the table contained costs instead of profits as the payoffs, the
conservative approach would be to select the maximum cost for
each decision. Then the decision that resulted in the minimum, the
minimax, of these costs would be selected

Example
Minimum under each decision are respectively

–80 –60 –20. The action A3 is to be taken according to this criterion because it is the
maximum among minimums.
The Hurwicz Criterion (Criterion of Realism
• The Hurwicz criterion is a compromise between the
maximax and maximin criteria.
• The principle underlying this decision criterion is that the
decision maker is neither totally optimistic (as the maximax
criterion assumes) nor totally pessimistic (as the maximin
criterion
assumes)

Realism Criterion--------
How to reach such decision?
• The decision payoffs are weighted by a coefficient of optimism, a measure of the
decision maker’s optimism. The coefficient of optimism, which we will define as is
between zero and one (i.e. 0 ≤ a ≤ 1).
• If a = 1 then the decision maker is said to be completely optimistic; if a = 0 then the
decision maker is completely
pessimistic.
• if a is the coefficient of optimism, 1 – a is the coefficient
of pessimism.)

Realism Criterion-----------
• For each decision alternative, the maximum payoff be multiplied by a
and the minimum payoff be multiplied by 1 – a
• If a equals 0.4 (i.e., the investor is slightly pessimistic), 1-a = 0.6, and the following
values will result:
• Thus, the decision would be to purchase the apartment building.

The Hurwicz Criterion Example 2

The Equal Likelihood Criterion
• When the maximax criterion is applied to a decision situation, the

decision maker implicitly assumes that the most favorable state of
nature for each decision will occur.
• Alternatively, when the maximin criterion is applied, the least
favorable states of nature are assumed.
• The equal likelihood, or LaPlace, criterion weights each state of
nature equally, thus assuming that the states
of nature are equally likely to occur

The Equal Likelihood Criterion
• Because there are two states of nature in our example,

we assign a weight of 0.50 to each one.
• We select the decision that has the maximum of these

weighted values. Because $40,000 is the highest weighted value,
the investor’s decision would be to purchase the apartment
building.

Example

Solution

The Minimax Regret Criterion
• Regret is the difference between the payoff from the best
decision and all other decision payoffs.
• The minimax regret criterion minimizes the maximum

regret

• In our example, suppose the investor decided to purchase the

warehouse, only to discover that economic conditions in the
future were better than expected. Naturally, the investor would be
disappointed that she had not purchased the office building
because it would have resulted in the largest payoff ($100,000)
under good economic conditions. In fact, the investor would regret
the decision to purchase the warehouse, and the degree of regret
would be $70,000, the difference between the payoff for the
investor’s choice and the best choice.

How to use such regret criterion?
• A decision maker first selects the maximum payoff under each state of nature
and subtract the other payoffs from the maximum in their respective state of
nature
• This is in the following minimax regret( opportunity loss table)


• The decision should be to purchase the apartment
building rather than the office building or the warehouse.
• This particular decision is based on the philosophy that the
investor will experience the least amount of regret by purchasing
the apartment building.
• if the investor purchased either the office building or the
warehouse, $70,000 worth of regret could result; however, the
purchase of the apartment building will result in, at most,
$50,000 in regret.

Example

Exercise
Payoff table
S1 S2 S3
A1 20 25 30
A2 12 15 20
A3 25 30 22
Opportunity loss Table

S1 S2 S3
A1 5 5 0
A2 13 15 10
A3 0 0 8
The maximum losses incurred by the decisions are 13, 15, and 10. The minimum
of Jimma
MB, BECO, theseUniversity
is 10. thus, the decision Supplement
maker should
1-240 take action A2
Decision Making with Probabilities
• It is often possible for the decision maker to know

enough about the future states of nature to assign
probabilities to their occurrence.
• It is also called decision making under risk

Decision Making with Probabilities
• Two of the criteria under here are:

1. Expected Monetary value
2. Expected opportunity loss
3. Expected value of perfect Information

Expected Monetary Value
• the decision maker must first estimate the

probability of occurrence of each state of nature.
• Then the expected value for each decision alternative
can be computed.
– The expected value is computed by multiplying each outcome (of a
decision) by the probability of its occurrence and then summing
these products

Expected Monetary Value
• Using our real estate investment example, let us

suppose that, based on several economic
forecasts, the investor is able to estimate a 0.60
probability that good economic conditions will
prevail and a 0.40 probability that poor economic
conditions will prevail.

Expected value
• The best decision is the one with the greatest expected
value.
• Because the greatest expected value is $44,000, the best
decision is to purchase the office building.
• The expected value means that if this decision situation
occurred a large number of times, an average payoff of
$44,000 would result.
• Alternatively, if the payoffs were in terms of costs,
the best decision would be the one with the lowest
expected value

Expected Opportunity Loss
• To use this criterion, we multiply the probabilities by the

regret (i.e., opportunity loss) for each decision outcome
rather than multiplying the decision outcomes by the
probabilities of their occurrence, as we did for expected
monetary value.
• First we need to develop opportunity loss( regret table),
then we find expected opportunity loss. As follows:

First : Find the opportunity loss, then expected opportunity loss

Because $28,000 is the minimum expected regret, the decision is to purchase the
office building

Expected Value of Perfect Information
• EVPI
– maximum value of perfect information to
the decision maker
– Maximum amount that would be paid to
gain information that would result in a
decision better than the one made without
perfect information
Expected Value of Perfect Information(EVIP)
• is the average (expected) return in the long run, if we have

perfect information before a decision is to be made.
• EVPI is the expected outcome with perfect information

minus the outcome with max EMV.
EVPI = Expected value with perfect information – max.
EMV
Consider the following example.

Example:
A1, A2, A3 are the acts and S1, S2, S3 are the states
of nature. Also, known that P(S1) = .5, P(S2) = .4
and P(S3) = .1
Solution: Pay-off table is as follows:


Exercise
You are given the following pay-offs of three acts A1,
A2 and A3, and the states of nature S1, S2 and S3.

Exercise2
• A management is faced with the problem of
choosing one of the products for manufacturing.
The probability matrix after market research for
the two products was as follows.
Next slide

Decision Trees
• A decision tree is a diagram consisting of
square decision nodes, circle probability nodes,
and branches representing
decision alternatives
• In a decision tree, the user computes the expected
value of each outcome and makes a decision based
on these expected values.

Decision Trees
• The primary benefit of a decision tree is that it

provides an illustration (or picture) of the decision-
making process.
• This makes it easier to correctly compute the
necessary expected values and to understand the
process of making the decision.

Decision Trees
• The circles (●) and the square (■) in the following

figure are referred to as nodes.
• The square is a decision node, and the branches
emanating from a decision node reflect the
alternative decisions possible at that point

Pay off table with probabilities

Decision Trees
• Determining the best decision by using a
decision tree involves computing the
expected value at each probability node.
This is accomplished by starting with the
final outcomes (payoffs) and working
backward through the decision tree toward
node 1.

Decision Trees
• First, the expected value of the payoffs is
computed at each probability node:

Decision Trees
• Each of these three expected values at nodes 2, 3, and 4 is

the outcome of a possible decision that can occur at node 1.
• Moving toward node 1, we select the branch that comes
from the probability node with the highest expected payoff.
• In the above example the branch corresponding to the
highest payoff, $44,000, is from node 1 to node 3. This
branch represents the decision to purchase the office
building.

Decision Trees
• The decision to purchase the office building, with an
expected payoff of $44,000, is the same result we achieved
earlier by using the expected value criterion.

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Introduction to

 Quantitative analysis is the scientific approach

Profit per unit $ 60 $50

resources .these( daily) amounts are:

Resource Amount available

Number of Total annual Corresponding

2 15,000 301 t0 600

3 20,000 601 to 900

By the end of this unit you will be able to:

• Resources to be optimally allocated usually involve a given

• Most common objective of the transportation problem is to

 Example would be a warehouse where shipments

 It may be possible for a firm to achieve cost savings

A product is to be transported from a number of sources

Transportation Costs Per Desk

XDA + XDB + XDC = 100 (Des Moines capacity)

XDA + XEA + XFA = 300 (Albuquerque demand) and

Problem: How many tons of wheat to transport from each grain

Minimize Z = 6x1A + 8x1B + 10x1C + 7x2A + 11x2B + 11x2C +

• It has three plants in: Cleveland, Detroit, Greensboro.

• It has four distribution centers in:

• Management at Carlton would like to ship cases of a

1. Show the network

When demand is greater than supply

Formulate linear programming model of the above

• If supply exceeds demand then a dummy destination is added which

 The transportation problem is solved in two phases:

MB, BECO, Jimma University 89

• The initial solution is complete when all rim requirements

The complete initial minimum cell cost solution; total

• Begin with computing each row and column a penalty.

MB, BECO, Jimma University 98

The initial VAM solution; total cost = $5,125

The Initial VAM

1. Determine the penalty cost for each row and column.

• Find the initial feasible solution using northwest corner method,

MB, BECO, Jimma University 103

• What is the initial feasible solution of the above example

Find the initial feasible solution of the following

MB, BECO, Jimma University 105

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MB, BECO, Jimma University 107

Basic feasible solution to a transportation problem

MB, BECO, Jimma University 108

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The stepping-stone method determines if there is a cell with no

MB, BECO, Jimma University 110

• Negative sign indicates a cost reduction can be made by

MB, BECO, Jimma University 111

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MB, BECO, Jimma University 114

The answer is 4525

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• MODI is a modified version of the stepping-stone method in which math

• Computed for all cells with allocations: ui + vj = cij = unit

MB, BECO, Jimma University 118

Formulas for cells containing

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- Use following to evaluate all empty cells:

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