Welcome to BA 452 Analysis

Quantitative

Getting acquainted What is Quantitative Analysis? Quantitative Analysis applies linear programming, game theory, queuing models, simulation, and decision theory to help managers make decisions. It emphasizes formulating and solving complex decision problems, and so differs from anticipating changes in simplified decision problems in Managerial Economics (BA 445).

BA 452 Lesson I.1 Formulating Linear Programs

Welcome to BA 452 Analysis

Quantitative

Getting started Read and bookmark the online course syllabus: http://faculty.pepperdine.edu/jburke2/ba452/index.htm It provides review questions for each lesson, and serves as a contract specifying our obligations to each other. In particular, note: Linear Algebra (solve 2 equations for 2 variables), Calculus (take a derivative), and Introduction to Microeconomics are prerequisites, so review as needed. Before each class meeting, download and read the PowerPoint lesson, as presented under the Schedule link. Have a laptop with Management Scientist installed
BA 452 Lesson I.1 Formulating Linear Programs 2

Readings

Readings
For each lesson, you can use either the 12th edition or the 13th edition of the Anderson, Sweeney, Williams, text. For the first lesson in Part I (Lesson I.1), read Chapter 1

BA 452 Lesson I.1 Formulating Linear Programs

Overview

Overview

BA 452 Lesson I.1 Formulating Linear Programs

Overview
Quantitative Analysis applies linear and nonlinear programming, game theory, queuing models, simulation, and decision theory to help managers make profitable decisions. Linear Programming Problems in managerial applications often maximize profit, which equals revenue from outputs minus cost of inputs. Profit is a linear function of output and input decision variables. Resource Allocation Problems are Linear Programming Profit Maximization problems when available input resources are fixed. The opportunity cost of resources define willingness to pay for inputs. Portfolio Selection Problems help financial managers select specific investments (stocks, bonds, ) to generate returns to either maximize expected return or minimize risk.

BA 452 Lesson I.1 Formulating Linear Programs

Quantitative Analysis

Quantitative Analysis

BA 452 Lesson I.1 Formulating Linear Programs

Quantitative Analysis

Overview Quantitative Analysis applies linear and nonlinear programming, game theory, queuing models, simulation, and decision theory to help managers make profitable decisions.

BA 452 Lesson I.1 Formulating Linear Programs

Quantitative Analysis

The Harris Corporation

s s

Major electronics company in Melbourne, FL. Developed a computerized optimization-based production planning system. Benefits: On-time deliveries increased from 75% to 95%. Expanded markets and market share. Increased profits by $115 million annually.

BA 452 Lesson I.1 Formulating Linear Programs

Quantitative Analysis

KeyCorp One of the largest bank holding companies in the US ($66.8 billion in assets). s Developed a system to measure branch activities, customer wait times, teller productivity. sBenefits: Customer processing time reduced 53%. Customer wait time reduced. Cost savings of $98 million over 5 years.
s

BA 452 Lesson I.1 Formulating Linear Programs

Quantitative Analysis

NYNEX Major telecommunications provider (16.5 million customers worldwide). s Developed optimization techniques for network planning. sBenefits: Improved quality and reliability of network plans. Savings of $33 million.
s

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Quantitative Analysis

The definition of a model:

s

Models are simplified versions of the things they represent. A useful model accurately represents the relevant or essential characteristics of the object or decision being studied. (Like a model airplane studied in a wind tunnel.)

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Quantitative Analysis

Good decisions vs. good outcomes:

sA structured, modeling approach to decision making helps

make good decisions, but cant guarantee good outcomes because of uncertainty (risk). Life insurance is often a good decision, even when it turns out you do not die that year. Other examples of good decisions with bad outcomes? Betting your retirement savings on 17 Black in Roulette is often a bad decision, even if it turns out 17 Black wins. Other examples of bad decisions with good outcomes?
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Linear Programming

Linear Programming

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Linear Programming

Overview Linear Programming Problems in managerial applications often maximize profit, which equals revenue from outputs minus cost of inputs. Profit is a linear function of output and input decision variables, and linear constraints restrict permissible decision variables. A key lesson of quantitative analysis is exposure to the variety of profitmaximization linear-programming problems.

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Linear Programming

First, profit-maximization linear-programming problems can vary by whether outputs are fixed or variable, or whether inputs are fixed or variable: sIn some problems, outputs are fixed (say, customers made reservations), so revenue is fixed and the objective of profit maximization reduces to the objective of cost minimization. sIn other problems, inputs are fixed (say, airlines make short-run decisions about using their fixed stock of planes), so cost is fixed and the objective of profit maximization reduces to the objective of revenue maximization.

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Linear Programming

Second, problems can vary by whether available input resources are fixed or whether additional inputs may be bought: sIn some problems, available input resources are fixed (say, firms make short-run decisions about how much labor to employ, from 0 up to a fixed maximum), so the problem is how to best allocate those resources to produce various outputs. sIn other problems, additional inputs may be bought, so the problem is to balance the productivity of an input and its cost. sIn still other problems, inputs can be either made or bought (say, Sony can either make parts for its televisions or buy parts).
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Linear Programming

Third, problems can vary by outputs and inputs are defined: sIn some problems, outputs have different physical characteristics (say, Toyota produces both cars and trucks). sIn other problems, outputs occur at different periods in time (say, Toyota produces cars for sale this year, and cars for sale next year). sIn other problems, outputs occur at different locations (say, Toyota offers cars for sale in the US, and cars for sale in Japan). Likewise, inputs can have different physical characteristics, occur at different periods in time, and occur at different locations

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Linear Programming

Many linear programming applications are interrelated, according to the following chart. For example, Assignment is a type of Transportation Problem, which in turn is a type of Transshipment Problem, which is a type of Resource Allocation Problem.
L i n e a r P r o g r a m P r o f i t M a x i m i z a R A P S s o u r M e a c l l o c a t i o n u e k e o r m i n g t i o n BB lu e y n d i n g

r o d u c t i Wo n o r k f o r c P e r o d c h e d u Ai n s gs i g n m l e Mn ti x

c t R e v e n uT er a n s s h M a n a g e m e n t T A r a n s p n

i p

o S r t h a o t i r o t en s t m e n t

s s i g

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Linear Programming

s s

Linear programming problems have constraints on pursuing the objective of maximization or minimization. A feasible solution satisfies all the constraints. An optimal solution (or optimum) is a feasible solution that results in the largest possible objective-function value when maximizing (or smallest when minimizing).

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Linear Programming

In a linear-programming problem, the objective function and the constraints are linear. Functions are linear when each variable appears in a separate term raised to the first power and is multiplied by a constant (which could be 0). Thus 5x1 + 7x2 is a linear function, but 5x12 +7x1x2 is not. Linear constraints (or, standard linear constraints) are linear functions that are restricted to be "less than or equal to", "equal to", or "greater than or equal to" a constant. Thus 2x1 + 3x2 < 19 is a linear constraint, but 2x1 + 3x2 < 19 and 2x1 + 3x1x2 < 19 are not.
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Linear Programming

The three steps to linear programming: s Formulate the linear programming problem. s Solve the problem, using either graphical or computer analysis. In BA 452 lectures, homeworks and exams, you will solve some simple LP problems graphically, for the purpose of introducing and better understanding the concepts. In BA 452 lectures, homeworks and exams, you will solve other complex LP problems by any means possible, including using program and spreadsheet templates stored on your laptop. s Interpret the solution.
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Linear Programming

Problem formulation (or modeling) is the translation of a verbal statement of a decision problem into a mathematical statement. Here are guidelines for linear programming problem formulation: Describe the objective. Describe each constraint. Define the decision variables. Write the objective in terms of the decision variables. Write the constraints in terms of the decision variables.

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Resource Allocation

Resource Allocation

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Resource Allocation

Overview Resource Allocation Problems are Linear Programming Profit Maximization problems when available input resources are fixed. Resource Allocation Problems thus help production managers allocate various fixed resources (labor, machine use, storage space, ) to produce various outputs (cars, trucks, ) to maximize profit or minimize cost. The opportunity cost of the scarce resources used in manufacture define the maximum willingness to pay if additional inputs became available.

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Resource Allocation

Question: Iron Works, Inc. seeks to maximize profit by making two products from steel. sIt just received this month's allocation of 19 pounds of steel. sIt takes 2 pounds of steel to make a unit of product 1, and 3 pounds of steel to make a unit of product 2. sThe physical plant has the capacity to make at most 6 units of product 1, and at most 8 units of total product (product 1 plus product 2). sProduct 1 has unit profit 5, and product 2 has unit profit 7. Formulate the linear program to maximize profit.

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Resource Allocation

Answer: Here is a mathematical formulation of the objective. sLet x1 and x2 denote this month's production level of product 1 and product 2. sThe total monthly profit = (profit per unit of product 1) x (monthly production of product 1) + (profit per unit of product 2) x (monthly production of product 2) = 5x1 + 7x2
sMaximize total monthly profit: Max 5x1

+ 7x2

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Resource Allocation Here is a mathematical formulation of constraints. s The total amount of steel used during monthly production = (steel used per unit of product 1) x (monthly production of product 1) + (steel used per unit of product 2) x (monthly production of product 2) = 2x1 + 3x2
s

That quantity must be less than or equal to the allocated 19 pounds of steel (the inequality < in the constraint below assumes excess steel can be freely disposed; if disposal is impossible, then use equality =) : 2x1 + 3x2 < 19 The constraint that the physical plant has the capacity to make at most 6 units of product 1 is formulated x1 < 6 The constraint that the physical plant has the capacity to make at most 8 units of total product (product 1 plus product 2) is x1 + x2 < 8
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Resource Allocation

Adding the non-negativity of production completes the formulation.

Max s.t. 5x1 + 7x2 x1 < 6

2x1 + 3x2 < 19 x1 + x2 < 8 x1 > 0 and x2 > 0

Objectiv e function Standard constraints Nonnegativity constraints

Max means maximize, and s.t. means subject to.

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Portfolio Selection

Portfolio Selection

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Portfolio Selection

Overview Portfolio Selection Problems help financial managers select specific investments (stocks, bonds, ) to generate returns to either maximize expected return or minimize risk. Constraints may restrict permissible investments by state laws or company policy, and restrict risk.

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Portfolio Selection

Question: Fidelity Investments manages funds for a variety of clients. The investment strategy is tailored to each clients needs. For a new client, Fidelity has been authorized to invest up to $1.2 million in two funds: a stock fund and a money market fund. Each unit of the stock fund costs $50 and returns an expected 10% annually. Each unit of the money market fund costs $100 and returns an expected 4% annually.

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Portfolio Selection

The client wants to minimize risk subject to the expected annual income is at least $60,000. According to Fidelitys risk measurement system, each unit invested in the stock fund has a risk index of 8, and each unit in the money market fund has index of 3. (A higher index indicates a riskier investment.) Fidelitys client also specified that at least $300,000 be invested in the money market fund. Formulate the linear program to minimize the total risk index of the portfolio.

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Portfolio Selection
Answer: s Define decision variables: S = number of units purchased in the stock fund 50S are the dollars invested in the stock fund 5S is the 10% return from the dollars invested in the stock fund M = number of units purchased in the money market fund 100M are the dollars invested in the money fund 4M is the 4% return from the dollars invested in the money fund s Define objective: Minimize 8S + 3M s Define constraints: 50S + 100M < 1,200,000 (Funds available) (Annual income) 5S + 4M > 60,000 (Minimum units in money market) M > 3,000 (Non-negativity) S, M > 0

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BA 452

Quantitative Analysis

End of Lesson I.1

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