Or Notes Mcom
Or Notes Mcom
Or Notes Mcom
Describe in details the OR approach of problem solving. What are the limitations of
the Operations Research?
Answer:
OR approach of problem solving:
Optimization is the act of obtaining the best result under any given
circumstance. In various practical problems we may have to take many technical
or managerial decisions at several stages. The ultimate goal of all such decisions
is to either maximize the desired benefit or minimize the effort required. We make
decisions in our every day life without even noticing them. Decision-making is
one of the main activities of a manager or executive.
In simple situations decisions are taken simply by common sense, sound
judgment and expertise without using any mathematics. But here the decisions we
are concerned with are rather complex and heavily loaded with responsibility.
Examples of such decision are finding the appropriate product mix when there are
large numbers of products with different profit contributions and production
requirement or planning public transportation network in a town having its own
layout of factories, apartments, blocks etc. Certainly in such situations also
decision may be arrived at intuitively from experience and common sense, yet
they are more judicious if backed up by mathematical reasoning.
The search of a decision may also be done by trial and error but such a search
may be cumbersome and costly. Preparative calculations may avoid long and
costly research. Doing preparative calculations is the purpose of Operations
research. Operations research does mathematical scoring of consequences of a
decision with the aim of optimizing the use of time, efforts and resources and
avoiding blunders.
The application of Operations research methods helps in making decisions in such
complicated situations. Evidently the main objective of Operations research is to
provide a scientific basis to the decision-makers for solving the problems
involving the interaction of various components of organization, by employing a
team of scientists from different disciplines, all working together for finding a
solution which is the best in the interest of the organization as a whole. The
solution thus obtained is known as optimal decision.
It is System oriented:
OR studies the problem from over all points of view of organizations or
situations since optimum result of one part of the system may not be optimum for
some other part.
It imbibes Inter disciplinary team approach:
Since no single individual can have a thorough knowledge of all fast
developing scientific know-how, personalities from different scientific and
managerial cadre form a team to solve the problem.
It makes use of Scientific methods to solve problems.
OR increases the effectiveness of a management Decision making ability.
It makes use of computer to solve large and complex problems.
It gives Quantitative solution.
It considers the human factors also.
The first and the most important requirement is that the root problem should be
identified and understood. The problem should be identified properly, this indicates
three major aspects:
A description of the goal or the objective of the study.
An identification of the decision alternative to the system.
Recognition of the limitations, restrictions and requirements of the system.
Limitations of OR:
The limitations are more related to the problems of model building, time and money
factors.
Magnitude of computation: Modern problem involve large number of variables
and hence to find interrelationship, among makes it difficult.
Non quantitative factors and Human emotional factor cannot be taken into
account.
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There is a wide gap between the managers and the operation researches.
Time and Money factors when the basic data is subjected to frequent changes then
incorporation of them into OR models are a costly affair.
Implementation of decisions involves human relations and behavior
It is System oriented: OR studies the problem from over all points of view of
organizations or situations since optimum result of one part of the system may not
be optimum for some other part.
It imbibes Inter disciplinary team approach. Since no single individual can
have a thorough knowledge of all fast developing scientific know-how,
personalities from different scientific and managerial cadre form a team to solve
the problem.
It makes use of Scientific methods to solve problems.
OR increases the effectiveness of a management Decision making ability.
It makes use of computer to solve large and complex problems.
It gives Quantitative solution.
It considers the human factors also.
The first and the most important requirement is that the root problem should be
identified and understood. The problem should be identified properly, this
indicates three major aspects:
(1) A description of the goal or the objective of the study,
(2) An identification of the decision alternative to the system, and
(3) A recognition of the limitations, restrictions and requirements of the system.
Limitations of OR
The limitations are more related to the problems of model building, time and
money factors.
Magnitude of computation: Modern problem involve large number of variables
and hence to find interrelationship, among makes it difficult.
Non quantitative factors and Human emotional factor cannot be taken into
account.
There is a wide gap between the managers and the operation researches.
Time and Money factors when the basic data is subjected to frequent changes
then incorporation of them into OR models are a costly affair.
Implementation of decisions involves human relations and behaviour
Operation Research is an aid for the executive in making his decisions by providing
him the needed quantitative information, based on scientific method analysis.
Discuss.
Answer:- The Operations Research may be regarded as a tool which is utilized to
increase the effectiveness of management decisions. In fact, OR is the objective feeling of
the administrator (decision-maker). Scientific method of OR is used to understand and
describe the phenomena of operating system.
OR models explain these phenomena as to what changes take place under altered
conditions, and control these predictions against new observations. For example, OR may
suggest the best locations for factories, warehouses as well as the most economical means
of transportation. In marketing, OR may help in indicating the most profitable type, use
and size of advertising campaigns subject to the final limitations.
The advantages of OR study approach in business and management decision making may
be classified as follows:
1. Better Control. The management of big concerns finds it much costly to provide
continuous executive supervisions over routine decisions. An OR approach directs the
executives to devote their attention to more pressing matters. For example, OR approach
deals with production scheduling and inventory control.
2. Better Co-ordination. Some times OR has been very useful in maintaining the law
and order situation out of chaos. For example, an OR based planning model becomes a
vehicle for coordinating marketing decisions with the limitation imposed on
manufacturing capabilities.
3. Better System. OR study is also initiated to analyses a particular problem of decision
making such as establishing a new warehouse. Later, OR approach can be further
developed into a system to be employed repeatedly. Consequently, the cost of
undertaking the first application may improve the profits.
4. Better Decisions. OR models frequently yield actions that do improve an intuitive
decision making. Sometimes, a situation may be so complicated that the human mind can
never hope to assimilate all the important factors without the help of OR and computer
analysis.
QUANTITATIVE TECHNIQUES OF OR:
A brief account of some of the important OR models providing needed quantitative
information base on scientific method analysis are given below:
1. Distribution (Allocation) Models: Distribution models are concerned with the
allotment of available resources so as to minimize cost or maximize profit subject to
prescribed restrictions. Methods for solving such type of problems are known as
mathematical programming techniques. We distinguish between liner and non-liner
programming problems on the basis of linearity and non-linearity of the objective
function and/or constraints respectively. In linear programming problems, the objective
function is linear and constraints are also linear inequalities/equations. Transportation and
Assignment models can be viewed as special cases of linear programming. These can be
solved by specially devised procedures called Transportation and Assignment
Techniques.
In case the decision variables in a linear programming problem are restricted to either
integer or zero-one value, it is known as Integer and Zero-One programming problems,
respectively. The problems having multiple, conflicting and incommensurable objective
functions (goals) subject to linear constraints are called linear goal programming
problems. If the decision variables in a linear programming problem depend on chance,
then such problems are called stochastic linear programming problems.
2. Production/Inventory Models: Inventory/Production Models are concerned with the
determination of the optimal (economic) order quantity and ordering (production)
intervals considering the factors such asdemand per unit time, cost of placing orders,
costs associated with goods held up in the inventory and the cast due to shortage of
goods, etc. Such models are also useful in dealing with quantity discounts and multiple
products.
3. Waiting Line (or Queuing) Models: In queuing models an attempt is made to predict:
(i) How much average time will be spent by the customer in a queue?
(ii) What will be an average length of waiting linear or queue?
(iii) What will be the traffic intensity of a queuing system? etc.
The study of waiting line problems provides us methods to minimize the sum of cost of
providing services and cost obtaining service which are primarily associated with the
value of time spent by the customer in a queue.
4. Markovian Models: These models are applicable in such situation where the state of
the system can be defined by some descriptive measure of numerical value and where the
system moves from one state to another on probability basis. Brand-switching problems
considered in marketing studies are an example of such models.
5. Competetive Strategy Models (Games Theory): These models are used to determine
the behavior of decision-making under completion or conflict. Methods for solving such
models have not been found suitable for industrial applications, mainly because they are
referred to an idealistic world neglecting many essential features of reality.
6. Net work Models: These models are applicable in large projects involving
complexities and inter-dependencies of activities. Project Evaluation and Review
Techniques (PERT) And critical Method (CPM) are used for planning, scheduling and
controlling complex project which can be characterized net-work.
7. Job Sequencing Models: These Models involve the selection of such a sequence of
performing a series of jobs to be done on service facilities (machines) that optimize the
efficiency measure of performance of the system. In other words, sequencing is
conserved with such a problem in which efficiency measure depends upon the order or
sequences of performing a series of jobs.
8. Replacement Models: The models deal with the determination of optimum
replacement policy in situations that arise when some items or machinery need
replacement by a new one. Individual and group replacement polices can be used in the
case of such equipments that fail completely and instantaneously.
9. Simulation Models: Simulation is a very powerful technique for solving much
complex models which cannot be solved otherwise and thus it is being extensively
applied to solve to solve a variety of problems. This technique is more useful when
following two types of difficulties may arise:
(i) The number of variables and constraint relationships may be so large that it is not
computationally feasible to pursue such analysis.
(ii) Secondly, the model may be much away from the reality that no confidence can be
placed on the computational results.
In fact, such models are solved by simulation techniques where no other method is
available for its solution.
A linear equation represents a straight line. Limited time, labour etc. may be expressed as
linear inequations or equations and are called constraints.
e.g., If 2 tables and 3 chairs are to be made in not more than 10 hours and 1 table is made
in x hours while 1 chair is made in y hours, then this constraint may be written as
A linear equation is also called a linear constraint as it restricts the freedom of choice of
the values of x and y.
Optimisation
A decision which is considered the best one, taking into consideration all the
circumstances is called an optimal decision. The process of getting the best possible
outcome is called optimisation. The best profit is the maximum profit. Hence optizmizing
the profit would mean maximising the profit. Optimising the cost would mean
minimising the cost as this would be most favourable.
Solution of a LPP
A set of values of the variables x1, x2,.xn which satisfy all the constraints is called the
solution of the LPP.
Feasible Solution
A set of values of the variables x1, x2, x3,.,xn which satisfy all the constraints and also
the non-negativity conditions is called the feasible solution of the LPP.
Optimal Solution
The feasible solution, which optimises (i.e., maximizes or minimizes as the case may be)
the objective function is called the optimal solutio
Simplex method is considered one of the basic techniques from which many linear
programming techniques are directly or indirectly derived. The simplex method is an
iterative, stepwise process which approaches an optimum solution in order to reach
an objective function of maximization or minimization.
The word , programming is used to specify a sort of planning that involves the
economic allocation of limited resources by adopting a particular course of action or
strategy among various alternatives strategies to achieve the desired objective.
Hence, Linear Programming is a mathematical technique for optimum allocation of
limited or scarce resources, such as labour, material, machine, money energy etc.
Structure of Linear Programming model.
The general structure of the Linear Programming model essentially consists
of three components.
i) The activities (variables) and their relationships
ii) The objective function and
iii) The constraints
The activities are represented by X1, X2, X3 ..Xn.
These are known as Decision variables.
The objective function of an LPP (Linear Programming Problem) is a mathematical
representation of the objective in terms a measurable quantity such as profit, cost,
revenue, etc.
Optimize (Maximize or Minimize) Z=C1X1 +C2X2+ ..Cn Xn
Where Z is the measure of performance variable
X1, X2, X3, X4..Xn are the decision variables
And C1, C2, Cn are the parameters that give contribution to decision variables.
The constraints These are the set of linear inequalities and/or equalities which impose
restriction of the limited resources
Assumptions of Linear Programming
Certainty.
In all LP models it is assumed that, all the model parameters such as availability of
resources, profit (or cost) contribution of a unit of decision variable and consumption of
resources by a unit of decision variable must be known and constant.
Divisibility (Continuity)
The solution values of decision variables and resources are assumed to have either whole
numbers (integers) or mixed numbers (integer or fractional). However, if only integer
variables are desired, then Integer programming method may be employed.
Additivity
The value of the objective function for the given value of decision variables and the total
sum of resources used, must be equal to the sum of the contributions (Profit or Cost)
earned from each decision variable and sum of the resources used by each decision
variable respectively. /The objective function is the direct sum of the individual
contributions of the different variables
Linearity
All relationships in the LP model (i.e. in both objective function and constraints) must be
linear.
General Mathematical Model of an LPP
Optimize (Maximize or Minimize) Z=C1 X1 + C2 X2 ++CnXn
Subject to constraints,
a11X1+ a 12X2++ a 1nXn (<,=,>) b1
a21X1+ a 22X2++ a 2nXn (<,=,>) b2
a31X1+ a 32X2++ a 3nXn (<,=,>) b3
am1X1+ a m2X2++ a mnXn (<,=,>) bm
and X1, X2 .Xn >
Guidelines for formulating Linear Programming model
i) Identify and define the decision variable of the problem
ii) Define the objective function
iii) State the constraints to which the objective function should be optimized
(i.e. Maximization or Minimization)
iv) Add the non-negative constraints from the consideration that the negative values of
the decision variables do not have any valid physical interpretation
Duality in Linear Programming
Duality in Linear Programming For every LPP there is a unique LPP associated with it
involving the same data and closely related optimal solution. The original problem is then
called primal problem while the other is called its Dual problem
Let the primal problem be
Maximize Z = C1 X1 + C2 X2 + + CnXn
Subject to constraints,
a11X1+ a 12X2++ a 1nXn <, b1
a21X1+ a 22X2++ a 2nXn <,b2
a31X1+ a 32X2++ a 3nXn <,b3
am1 X1+ a m2X2++ a mnXn <,bm
and X1, X2 .Xn > 0
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11
W 1 - W2 - W3 + W4 < 2
0W 1 - 6W2 3(W3- W4 ) < 5
W 1, W2, W3,W4 > 0
Max.G = 2W1 -6W2+ 4W5
Subject to constraints,
W 1 -2W2 + W5 < 0
W 1 - W2 W5 < 2
0W 1 - 6W2 3W5 < 5
W 1, W2, > 0 , W5 is unrestricted in sign
Example.2
Write the Dual of the following LPP
Min Z = 4X1 + 5X2- 3X3
Subject to constraints,
X1+ X2 + X3 = 22
3X1+ 5X2 - 2X3 < 65
X1+ 7X2 +4X3 > 120
X1 , X2 > 0 and X3 is unrestricted
Since X3 is Unrestricted, replace X3 with (X4 - X5 ) and
bring the problem into standard form
Min Z = 4X1 + 5X2- 3(X4 - X5)
Subject to constraints,
X1+ X2 + (X4 - X5) >22
-X1- X2 - (X4 - X5) >- 22
-3X1- 5X2 + 2(X4 - X5) > -65
X1+ 7X2 +4(X4 - X5) > 120
X1 , X2 , X4 ,X5 > 0
The Dual of the above primal is as follows
Max.G = 22(W1 -W2)- 65W3 + 120W4
Subject to constraints,
W 1 -W2 - 3W3 +W4< 4
W 1 - W2 - 5W3 + 7W4 < 5
W 1 - W2 + 2W3+ 4W4 < -3
-W 1 + W2 - 2W3- 4W4 < 3
W 1, W2, W3,W4 > 0
Max.G = 22W5 - 65W3 + 120W4
Subject to constraints,
W 5- 3W3 +W4< 4
W5 -5W3 + 7W4 < 5
W 1 - W2 + 2W3+ 4W4 < -3
-W 1 + W2 - 2W3- 4W4 < 3
W 1, W2, W3,W4 > 0
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What are the characteristics of the standard form of L.P.P.? What is the standard
form of L.P.P.? State the fundamental theorem of L.P.P?
Answer:
Introduction:
In mathematics, linear programming (LP) is a technique for optimization of a
linear objective function, subject to linear equality and linear inequality constraints.
Informally, linear programming determines the way to achieve the best outcome (such as
maximum profit or lowest cost) in a given mathematical model and given some list of
requirements represented as linear equations.
More formally, given a polyhedron (for example, a polygon), and a real-valued
affine function defined on this polyhedron, a linear programming method will find
a point on the polyhedron where this function has the smallest (or largest) value if
such point exists, by searching through the polyhedron vertices.
Linear programs are problems that can be expressed in canonical form:
Maximize
Subject to
Represents the vector of variables (to be determined), while and are vectors of
(known) coefficients and
is a (known) matrix of coefficients. The expression to be
maximized or minimized is called the objective function (
in this case). The
equations
are the constraints which specify a convex polytope over which the
objective function is to be optimized.
Linear programming can be applied to various fields of study. Most extensively it
is used in business and economic situations, but can also be utilized for some engineering
problems. Some industries that use linear programming models include transportation,
energy, telecommunications, and manufacturing. It has proved useful in modeling diverse
types of problems in planning, routing, scheduling, assignment, and design.
Uses:
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Non-negative variables
e.g.
PERT/CPM
PERT Program Evaluation & Review Technique It is generally used for those
projects where time required to complete various activities are not known as a priori. It is
probabilistic model & is primarily concerned for evaluation of time. It is event oriented.
CPM Critical Path Analysis It is a commonly used for those projects which are
repetitive in nature & where one has prior experience of handling similar projects. It is a
deterministic model & places emphasis on time & cost for activities of a project.
Steps for drawing CPM/PERT network:
1. Analyze & break up of the entire project into smaller systems i.e. specific
activities and/or
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events.
2. Determine the interdependence & sequence of those activities.
3. Draw a network diagram.
4. Estimate the completion time, cost, etc. for each activity.
5. Identify the critical path (longest path through the network).
6. Update the CPM/PERT diagram as the project progresses.
Network Representation:
Each activity of the project is represented by arrow pointing in direction of progress of
project. The events of thenetwork establish the precedence relationship among different
activities.
Three rules are available for constructing the network.
Rule 1. Each activity is represented by one & only one, arrow.
Rule 2. Each activity must be identified by two distinct events & No two or more
activities can have the same tail and head events.
Following figure shows how a dummy activity can be used to represent two concurrent
activities, A & B. By definition, a dummy activity, which normally is depicted by a
dashed arrow, consumes no time or resources.
Dummy activity is a hypothetical activity which takes no resource or time to complete. It
is represented by broken arrowed line & is used for either distinguishing activities having
common starting & finishing events or to identify & maintain proper precedence
relationship between activities that are not connected by events.
15
Inserting dummy activity in one four ways in the figure, we maintain the concurrence of
A & B, and provide unique end events for the two activities (to satisfy Rule 2).
Rule 3. To maintain correct precedence relationship, the following questions must be
answered as each activity is added to the network:
(a) What activities must be immediately precede the current activity?
(b) What activities must follow the current activity?
(c) What activities must occur concurrently with the current activity?
The answers to these questions may require the use of dummy activities to ensure correct
precedences among the activities. For example, consider the following segment of a
project:
1. Activity C starts immediately after A and B have been completed.
2. Activity E starts only after B has been completed.
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Part (a) of the figure above, shows the incorrect representation of the precedence
relationship because it requires both A & B to be completed before E can start. In part (b)
the use of dummy rectifies situation.
Numbering the Events (Fulkersons Rule)
1.The initial event which has all outgoing arrows with no incoming arrow is numbered
1.
2. Delete all the arrows coming out from node 1. This will convert some more nodes
into initial events. Number these events as 2, 3, 4, .
3. Delete all the arrows going out from these numbered events to create more initial
events. Assign the next numbers to these events.
4. Continue until the final or terminal node, which has all arrows coming in with no
arrow going out is numbered.
Determination of time to complete each activity:
The CPM system of networks omits the probabilistic consideration and is based on a
Single Time Estimate of the average time required to execute the activity.
In PERT analysis, there is always a great deal of uncertainty associated with the activity
durations of any project. Therefore, te estimated time is better described by a probability
distribution than by a single estimate. Three time estimates (from beta probability
distribution) are made as follows:
1) The Optimistic Time Estimate (to): Shortest possible time in which an activity can be
completed in ideal conditions. No provisions are made for delays or setbacks while
estimating this time.
2) The Most Likely Time (tm): It assumes that things go in normal way with few
setbacks.
3) The Pessimistic Time (tp): The max. possible time if everything go wrong & abnormal
situations prevailed. However, major catastrophes such as earthquakes, labour troubles,
etc. are not taken into account.
The expected time (mean time) for each activity can be approximated using the weighted
average i.e.
Expected Time (te) = (to + 4tm + tp)/6
Forward Pass Computation: It is the process of tracing the network from START to
END. It gives the earliest start & finish times for each activity.
Earliest event time (Ej): The time that event j will occur if the preceding activities are
started as early as possible. Ej is the max. of the sums Ei + tij involving each
immediately precedent event i & intervening event ij.
Backward Pass Computation: It is the process of tracing the network starting from
LAST node & moving backward.
Latest event time (Lj): The latest time that event i can occur without delaying
completion of beyond its earliest time. Li is the min. of the differences Li - tij involving
each immediately precedent event j & intervening event ij.
The critical path can be identified by determining the following four parameters for each
activity:
EST - earliest start time: the earliest time at which the activity can start given that all its
precedent activities must be completed first = Ei
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EFT - earliest finish time, equal to the earliest start time for the activity plus the time
required to complete the activity = EST(i-j) + tij
LFT - latest finish time: the latest time at which the activity can be completed without
delaying (beyond its targeted completion time) the project = Lj
LST - latest start time, equal to the latest finish time minus the time required to
complete the activity = LFT(i-j) - tij
CRITICAL PATH: The critical path is the path through the project network in which
none of the activities have float (total float is zero) i.e. A critical path satisfies following 3
conditions:
EST =LST
EFT=LFT
Ej Ei = Lj Li = tij
The duration of project is fixed by the time taken to complete the path through the
network with the greatest total duration. This path is known as critical path & activities
on it are known as critical activities. A delay in the critical path delays the project.
Similarly, to accelerate the project it is necessary to reduce the total time required for the
activities in the critical path.
The total float time for an activity is the time between its earliest and latest start time, or
between its earliest and latest finish time. It is the amount of time that an activity can be
delayed past its earliest start or earliest finish without delaying the project. = LST-EST
or LFT-EFT = LFT-EST-tij = LFT- (EST+tij)
The slack time or slack of an event in a network is the difference the latest event time &
earliest event time i.e. Li- Ei
The free float time of an activity is equal to the amount by which its duration can be
increased without affecting either the project time or the time available for the subsequent
activities. It indicates the value by which an activity can be delayed beyond the earliest
starting point without affecting the earliest start, & therefore, the total float of
the activities following it. = Total Floatij (Slack of event j)
The independent float time of an activity is the amount by which the duration of an
activity could be extended without affecting the total project time, the time available for
subsequent activities or the time available for the preceding activities. = [Free Floatij
(Slack of event i)] or ZERO, whichever is higher. Also EST of following
activity LFT of preceding activity Duration of current activity or Zero, whichever is
higher.
The interfering float time is the part of total float which causes a reduction in the float of
successor activities. It is that portion of the activity float which cannot be consumed
without affecting adversely the float of the subsequent activity or activities. = LFT
(EST of following activity) or ZERO, whichever is higher.
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Project Crashing: There are usually compelling reasons to complete the project earlier
than the originally estimated duration of critical path computed on the normal basis of a
new project.
Direct Cost: This is the cost of the materials, equipment and labour required to perform
the activity. When the time duration is reduced the project direct cost increases.
Activity Cost Slope = (Cc- Nc)(Nt-Ct)
Where, Cc = Crash Cost = Direct cost that is anticipated in completing an activity within
crash time.
Nc = Normal Cost = This is the lowest possible direct cost required to complete an
activity
Nt = Normal Time = Min. time required to complete an activity at normal cost.
Ct = Crash Time = Min. time required to complete an activity.
Indirect Cost: It consists of two parts: fixed cost and variable cost. The fixed cost is due
to general and administrative expenses, insurance, etc. Variable indirect cost consists of
supervision, interest on capital, etc.
The total project cost is the sum of the direct & the indirect costs.
Optimum duration is the project duration at which total project cost is lowest.
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A linear program can be solved to determine the completion time for the project:
MIN Time to finish Project
s.t. Activities cannot start before their immediate predecessors are completed
All times 0
You should know how to use the PERT/CPM template for projects
whose activity completion times are known with certainty.
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Activity completion times are rarely (if ever) known with certainty, so a probability
approach is more realistic in evaluating a projects expected completion time. A
three-time estimate approach allows for such probability analyses
Three time estimates are determined (by studies, guesses, etc.) for each activity
o a = an optimistic completion time (the chance of finishing in < a is very small)
o m = a most likely completion time (this is the mode)
o b = a pessimistic completion time (the chance of finishing in > b is very small)
Activity approximations
o An approximation for the distribution of an activitys completion time is a
BETA distribution
o An approximation for the mean completion time for an activity is a weighted
a 4m b
6
average (1/6, 4/6, 1/6) of the three completion times; so it is
o An approximation for the standard deviation for the completion time for an
ba
ba
Project assumptions
1. The distribution of the project completion time is determined by the critical path
using the mean activity completion times
2. The activity completion times are independent just because one activity takes
longer or shorter than expected does not affect another activitys time.
3. There are enough activities on the critical path so that the central limit can be used
to determine the distribution, mean, variance and standard deviation of the project
Project distribution
Given the above assumption this means
o The project completion time distribution is normal
o The mean (expected) completion time, , of the project is the sum of the
expected completion times along the critical path
o The variance of the completion time, 2, of the project is the sum of the
variance in completion times along the critical path
o The standard deviation of the completion time, , of the project is the square
root of the variance of the completion time of the project
The probability of completing by a certain date t, can now be found by finding the
P(X < t) from a normal distribution with mean and standard deviation
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Key terms
Activity
A task to be completed.
CPM (Critical Path Method)
A project management technique based on a project network; the focus of CPM is
project planning, with the critical path defining those activities into which
additional resources might be poured to accelerate the schedule.
Critical path
The path through a project network that links the critical events that must begin
on time and the critical activities that must require no more than their estimated
duration if the project is to be completed on time.
Diverge
To split a single input path into multiple paths.
Dummy activity
An activity that links parallel events, but consumes neither time nor resources.
Duration
The elapsed time required to complete an activity.
Earliest event time (EET)
The earliest time the event can possibly begin.
Event
The beginning or end of an activity.
Latest event time (LET)
The latest time an event can occur without impacting the project schedule.
Merge
To combine two or more input paths into a single output path.
PERT (Program Evaluation and Review Technique)
A project management technique based on a project network; with PERT, the
critical path is the primary focus of management control and monitoring the
critical events provides an early warning if estimates are inaccurate.
Project network
A bubble chart that graphically depicts activities, their starting and completion
times, and their interrelationships.
Slack
The maximum time an activity can slip without affecting the project schedule.
Compare and contrast CPM and PERT. Under what conditions would you
recommend scheduling by PERT? Justify your answer with reasons.
Answer :- Project management has evolved as a new field with the development of two
analytic techniques for planning, scheduling and controlling projects. These are the
Critical Path Method (CPM) and the Project Evaluation and Review Technique (PERT).
PERT and CPM are basically time-oriented methods in the sense that they both lead to
the determination of a time schedule.
22
PERT was developed in connection with an R&D work. Therefore, it had to cope
with the uncertainties that are associated with R&D activities. In PERT, the total
project duration is regarded as a random variable. Therefore, associated
probabilities are calculated so as to characterise it.
CPM
23
2. Project Scheduling: Once the planning phase is over, scheduling of the project is
when each of the activities required to be performed, is taken up. The various steps
involved during this phase are listed below:
Estimate the durations of activities. Take into account the resources required for
these execution in the most economic manner.
Based on the above time estimates, prepare a time chart showing the start and
finish times for each activity. Use the time chart for the following exercises.
To calculate the total project duration by applying network analysis techniques, such as
forward (backward) pass and floats calculation
To identify the critical path
To carry out resource smoothing (or levelling) exercises for critical or scarce resources
including re-costing of the schedule taking into account resource constraints
3. Project Control: Project control refers to comparing the actual progress against the
estimated schedule. If significant differences are observed then you need to re-schedule
the project to update or revise the uncompleted part of the project.
SIMULATION
24
Counting how many people come to the bank; how many tellers, how long
each customer is in service; etc.
Once developped, a model has to be validated. There are many different ways to
validate a model: observation (measurement); analytical model comparison
(analysis).
A system is a group of objects that are joined together in some regular interaction
or interdependence toward the accomplishment of some purpose.
A system is often affected by changes occurring outside the system. Such changes
are said to occur in the system environment. In modeling a system, it is necessary
to decide on the boundary between the system and its environment.
E.g. When studying cache memory using simulation, one has to decide where is
the boundary of the system. It can be simply the CPU and cache, or it can include
main memory, disk, O.S., compiler, or even user programs.
25
Components of a System
An activity represents a time period of specified length. Here the time period is
emphasized because often the simulation involves time. E.g. deposit money into
the checking account at a specified date and time.
A discrete system is one in which the state variable(s) change only at a discrete set
of points in time. E.g. customers arrive at 3:15, 3:23, 4:01, etc.
Model of a System
A model is defined as a representation of a system for the purpose of studying the system.
Many times one can't experiment with a real system such as a bank, or a highway system.
One has to expriment with a model of the real system. A model is often not exactly the
same as the real system it presents. Rather, it includes a few (or majority of) key aspects
of the real system. It is an abstraction of the real system.
Types of Models
Static vs. dynamic: A static simulation model, sometimes called Monte Carlo
simulation, represents a system at particular point in time. A dynamic simulation
model represents systems as they change over time.
26
27
State two major reasons for using simulation. Explain the basic steps of MonteCarlo simulation. Briefly describe the application in finance & Accounting.
Answer: major reasons for using simulation
Simulation is also called experimentation in the management laboratory. While dealing
with business problems, simulation is often referred to as Monte Carlo Analysis. Two
American mathematicians, Von Neumann and Ulan, in the late 1940s found a problem in
the field of nuclear physics too complex for analytical solution and too dangerous for
actual experimentation. They arrived at an approximate solution by sampling. The
method they used had resemblance to the gamblers betting systems on the roulette table;
hence the name Monte Carlo has stuck.
Imagine a betting game where the stakes are based on correct prediction of the number of
heads, which occur when five coins are tossed. If it were only a question of one coin;
most people know that there is an equal likelihood of a head or a tail occurring, that is the
probability of a head is . However, without the application of probability theory, it
would be difficult to predict the chances of getting various numbers of heads, when five
coins are tossed. In this kind of situation simulation plays an important role.
MONTE CARLO SIMULATION
Monte Carlo simulation is useful when same elements of a system, such as arrival of
parts to a machine, etc., exhibit a chance factor in their behavior. Experimentation on
probability distribution for these elements is done through random sampling. Following
five steps are followed in the Monte Carlo simulation:
Procedure of Monte Carlo Simulation:
1. Decide the probability distribution of important variables for the stochastic
process.
2. Calculate the cumulative probability distributing for each variable in Step 1
3. Decide an interval of random numbers for each variable.
4. Generate random numbers.
5. Simulate a series of trials and determine simulated value of the actual random
variables.
28
The assignment problem can be stated as a problem where different jobs are to be
assigned to different machines on the basis of the cost of doing these jobs. The
objective is to minimize the total cost of doing all the jobs on different machines
The peculiarity of the assignment problem is only one job can be assigned to one
machine i.e., it should be a one-to-one assignment
The cost data is given as a matrix where rows correspond to jobs and columns to
machines and there are as many rows as the number of columns i.e. the number of
jobs and number of Machines should be equal
29
observe various situations where assignment problem can exist e.g., assignment
of workers to jobs like assigning clerks to different counters in a bank or salesman
to different areas for sales, different contracts to bidders.
Assignment becomes a problem because each job requires different skills and the
capacity or efficiency of each person with respect to these jobs can be different.
This gives rise to cost differences. If each person is able to do all jobs equally
efficiently then all costs will be the same and each job can be assigned to any
person.
30
Unbalanced assignment is one when the number of rows not equal to the number of
columns and vice versa. e.g. The number of machines may be more than the number of
jobs or the number of jobs may be more than the number of machines.
In such a situation we introduce dummy row/column(s) in the matrix. These rows or
columns have a zero cost element. Thus we can balance the problem and then use
Hungarian method to find optimal assignment.
31
Transportation
Problem
Complete Enumeration
Simplex Method
Hungarian method
32
33
Step 1:
Determine the opportunity cost table
Step 2:
Determine the possibility of an optimal assignment
Step 3
Modify the second reduced cost table
Step 4:
Make the optimum assignment
Step 1:
Determine the opportunity cost tableI
Locate the smallest cost in each row and subtract it from each cost figure in that
row. This would result in at least one zero in each row. The new table is called
reduced cost table.
Locate the lowest cost in each column of the reduced cost table subtract this
figure from each cost figure in that column. This would result in at least one zero
in each row and each column, in the second reduced cost table.
Step 2:
Determine the possibility of an optimal assignment:
34
Draw minimum number of straight lines vertical and horizontal, to cover all the
zero elements in the second reduced cost table. One cannot draw a diagonal
straight line. The aim is that the number of lines (N) to cover all the zero
elements should be minimum. If the number of lines is equal to the number of
rows (or columns) (n) i.e N=n it is possible to find optimal assignment .
Example :for a 3 x 3 assignment table we need 3 straight lines which cover all the
zero elements in the second reduced cost table. If the number of lines is less than
the number of rows (columns) N < n optimum assignment cannot be made. we
then move to the next step.
Step 3:
Modify the second reduced cost table:
Select the smallest number in the table which is not covered by the lines. Subtract
this number from all uncovered numbers aswell as from itself.
Add this number to the element which is at the intersection of any vertical and
horizontal lines.
Draw minimum number of lines to cover all the zeros in the revised opportunity
cost table.
Step 4:
Make the optimum assignment:
If the assignment table is small in size it is easy to make assignment after step 3.
However, in case of large tables it is necessary to make the assignments systematically.
So that the total cost is minimum. To decide optimum allocation.
Select a row or column in which there is only one zero element and encircle it
Assign the job corresponding to the zero element i.e. assign the job to the circle
with zero element. Mark a X in the cells of all other zeros lying in the column
(row) of the encircled zero. So that these zeros cannot be considered for next
assignment.
Again select a row with one zero element from the remaining rows or columns.
Make the next assignment continue in this manner for all the rows.
Repeat the process till all the assignments are made i.e. no unmarked zero is left.
now we will have one encircled zero in each row and each column of the cost
matrix. The assignment made in this manner is Optimal.
Calculate the total cost of assignment from the original given cost table.
Maximization method
In order to solve a maximization type problem we find the regret values instead of
opportunity cost. the problem can be solved in two ways
36
The first method is by putting a negative sign before the values in the assignment
matrix and then solves the sum as a minimization case using Hungarian methods
as shown above.
Second method is to locate the largest value in the given matrix and subtract each
element in the matrix from this value. Then one can solve this problem as a
minimization case using the new modified matrix.
Hence there are mainly four methods to solve assignment problem but the most efficient
and most widely used method is the Hungarian method
Q5 ) Note on Traveling Salesmen problem.
37
The peculiar nature of the problem and the various restrictions imposed on resulting
solution indicate that the method of solution to a traveling salesman problem should
include:
(1) Assigning an infinitely large element M in the diagonal of the distance matrix.
(2) Solve the problem using Hungarian Method as it gives shortcut route but,
(3) Test the solution for feasibility whether it satisfies the condition of a continues route
without visiting a city more than once.
If the route is not feasible, make adjustments with minimum increase in the total distance
traveled by the salesman. This is how one can solve traveling sales man problem
6) What is a Transportation Problem?
38
(i)
(ii)
Such problems are called unbalanced problems. It is necessary to balance them before
they are solved.
Balancing the transportation problem
In such a case the excess supply is, assumed to go to inventory and costs nothing for
shipping(transporting). This type of problem is balanced by creating a fictitious
destination. This serves the same purpose as the slack variable in the simplex/method A
column of slack variables is added to the transportation tableau which represents a
dummy destination with a requirement equal to the amount of excess supply and the
transportation cost equal to zero. This problem can now be solved using the usual
transportation methods.
When aggregate demand exceeds aggregate supply in a transportation
problem
39
(i)
(ii)
(iii)
Entry restriction.
Entry restriction.
40
The initial basic feasible solution to a transportation problem should have a total number
of occupied cell (stone squares) which is equal to the total number of rim requirements
minus one i.e. m + n 1. When this rule is not met the solution is degenerate.
Degeneracy may occurIf the number of occupied cells is more than m + n 1.
This type of degeneracy arises only in developing the initial solution. It is caused by
an improper assignment of frequencies or an error in formulating the problem. In such
cases one must modify the initial solution in order to get a solution which satisfies the
rule m + ni.
The problem becomes degenerate at the(i)
Initial stage
When in the initial solution the number of occupied cells is less than
m+n1
Degeneracy may appear subsequently when two or more cells are vacated
simultaneously in the process of transferring the units, along the closed loop to
obtain an optimal solution.
When transportation problem becomes degenerate
When transportation problem becomes degenerate it cannot be tested for
optimality because it is impossible to compute u and, v values with MODI method. To
overcome the problem of insufficient number of occupied cell we proceed by assigning
an infinitesimally small amount (close to zero) to one or more (if needed) empty cell and
treat that cell as occupied cell. This amount is represented by the Greek letter E (epsilon).
It is an insignificant value and does not affect the total cost. But it is appreciable enough
to be considered a basic variable. When the initial basic solution is degenerate, we assign
c to an independent empty cell. An independent cell is one from which a closed loop
41
cannot be traced. It is preferably assigned to a cell which has minimum per unit cost.
After introducing e we solve the problem using usual methods of solution.
10) Steps to solve a Transportation Problem.
A transportation problem can be solved in 2 phases
PHASE I
Step 1:
Check whether the given T.P. is balanced or not
Step 2:
Develop initial feasible solution by any of the five methods
Step 1:
Check whether the given T.P. is balanced or not. If it is unbalanced then balance it by
adding a row or a column.
Step 2:
Develop initial feasible solution by any of the five methods:
a) North West Corner Rule (NWCR) or South West Corner Rule (SWCR)
b) Row Minima Method (RMM)
c) Column Minima Method (CMM)
d) Matrix Minima Method (MMM)
e) Vogels Approximation Method (VAM)
42
We discuss here the two commonly used methods to make initial assignments
(1) Northwest corner rule
43
(i) Consider each row of the cost matrix individually and find the difference between two
least cost cells in it. Then repeat this exercise for each column. Identify the row or
column with the Largest difference (select any one in case of a tie).
(ii) Now consider the cell with minimum cost in that column (or row) and assign the
maximum units possible to that cell.
(iii) Delete the row/column that is satisfied.
(iv) Again find out the differences and proceed in the same manner as stated in earlier
paragraph and continue until all units have been assigned.
44
We explain here the Modified Distribution (MODI) Method for testing the optimality.
If the solution is non-optimal as found from MODI method then we improve the solution
by exchanging non-basic variable for a basic variable. In other words we rearrange the
allocation by transferring units from an occupied cell to an empty cell that has the largest
net cost change or improvement index, and then shift the units from other related cells so
that all the rim (supply, demand) requirements are satisfied. This is done by tracing a
closed path or closed loop.
Step 1:
Add a column u to the RHS of the transportation tableau and a
row v at the bottom of the tableau.
Step 2:
Assign, arbitrarily, any value to u or v generally u = 0.
Step 3
Having determined u1 and v calculate ij = (u1 + v1) for every
unoccupied cell.
Step 4:
If the solution is not optimal select the cell with largest positive
improvement index.
Step 5:
Test the solution again for optimality and improve fit if
Step I:
necessary
Add a column u to the RHS of the transportation tableau and a row v at the bottom of the
tableau.
45
Step 2:
Assign, arbitrarily, any value to u or v generally u = 0. This method of assigning values
to u1 and v1 is workable only if the initial solution is non-degenerate i.e., for a table there
are exactly m + n -1 occupied cells.
Step 3:
Having determined u1 and v calculate ij = (u1 + v1) for every unoccupied cell. This
represents the net cost change or improvement index of these cells
(1) If all the empty cells have negative net cost change ij, the solution is optimal and
unique
(2) If an empty cell has a zero Xij and all other empty cells have negative Xij the solution
is optimal but not unique.
(3) If the solution has positive Ai for one or more empty cells the solution is not optimal.
Step 4:
If the solution is not optimal select the cell with largest positive improvement index.
Then trace a closed loop and transfer the units along the route.
Tracing loop (closed path):
1) Choose the unused square to be evaluated.
(2) Beginning with the selected unused square trace a loop via used squares back to the
original unused squares. Only one loop exists for any unused square in a given solution.
(3) Assign (+) and () signs alternately at each square of the loop beginning with a plus
sign at the unused square. Assign these sign in clockwise or anticlockwise direction.
These signs indicate addition or subtraction of units to a square.
46
(4) Determine the per unit net change in cost as a result of the changes made in tracing
the loop. Compare the addition to the decrease in cost. It will give the improvement
index. (It is equivalent to j in a LPP).
(5) Determine the improvement index for each unused square.
(6) In a minimization case. If all the indices are greater than or equal to zero, the solution
is optimal. If not optimal, we should find a better solution.
We may also note the following points:
(i) An even number of at least four cells participate in a closed loop. An occupied cell can
be considered only once.
(ii) If there exists a basic feasible solution with m + n 1 positive variables, then there
would be one and only one closed loop for each cell.
(iii) All cells that receive a plus or minus sign except the starting empty cell, must be the
occupied cells.
(iv) Closed loops may or may not be square or rectangular in shape. They may have
peculiar configurations and a loop may cross over itself.
Step 5:
Test the solution again for optimality and improve fit if necessary. Repeat the process
until an optimum solution is obtained.
11) What are the differences between assignment problem and transportation
problem?
47
48
49
Theorem:
A necessary and sufficient condition for the existence of a feasible solution to the
transportation problem (2) is that
The solution to T.P is obtained in two stages. In the first stage we find Basic
feasible solution by any one of the following methods a) North-west corner rule b) Matrix
Minima Method or least cost method c) Vogels approximation method. In the second
50
stage we test the B.Fs for its optimality either by MODI method or by stepping stone
method.
Q.5: Describe the North-West Corner rule for finding the initial basic feasible
solution in the transportation problem.
Answer:
51
Step1:
a. The first assignment is made in the cell occupying the upper left hand
(North West) corner of the transportation table.
b. The maximum feasible amount is allocated there, that is x11 = min (a1,
b1) So that either the capacity of origin O1 is used up or the requirement
at destination D1 is satisfied or both.
c. This value of x11 is entered in the upper left hand corner (Small Square)
of cell (1, 1) in the transportation table.
Step 2:
a. If b1 > a1 the capacity of origin O, is exhausted but the requirement at
destination D1 is still not satisfied , so that at least one more other variable
in the first column will have to take on a positive value.
52
b. Move down vertically to the second row and make the second allocation
of magnitude x21 = min (a2, b1 x21) in the cell (2, 1). This either
exhausts the capacity of origin O2 or satisfies the remaining demand at
destination D1.
c. If a1 > b1 the requirement at destination D1 is satisfied but the capacity of
origin O1 is not completely exhausted. Move to the right horizontally to
the second column and make the second allocation of magnitude x12 =
min (a1 x11, b2) in the cell (1, 2).
d. This either exhausts the remaining capacity of origin O1 or satisfies the
demand at destination D2 .If b1 = a1, the origin capacity of O1 is
completely exhausted as well as the requirement at destination is
completely satisfied.
e. There is a tie for second allocation; an arbitrary tie breaking choice is
made. Make the second allocation of magnitude x12 = min (a1 a1, b2) =
0 in the cell (1, 2) or x21 = min (a2, b1 b2) = 0 in the cell (2, 1).
Step 3:
a. Start from the new North West corner of the transportation table satisfying
destination requirements and exhausting the origin capacities one at a
time.
b. Move down towards the lower right corner of the transportation table until
all the rim requirements are satisfied.
53
State and discuss the methods for solving an assignment problem. How is Hungarian
method better than other methods for solving an assignment problem?
Answer : Assignment becomes a problem because each job requires different skills and
the capacity or efficiency of each person with respect to these jobs can be different. This
gives rise to cost differences. If each person is able to do all jobs with same efficiency
then all costs will be the same and each job can be assigned to any person. When
assignment is a problem it becomes a typical optimisation problem. Therefore, you can
compare an assignment problem to a transportation problem.
Solution Methods
The assignment problem can be solved by the following four methods :
Enumeration method
Simplex method
Transportation method
Hungarian method
Enumeration method:
In this method, a list of all possible assignments among the given resources and activities
is prepared. Then an assignment involving the minimum cost, time or distance or
maximum profits is selected. If two or more assignments have the same minimum cost,
time or distance, the problem has multiple optimal solutions. This method can be used
only if the number of assignments is less. It becomes unsuitable for manual calculations
if number of assignments is large
Simplex method:
The simplex method focuses on solving LPP of any enormity involving two or more
decision variables.
The simplex algorithm is an iterative procedure for finding the optimal solution to a
linear programming problem. The objective function controls the development and
evaluation of each feasible solution to the problem. If a feasible solution exists, it is
located at a corner point of the feasible region determined by the constraints of the
system.
The simplex method simply selects the optimal solution amongst the set of feasible
solutions of the problem. The efficiency of this algorithm is because it considers only
those feasible solutions which are provided by the corner points, and that too not all of
54
them. You can consider obtaining an optimal solution based on a minimum number of
feasible solutions.
Transportation method
Transportation model is an important class of linear programs. For a given supply at each
source and a given demand at each destination, the model studies the minimisation of the
cost of transporting a commodity from a number of sources to several destinations.
As assignment is a special case of transportation problem it can also be solved using
transportation model. But the degeneracy problem of solution makes the transportation
method computationally inefficient for solving the assignment problem.
Hungarian method
There are various ways to solve assignment problems. Certainly it can be formulated as a
linear program (as we saw above), and the simplex method can be used to solve it. In
addition, since it can be formulated as a network problem, the network simplex method
may solve it quickly.
However, sometimes the simplex method is inefficient for assignment problems
(particularly problems with a high degree of degeneracy). The Hungarian Algorithm
developed by Kuhn has been used with a good deal of success on these problems and is
summarized as follows.
Step 1. Determine the cost table from the given problem.
Step 2. Add a dummy source or dummy destination, so that the cost table becomes a
square matrix. The cost entries of the dummy source/destinations are always zero.
Step 3. Locate the smallest element in each row of the given cost matrix and then
subtract the same from each element of the row.
Step 4. In the reduced matrix obtained in the step 3, locate the smallest element of each
column and then subtract the same from each element of that column. Each column and
row now have at least one zero.
Step 5. In the modified matrix obtained in the step 4, search for the optimal assignment
as follows:
55
(a) Examine the rows successively until a row with a single zero is found. Enrectangle
this row ()and cross off (X) all other zeros in its column. Continue in this manner until
all the rows have been taken care of.
(b) Repeat the procedure for each column of the reduced matrix.
(c) If a row and/or column has two or more zeros and one cannot be chosen by inspection
then assign arbitrary any one of these zeros and cross off all other zeros of that row /
column.
(d) Repeat (a) through (c) above successively until the chain of assigning () or cross (X)
ends.
Step 6. If the number of assignment () is equal to n (the order of the cost matrix), an
optimum solution is reached.
If the number of assignment is less than n(the order of the matrix), go to the next step.
Step7. Draw the minimum number of horizontal and/or vertical lines to cover all the
zeros of the reduced matrix.
Step 8. Develop the new revised cost matrix as follows:
(a)Find the smallest element of the reduced matrix not covered by any of the lines.
(b)Subtract this element from all uncovered elements and add the same to all the elements
laying at the intersection of any two lines.
Step 9. Go to step 6 and repeat the procedure until an optimum solution is attained.
DECISION ANALYSIS
INTRODUCTION:
A decision is defined as the selection by the decision-maker of an act, considered to be
best according to some pre-designated standard, from among the several available
options.
Decision-making problem:
There are certain essential elements which are common to all such problems. These are:
Course of action: A decision is made from a set of defined alternative courses of
action. These are also called actions, acts or strategies.
State-of-nature: These are the consequences of any courses of action are
dependent upon certain factors beyond the control of the decision-maker.
Uncertainty: This is indicated in terms of probabilities assigned to the
occurrence of events.
Payoff: It measures the net benefit to the decision- maker that accrues from a
given combination of decision alternatives and events.
56
Payoff table: Suppose the problem under consideration has n possible events
(state of nature) denoted by E1, E2 En and m alternatives acts (strategies)
denoted by A1, A2, ..Am. Then the payoff corresponding to strategy Aj of the
decision-maker under the event (state-of-nature) Ei will be denoted by aij
(i=1,2..,n;j=1,2,.,m).
DECISION-MAKING PROCESS:
Step 1: Determine the various alternative courses of action from which the final decision
is to be made.
Step 2: Identify the possible outcomes called the state-of-nature for the decision
problems. The events are beyond the control of the decision-maker.
Step 3: Determine the payoff function which describes the consequences resulting from
the different combinations of the act and events.
Step 4: Construct the regret opportunity loss table. An opportunity loss occurs due to
failure of not adopting best available course of action.The opportunity loss values are
calculated separately ofr each outcomes (state-of nature) by first locating the most
favorable course of action for that outcomes and then determining the departure of the
payoff value for that course of action and payoff value for the best possible course of
action that could have been selected.
Consider a fixed state-of nature Ei (i=1, 2 ,3..n) for which the payoff
corresponding to the n courses of action are given by Pi1, Pi2,.Pm. Let M1 be the
payoff for the least possible occur of action. The opportunity loss table will be shown as
follows:
State-of-nature
Events
A2
A3
..
Am
E1
p1m
M1 p11
M1 p12
M1 p13
..
M1
E2
M2 p21
M2 p22
M2 p23
..
M2 p2m
E3
.
.
En
M3 P31
.
.
Mn pn1
M3 p32
.
.
Mn pn2
M3 p33
.
.
Mn pn3
..
M3 p3m
..
Mn pnm
DECISION-MAKING ENVIRONMENT:
Decision-making is used to determine optimum strategies where a decision-maker is
faced with several decision alternatives. We may come across several decision-making
situations:
57
Decision under certainty: Whenever there exists only one outcome for a decision,
we are dealing with the category. Examples-linear programming, transportation
etc.
Decision under conflict: In many cases neither state-of nature are completely
known nor are they completely uncertain. Partial knowledge is available and
therefore it may be termed as decision-making under `partial uncertainty`. An
example of this is the situation of conflict involving two or more competitors
marketing the same product.
Decision under uncertainty: These refer to situations where more than one
outcome can result from any single decision.
Decision under risk: This refers to decision situations wherein decision-maker
chooses from among several possible outcomes where probabilities of occurrence
can be stated objectively from the past data.
DECISIONS UNDER UNCERTAINTY:
Under uncertainty, only payoffs are known and nothing is known about the likelihood of
each state of nature.
1. THE LAPLACE PRINCIPLE
The Laplace uses all the information by assessing value equal probabilities to the
possible payoffs for each action and then selecting that alternatives which corresponds to
the maximum expected payoff.
The basic steps of this are :
Step 1: Assign equal probabilities (1/n) to each payoff of a strategy( having n possible
payoffs)
Step 2: Determine the expected payoff value for each alternatives.
Step 3: Select that alternatives which corresponds to the maximum of the above expected
payoffs.
2. THE MAXIMIN OR MININMAX PRINCIPLE
The maximin is based upon the conservative approach to assume that the worst
possible is going to happen. The decision maker consider each strategy and locates the
minimum payoff for each; and then select that alternatives which maximizes the
minimum payoff.
This consist of two steps:
Step 1: Determine the minimum assured payoff for each alternative.
Step 2: Choose that alternative which corresponds to the maximum of above minimum
payoffs.
When dealing with the costs , the maximum cost associated with each alternative
criterion used is the Minimax and carried out in two steps:
Step 1: Determine the maximum possible cost for each alternative.
Step 2: Choose the alternative which corresponds to the minimum of the above costs.
3. THE MAXIMAX OR MINIMIN PRINCIPLE
The maximax is based upon extreme optimism .The decision maker selects that
particular strategy which corresponds to the maximum of the maximum payoffs for each
strategy.
58
DECISION THEORY
59
INTRODUCTION
Every day we, are humans, make many decisions; and occasionally we make an
important decision that can have immediate and/or long-term effects on our lives. Such
decisions as where to attend school, whether to rent or buy, whether your company
should accept a merger proposal, and so on, are important decisions for which we would
prefer to make correct choice.
The success or failure that an individual or organization experiences, depends to a
large extent on the ability of making appropriate decisions. Making of a decision requires
an enumeration of feasible and viable alternatives (courses of action or strategies), the
projection of consequences associated with different alternatives, and the measure of
effectiveness (or an objective) to identify best alternative to be used.
Everyone engages in the process of making decisions on a daily basis. Some of
these decisions are quite easy to make and almost automatic. Other decisions can be very
difficult to make and almost debilitating. Likewise, the information needed to make a
good decision varies greatly. Some decisions require a great deal of information whereas
others much less. Sometimes there is not much if any information available and hence the
decision becomes intuitive, if not just a guess. Many, if not most, people make decisions
without ever truly analyzing the situation and the alternatives that exist. There is a
subjective and intrinsic aspect to all decision making, but there are also systematic ways
to think about problems to help make decisions easier. The purpose of decision analysis is
to develop techniques to aid the process of decision making, not replace the decision
maker.
Earlier, the decisions were taken subjectively based on the skill, experience and
intuition of the decision maker. But in todays world of dynamism, the decision making
has become very complex, particularly in business, marketing and management because
they involve a number of interactive variables (factors) whose values and relationships
cannot be determined accurately. In such situations, mere intuition and expertise of the
decision maker are inadequate and we require well considered judgment and analysis
based on the use of several quantitative techniques and even computers in solving
60
problems. It is in this context that we need a full-fledged decision theory which provides
a sound and scientific basis for improved decision making.
Decision making is the essence of management. In general, the process of making
decisions calls for (i) identifying the alternatives, (ii) gathering all the relevant
information about them, and (iii) selecting the best alternative on the basis of some
criterion.
The decision theory, also called the decision analysis, is used to determine optimal
strategies where a decision-maker is faced with several decision alternatives and an
uncertain, or risky, pattern of future events. To recapitulate, all decision-making situations
are characterized by the fact that two or more alternative courses of action are available
to the decision-maker to choose from. Further, a decision may be defined as the selection
by the decision-maker of an act, considered to be best according to some pre-designated
standard, from among the available options.
When analyzing the decision making process, the context or environment of the decision
to be made allows for a categorization of the decisions based on the nature of the problem
or the nature of the data or both. There are two broad categories of decision problems:
decision making under certainty and decision making under uncertainty.
THEORETICAL QUESTIONS ABOUT DECISIONS
The following are examples of decisions and of theoretical problems that they give rise
to.
Shall I bring the umbrella today? The decision depends on something which I do not
know, namely whether it will rain or not.
I am looking for a house to buy. Shall I buy this one? This house looks fine, but
perhaps I will find a still better house for the same price if I go on searching. When shall I
stop the search procedure?
Am I going to smoke the next cigarette? One single cigarette is no problem, but if I
make the same decision sufficiently many times it may kill me.
The court has to decide whether the defendant is guilty or not. There are two
mistakes that the court can make, namely to convict an innocent person and to acquit a
61
guilty person. What principles should the court apply if it considers the first of these
mistakes to be more serious than the second?
A committee has to make a decision, but its members have different opinions.
What rules should they use to ensure that they can reach a conclusion even if they are in
disagreement? Almost everything that a human being does involves decisions. Therefore,
to theorize about decisions is almost the same as to theorize about human activities.
However, decision theory is not quite as all-embracing as that. It focuses on only some
aspects of human activity. In particular, it focuses on how we use our freedom. In the
situations treated by decision theorists, there are options to choose between, and we
choose in a non-random way.
Our choices, in these situations, are goal-directed activities. Hence, decision theory is
concerned with goal-directed behaviour in the presence of options.
A Truly Interdisciplinary Subject
Modern decision theory has developed since the middle of the 20 th century through
contributions from several academic disciplines. Although it is now clearly an academic
subject of its own right, decision theory is typically pursued by researchers who identify
themselves as economists, statisticians, psychologists, political and social scientists or
philosophers. There is some division of labour between these disciplines. A political
scientist is likely to study voting rules and other aspects of collective decision-making. A
psychologist is likely to study the behaviour of individuals in decisions, and a
philosopher the requirements for rationality in decisions. However, there is a large
overlap, and the subject has gained from the variety of methods that researchers with
different backgrounds have applied to the same or similar problems.
Normative and Descriptive Theories
The distinction between normative and descriptive decision theories is, in principle, very
simple. A normative decision theory is a theory about how decisions should be made, and
a descriptive theory is a theory about how decisions are actually made.
The should in the foregoing sentence can be interpreted in many ways. There is,
however, virtually complete agreement among decision scientists that it refers to the
prerequisites of rational decision-making. In other words, a normative decision theory is a
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theory about how decisions should be made in order to be rational. This is a very limited
sense of the word normative. Norms of rationality are by no means the only or even
the most important norms that one may wish to apply in decision-making. However, it
is practice to regard norms other than rationality norms as external to decision theory.
Decision theory does not, according to the received opinion, enter the scene until the
ethical or political norms are already fixed. It takes care of those normative issues that
remain even after the goals have been fixed. This remainder of normative issues consists
to a large part of questions about how to act in when there is uncertainty and lack of
information. It also contains issues about how an individual can coordinate her decisions
over time and of how several individuals can coordinate their decisions in social decision
procedures.
If the general wants to win the war, the decision theorist tries to tell him how to achieve
this goal. The question whether he should at all try to win the war is not typically
regarded as a decision-theoretical issue. Similarly, decision theory provides methods for
a business executive to maximize profits and for an environmental agency to minimize
toxic exposure, but the basic question whether they should try to do these things is not
treated in decision theory.
Although the scope of the normative is very limited in decision theory, the distinction
between normative (i.e. rationality-normative) and descriptive interpretations of decision
theories is often blurred. It is not uncommon, when you read decision-theoretical
literature, to find examples of disturbing ambiguities and even confusions between
normative and descriptive interpretations of one and the same theory. Probably, many of
these ambiguities could have been avoided. It must be conceded, however, that it is more
difficult in decision science than in many other disciplines to draw a sharp line between
normative and descriptive interpretations. This can be clearly seen from consideration of
what constitutes a falsification of a decision theory. It is fairly obvious what the criterion
should be for the falsification of a descriptive decision theory.
ELEMENTS OF DECISION MAKING
63
Decision Maker: The entity responsible for making the decision. This may be a single
person, a committee, company, and the like. It is viewed here as a single entity, not a
group.
Alternatives: A finite number of possible decision alternatives or courses of action
available to the decision maker. The decision maker generally has control over the
specification and description of the alternatives. These alternatives are also called courses
of action (actions, acts or strategies) and are known to the decision-maker.
States of Nature: The scenarios or states of the environment that may occur but are not
under control of the decision maker. These are the circumstances under which a decision
is made. The states of nature are mutually exclusive events and exhaustive. This means
that one and only one state of nature is assumed to occur and that all possible states are
considered.
Payoff or Outcome: Outcomes are the measures of net benefit, or payoff, received by
the decision maker. This payoff is the result of the decision and the state of nature. Hence,
there is a payoff for each alternative and outcome pair. The measures of payoff should be
indicative of the decisions makers values or preferences. The payoffs are generally given
in a payoff matrix in which a positive value represents net revenue, income, or profit and
a negative value represents net loss, expenses, or costs. This matrix yields all alternative
and outcome combinations and their respective payoff and is used to represent the
decision problem.
General form of payoff matrix
Courses of Action
(Alternatives)
States of Nature Pr obability S1
S2
Sn
N1
p1
p11
p12
p1n
N2
p2
p 21
p 22
p 2n
M L
Nm
pm
p m1
p m2 L
p mn
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2. Listing of all possible future events, called states of nature, which can occur in the
context of the decision problem. Such events are not under the control of
decision-maker because these are erratic in nature.
3. Identification of all the courses of action (alternatives or decision choices) which
are available to the decision-maker. The decision-maker has control over these
courses of action.
4. Expressing the payoffs resulting from each pair of course of action and state of
nature. These payoffs are normally expressed in a monetary value.
5. Apply an appropriate mathematical decision theory model to select best course of
action from the given list on the basis of some criterion (measure of effectiveness)
that results in the optimal (desired) payoff.
TYPES OF DECISION-MAKING ENVIRONMENTS
To arrive at a good decision it is required to consider all available data, an exhaustive list
of alternatives, knowledge of decision environment, and use of appropriate quantitative
approach for decision-making. In this section four types of decision-making
environments: Certainty, uncertainty, risk and conflict have been described. The
knowledge of these environments helps in choosing appropriate quantitative approach for
decision-making.
Type 1 - Decision-Making under Certainty
The process of choosing an act or strategy when the state of nature is completely known
is called decision making under certainty. The decision-maker has the complete
knowledge (perfect information) of consequence of every decision choice (course of
action or alternative) with certainty. Obviously, he will select an alternative that yields the
largest return (payoff) for the known future (state of nature). In such situation, each act
will only result in one event and the outcome of the act can be predetermined with
certainty. Hence, such situations are also termed as deterministic situations. For example,
the decision to purchase either National Saving Certificate (NSC); or deposit in National
Saving Scheme is one in which it is reasonable to assume complete information about the
future because there is no doubt that the Pakistani government will pay the interest when
it is due and the principal at maturity. In this decision-model, only one possible state of
nature (future) exists.
65
(ii)
66
67
perfect information would increase expected profit from EMV up to the value of
EPPI, so the amount of that increase would be equal to EVPI. Thus, we have
EVPI = EPPI EMV
Type 3 - Decision-Making under Uncertainty
In this case the decision-maker is unable to specify the probabilities with which
the various states of nature (futures) will occur. However, this is not the case of decisionmaking under ignorance, because the possible states of nature are known. Thus, decisions
under uncertainty are taken even with less information than decisions under risk. For
example, the probability that Mr. X will be the prime minister of the country 15 years
from now is not known.
The decision situations where there is no way in which the decision-maker can
assess the probabilities of the various states of nature are called decisions under
uncertainty. In such situations, the decision-maker has no idea at all as to which of the
possible states of nature would occur nor has he a reason to believe why a given state is
more, or less, likely to occur as another. With probabilities of the various outcomes
unknown, the actual decisions are based on specific criteria. The several principles which
may be employed for taking decisions in such conditions include (i) Laplace Criterion,
(ii) Maximin or Minimax Criterion, (iii) Maximax or Minimin Criterion, (iv) Savage
Criterion, (v) Hurwicz Criterion (or Criterion of Realism).
Such situations are frequent in business and management. Will the new plant or industrial
unit be successful? Will the new product be able to compete with others in the market?
How much to produce and stock to get maximum returns?
(i)
68
(b) Select an alternative with best anticipated payoff value (maximum for profit
and minimum for cost).
Since in this criterion the decision-maker selects an alternative with largest (or
lowest) possible payoff value, it is also called an optimistic decision criterion.
(ii)
(iii)
(a) Assign equal probability value to each state of nature by using the formula:
69
1
number of states of nature .
(b) Compute the expected (or average) payoff for each alternative (course of
action) by adding all the payoffs and dividing by the number of possible states
of nature or by applying the formula:
(c) Select the best expected payoff value (maximum for profit and minimum
for cost).
This criterion is also known as the criterion of insufficient reason because, except
in a few cases, some information of the likelihood of occurrence of states of
nature is available.
(iv)
(c) Select an alternative with best anticipated weighted average payoff value.
In the case of costs, the principle works like this. The minimum of the costs for
each course of action is multiplied by (the indicator of the degree of
optimism of the decision maker), and the maximum of the costs for each
alternative is multiplied by(1 ). Then the sum of the products for each
action strategy is obtained the alternative for which the sum is the least is
selected.
(v)
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(c) Select the course of action (alternative) with the greatest anticipated
opportunity loss value.
Type 4 - Decision-Making under Conflict
In many situations, neither states-of-nature are completely known nor are they completely
uncertain. Partial knowledge is available and therefore it may be termed as decisionmaking under partial uncertainty. An example of this is the situation of conflict
involving two or more competitors marketing the same product.
Some Examples related to Different Decision-Making Environments
Example 1: A food product company is contemplating the introduction of a
revolutionary new product with new packaging or replace the existing product
at much higher price (S1) or a moderate change in the composition of the
existing product with a new packaging at a small increase in price (S 2) or a
small change in the composition of the existing product except the word New
with a negligible increase in price (S 3). The three possible states of nature or
events are: (i) high increase in sales (N1), (ii) no change in sales (N2) and (iii)
decrease in sales (N3). The marketing department of the company worked out
the payoffs in terms of yearly net profits for each of the strategies of three
events (expected sales). This is represented in the following table:
States of Nature
Strategies
S1
S2
N1
7,00,000
5,00,000
N2
3,00,000
4,50,000
N3
1,50,000
0
Which strategy should the concerned executive choose on
S3
3,00,000
3,00,000
3,00,000
the basis of the
following?
(a) Maximin criterion
72
States of Nature
Strategies
S1
N1
7,00,000
N2
3,00,000
N3
1,50,000
Column (minimum) 1,50,000
The maximum of column minima
S2
S3
5,00,000 3,00,000
4,50,000 3,00,000
0
3,00,000
0
3,00,000 Maximin
is 3,00,000. Hence, the company should adopt
strategy S3.
(b) Maximax Criterion
States of Nature
N1
N2
N3
Column (maximum)
S1
7,00,000
3,00,000
1,50,000
7,00,000
Strategies
S2
5,00,000
4,50,000
0
5,00,000
S3
3,00,000
3,00,000
3,00,000
3,00,000
Maximax
The maximum of column maxima is 7,00,000. Hence, the company should
adopt strategy S1.
(c) Minimax Regret Criterion (opportunity loss in case of profits)
States of
Nature
Strategies
S2
7,00,000 5,00,000
= 2,00,000
4,50,000 4,50,000
=0
3,00,000 0
=
3,00,000
3,00,000
S1
S3
7,00,000 7,00,000
7,00,000 3,00,000
=0
= 4,00,000
N2
4,50,000 3,00,000
4,50,000 3,00,000
= 1,50,000
= 1,50,000
N3
3,00,000 1,50,000
3,00,000 3,00,000
= 1,50,000
=0
Column
1,50,000
4,00,000
(maximum) Minimax regret
Hence, the company should adopt minimum opportunity loss strategy, S 1.
N1
(d)Laplace Criterion
Since, we do not know the probabilities of states of nature, assume that they
are equal. For this example, we would assume that each state of nature has a
probability 1/3 of occurrence. Thus,
Strategy
S1
S2
S3
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Since, the largest expected return is from strategy S 1; the executive must
select strategy S1.
Example 2: A Super Bazaar must decide on the level of supplies it must stock
to meet the needs of its customers during Eid days. The exact number of
customers is not known, but it is expected to be in one of the four categories;
300, 350, 400 or 450 customers. Four levels of supplies are thus suggested with
level j being ideal (from the viewpoint of incurred costs) if the number of
customers falls in category j. Deviations from the ideal levels results in
additional costs either because extra supplies are stocked needlessly or
because demand cannot be specified. The table below provides these costs in
thousands of rupees.
Supplies level
A1
A2
A3
A4
7
12
20
27
10
9
10
25
23
20
14
23
32
24
21
17
level of inventory is chosen on the basis of (i) Laplace criterion (ii)
Customer category
E1
E2
E3
E4
(a) Which
A1
(7 + 10 + 23 + 32)/4 = 18
A2
A3
A4
(27 + 25 + 23 + 17)/4 = 23
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Since, the lowest expected return is from strategy A2 and A3; the executive
must select strategy A2 or A3.
(ii)Minimax Criterion
States of Nature
Strategies
A1
A2
A3
E1
7
12
20
E2
10
9
10
E3
23
20
14
E4
32
24
21
Column (maximum)
32
24
21 Minimax
The minimum of column maxima is 21. Hence, the company should
A4
27
25
23
17
27
adopt
strategy A3.
(iii) Minimin Criterion
States of Nature
E1
E2
E3
E4
Column (minimum)
A1
7
10
23
32
7
Strategies
A2
12
9
20
24
9
A3
20
10
14
21
10
A4
27
25
23
17
17
Minimin
The minimum of column minima is 7. Hence, the company should adopt
strategy A1.
(8)
0.5
x
(7)
3.5
4.5
5
8.5
(6) +
(8)
19.5
16.5
15.5
22
75
Demand (units)
25,000
1,00,000
1,50,000
Probability
0.10
0.70
0.20
Probabilit
y
(1)
(2)
(3)
(4)
(1) x (2)
(1) x (3)
(1) x (4)
Gears &
Levels
Spring
Action
Weights
& Pulleys
Gears &
Levels
Spring
Action
Weights
& Pulleys
Light
0.10
25,000
10,000
1,25,000
2,500
1,000
12,500
Moderate
0.70
4,00,000
4,40,000
4,00,000
2,80,000
3,08,000
2,80,000
Heavy
0.20
6,50,000
7,40,000
7,50,000
1,30,000
1,48,000
1,50,000
76
4,12,500
4,55,000
4,17,500
State
of
Nature
Probabilit
Profit
from
optimal
Course of Action(Rs)
(Demand)
(1)
Light
Moderate
Heavy
Expected Profit
0.10
0.70
0.20
with Perfect
(2)
Gears
&
Levels
25,000
4,00,000
6,50,000
Information
(3)
Spring
(4)
Weights &
(4)
Profit
Action
10,000
4,40,000
7,40,000
(EPPI)
Pulleys
1,25,000
4,00,000
7,50,000
(Max
(1) x (4)
Weighted
Profit
2,500
3,08,000
1,50,000
4,60,500
graphic model of each combination of various acts and states of nature {S i, Aj};
(I = 1, 2, , m; j = 1, 2, , n) along with their payoffs, the probability
distribution of the various states of nature and the EMV or EOL for each act.
Decision tree is a very effective device in making decisions in various
diversified problems relating to personnel, investment, portfolios, project
management, new project strategies, etc.
Each combination (Si, Aj) is depicted by a distinct path through the
decision tree. An essential feature of the decision tree is that the flow should
be from left to right in a chronological order.
Standard symbols are used in drawing a decision tree.
(i)
A square (
which the decision maker has to decide about one of the various acts or
alternatives available to him.
(ii)
(iii)
(iv)
(v)
(vi)
78
Consequently to analyze a decision tree, we start from the end of the tree
(extremely RHS) i.e., we start from the last decision/event node, say D l and
work backwards. This technique of analyzing the decision tree, called the rollback technique is explained in the following steps.
1. (a) for each branch of the event node (of D l) we compute the conditional
expected payoffs.
(b) Adding these expected payoffs for each event-nodal branch, we obtain the
EMV for the given path (act or strategy) emanating from the square (decision
node Dl).
(c) The optimal act or strategy at Dl is the one which corresponds to the highest
EMV.
2. Next we move to the last but one decision node (D l-1), make the EMV analysis
as in steps 1 (a), (b) and (c) and then move back to the preceding decision
node (Dl-2) and so on.
3. This roll-back process is continued till we reach the first decision node (D l).
Example 1: A manufacturing company has to select one of the two products X
or Y for manufacturing. Product X requires investment of Rs. 30,000 and
product Y, Rs. 50,000. Market result survey shows high, medium and low
demands with corresponding probabilities and return from sales, (in thousand
rupees), for the two products, as given in the following table.
Demand
High
Medium
Low
Probability
Product X
0.4
0.4
0.2
Product Y
0.3
0.4
0.3
Construct the appropriate decision tree. What decision the company should
take?
Solution:
79
55000
80