Monte Carlo Simulation

What is simulation?
To simulate is to imitate.
Simulation involves developing a model of a real
phenomenon and then experimenting. A given
system is imitated and the variables and
constants associated with it are manipulated in
the artificial environment to examine the
behavior of the system.
There are 4 phases of a simulation process Definition of problem and statement of objective.
Construction of appropriate model.
Experimentation with model created
Evaluation of results of simulation

Monte Carlo Simulation

Imitate

the behavior of the stochastic

process.
Technique of solving problems through
random numbers.
Used to solve a variety of problems
involving stochastic situations (one where
some or all parameters of a problem are described by
random variables)

Used

for solving problems involving

decision making under uncertainty

Monte Carlo Analysis

Monte

Carlo analysis is a technique that

computes, or iterates, the project cost or
project schedule many times using input
values selected at random from
probability distribution of possible costs
or duration to calculate a distribution of
possible total project cost or completion
dates.

The benefit of simulation from the viewpoint of

the analyst stems from the fact that the results
of taking a particular course of action can be
estimated prior to the implementation in the
real world. Instead of using hunches and
intuition to determine what may happen, the
analyst using simulation can test and evaluate
various alternatives and select the one that
gives the best results.

Steps From

the given probability of occurrence of

events, establish cumulative probability.
Assign tag nos. to events in such a way that
tag nos. represent cumulative probability.
Obtain random nos. from a random no.
table.
Correlate random nos. with tag nos.
assigned to the events and identify the
value for respective events.

Random numbers
A random number generator (often abbreviated
as RNG) is a computational or physical device
designed to generate a sequence of numbers or
symbols that lack any pattern, i.e. appear RANDOM.
Hardware-based systems for random number
generation are widely used, but often fall short of this
goal, though they may meet some of the statistical
tests for randomness intended to ensure that they do
not have any easily discernible patterns.
Methods for generating random results have existed
since ancient times, including dice, coin flipping, the
shuffling of playing cards, and many other
techniques.

It is observed that demand for a product varies

in a random fashion. The demand per day is
observed to have the following probability.
Demand 25 33 42 51
Probability
.15 .25 .45 .15
Simulate the demand for the ensuing 15 days
using Monte Carlo Simulation.
The random nos. are
40, 92, 47, 01,60,05, 69,79,09, 66,77,
69,45,18,93

Demand varies in a random fashion.

Demand may get influenced by both internal

and external factors.
Demand
Probability Cum P
R.N interval.
25
.15
.15
0 to 14
33
.25
.40
15 to 39
42
.45
.85
40 to 84
51
.15
1.00
85 to 99

Random nos. are assigned from 0-99, both nos.

inclusive. There will be 100 tag nos.
representing a cumulative P of 1.

Choose a set of 2 digit random nos. for

conducting a series of trials. More the no. of
random nos., more the accuracy.

Trial
no.

1
2
3
4
5
6
7
8
9
10

Rando
m no.

40
92
47
01
60
05
69
79
09
66

Simulated Trial
demand/da no.
y

42
51
42
25
42
25
42
42
25
42

11
12
13
14
15

Rando
m no.

77
69
45
18
93

Simulated
demand/
day

42
42
42
33
51

Advantages of simulation

Has capacity to lend itself to problems that are

cumbersome or impossible to handle
mathematically using analytical methods.
The technique allows analysts to experiment
with the system behavior without subjecting it
to the risks that would be inherent in the
experimenting with the real system.
Also compresses time to enable the manager to
visualize long term effects in a quick manner.
Often used to test proposed analytical
solutions.

Disadvantages of simulation
Does

not represent a methodology for

derivations of optimal solutions to the given
problems.
This approach is designed merely to provide
a characterization of the behavior of the
system in general for a given set of inputs.
Yields only estimates which are subject to
sampling error.
Is restricted to situations which contain
elements which can be described by random
variables.

Example
A company manufactures 30 units per day. The sale
of these items depends on demand which has the
following distribution.
Sales
Distribution
27 0.10
28 0.15
29 0.20
30 0.35
31 0.15
32 0.05
The production cost and sale price of each unit are
Rs. 40 and Rs. 50 respectively. Any unsold product is
to be disposed off at a net loss of Rs.15 per unit.
There is a penalty of Rs. 5 per unit if the demand is
not met.

Using the following random numbers,

estimate the total profit/loss for the
company for the next ten days.
10,99,65,99,95,01,79,11,16,20
If the company decides to produce 29
units per day, what is the advantage or
disadvantage to the company?

Assignment of random nos.

Sales
Prob
Cum Prob
RNI
------------------------------------------------------------27
0.10
0.10
00-09
28
0.15
0.25
10-24
29
0.20
0.45
25-44
30
0.35
0.80
45-79
31
0.15
0.95
80-94
32
0.05
1.00
95-99

Now we simulate demand for next 10 days using

the given random nos.

From the given information we have

Profit per unit sold=Rs.50-40=Rs.10
Loss per unit unsold=Rs.15
Penalty for refusing demand=Rs.5 per unit
Using these inputs, the profit/loss for ten days is
calculated , first when production is 30 units per
day, and then when it is 29 units.
Total profit for 10 days=2695, when 30 units are
produced.
If the company decides to produce 29 units per
day, the total profit works out to be the
same.=Rs. 2695

Day

R.N

Estimated
sales

1
2
3
4
5
6
7
8
9
10

10
99
65
99
95
01
79
11
16
20

28
32
30
32
32
27
30
28
28
28

30 units

29 units

28*10-2*15=250
30*10-2*5=290
30*10=300
290
290
225
300
250
250
250

28*10-1*15=265
29*10-3*5=275
29*10-1*5=285
275
275
240
285
265
265
265

Assignment
Navguide corporation , a small electronic firm,
manufactures a navigational instrument used on
sailboats. Demand for the instrument is probabilistic,
and a review of past records has yielded the weekly
demand distribution as shown in table 1.
Navguide is considering the purchase of a
sophisticated industrial robot to be used in the
assembly of the instrument. Three different robots
are being considered, each having different
capacities, production efficiencies, and purchase
costs. Table 2 summarizes the no. of instruments
that could be manufactured each week on a regular
time & overtime basis, the expected production cost
per unit , and the overhead costs. Given that
Navguide sells the instrument for $ 1,800,

TABLE 1

Demand

Probability

10

0.10

20

0.14

30

0.26

40

0.24

50

0.18

60

0.08

TABLE 2

Regular time
capacity(units)/week
Overtime cap.
(units)/ week
Regular time
cost/unit
Overtime cost/unit
Overhead cost/week

Robot 1
30

Robot 2
40

30

40

$1,200

$1,100

$1,600
$10,000

$1,450
$15,000

Random Numbers: 44, 46, 85, 99, 09, 95, 22, 87, 64,
50.

Demand Probabilit
y

Cumulative
probability

Montecarlo
no. range

10

0.10

0.10

00-09

20

0.14

0.24

10-23

30

0.26

0.50

24-49

40

0.24

0.74

50-73

50

0.18

0.92

74-91

60

0.08

1.00

92-99

Simulated values for weekly demand

Mapping of random nos.
44, 46, 85, 99, 09, 95, 22, 87, 64, 50.
--------------------------------------------------------Week Demand

Cost(Robot1)

Robot2

30

(1200*30)+10,000=46,000

48,000

30

46,000

48,000

50

(1200*30)+(1600*20)+10,000=78,000

73,500

60

(1200*30)+(1600*30)+10,000=94,000

88,000

10

(1200*10)+10,000=22,000

26,000

60

94,000

88,000

20

(1200*20)+10,000=34,000

37,000

50

78,000

73,500

40

36000+16000+10,000=62,000

59,000

10

40

62,000

59,000

Weekly Profit= (1800*Weekly Demand)-Weekly Cost