Unit – 5 Decision Theory

Introduction, Structure of Decision-Making Problem – The Decision-maker, Acts and Events,

Payoff and Payoff Matrix, Regret or Opportunity Loos Table,
Decision-Making under Risk – Expected Monetary Value (EMV), Expected Value of Perfect
Information (EVPI), Expected Opportunity Loss (EOL),
Decision-Making under uncertainty – Maximax and Maximin Payoff Criterion, Minimax Regret
Criterion, Criterion of Equal Likelihood, Hurwitz α-Criterion
● Decision Tree Analysis: Single Stage Decision Problems.

I – Decision Making Under Risk (with Probabilities)

II – Decision Making Under Uncertainty (withOUT Probabilities)

III – Decision Tree

5.1 Decision making with probabilities (DM under risk):

Criteria: - EMV and EVPI, EOL

5.2 Decision making withOUT probabilities (DM under uncertainty):

Criteria: - Maximax, Maximin, Minimax Regret, Hurvicz (realism / optimism), Laplace

► Basic – Concepts of Decision Theory (Decision Analysis)

Introduction: Decision making means selecting the best course of action (strategy) from the
available alternatives to achieve objective. Following are the steps in the process of decision
making:

1. Problem Identification
2. Collection of necessary information
3. Identification of available alternatives
4. Cost-benefit analysis for each alternative
5. Selecting the most appropriate alternative (decision)
6. Implement the decision
Decision making is the study of making optimal choice from a given set of available alternatives.
Various models available for optimal decision making can be classified in four general
categories. The basis for classification is the type of decision-making situation (environment)
and ability to predict the consequences of each alternative.

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 Category Consequences

Title Meaning

DM under certainty (Low Deterministic Models Situations where the

uncertainty) alternatives and consequences
(Ex: LPP, TP, AP) of each alternative is known
(Unit-1,2*,3,4) with certainty.

DM under risk (5.1) Probabilistic Models Situations where alternative

are known but the
(Ex D-Tree) consequences of alternatives
are probabilistic.

DM under uncertainty (5.2) Uncertain situations Situations where probabilities

are not assigned / known

DM under conflict Competitive Strategies Situations where the

consequences of each
(Ex: Game Theory) decision alternative will be
influenced by the action of
the competitor.

Decision Making under Risk (5.1):

When the consequences of each alternative (ie decision) depends on probabilities. Here each
event has a probability of occurrence and total of all probabilities is One. Note that sources of
probabilities (p.dist.) are: Historical data or manager’s judgement.

Expected Monetary Value (EMV) is the decision-making technique used for DM under
risk.

Pay-off Table and Regret Table:

Payoff is an economic result which is conditional in nature. It is a result associated with each
decision, provided a certain event has occurred.

Regret or opportunity loss is the amount of pay-off (profit) lost by not adopting the optimal
course of action which has highest payoff.

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 Illustration – 1: A shopkeeper buys a product at the cost of Rs. 100 and
sells to the retailers for Rs. 150. The product cannot be sold after the expiry
date (Ex. same day). The market demand fluctuates between 1 to 5 units.
The dealer wants to decide how many units to order each day. Prepare a
conditional pay off matrix and use EMV approach to suggest optimal
decision. Also prepare a regret table and hence suggest optimal decision
using EOL approach. Suppose following probabilities are assigned to
various possible events (level of demand)
Demand 1 2 3 4 5

Prob 0.1 0.2 0.3 0.25 0.15

Solution: - Given: CP = 100, MP = 50, ML = 100

Payoff = MP*No of units sold + ML*No of unsold units

EMV Table: -

Demand 1 2 3 4 5 EMV

Prob 0.1 0.2 0.3 0.25 0.15

Alternatives 1 50 50 50 50 50 50

2 ▬50 100 100 100 100 85

3 ▬150 0 150 150 150 90

4 ▬250 ▬100 50 200 200 50

5 ▬350 ▬200 ▬50 100 250 -27.5

EMV(1) = 0.1*50 + 0.2*50 + 0.3*50 + 0.25*50 + 0.15*50 = 50

EMV(2) = 0.1*-50 + 0.2*100 + 0.3*100 + 0.25*100 + 0.15*100 = 85

EMV(3) = 0.1*-150 + 0.2*0 + 0.3*150 + 0.25*150 + 0.15*150 = 85

EMV(4) = 0.1*-250 + 0.2*-100 + 0.3*50 + 0.25*200 + 0.15*200 = 90

EMV(5) = 0.1*-350 + 0.2*-200 + 0.3*-50 + 0.25*100 + 0.15*250 = -27.5

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 Optimum decision corresponds to maximum EMV. Here, Max (EMV) = 90, hence
optimum decision is to keep a stock of 3 units.

►Next, Regret / Opportunity Loss for each State of Nature is calculated by subtracting
each payoff from the maximum payoff for that event.

EOL Table: -

Demand 1 2 3 4 5 EOL

Prob 0.1 0.2 0.3 0.25 0.15

Alternatives 1 0 50 100 150 200 107.5

2 100 0 50 100 150 72.5

3 200 100 0 50 100 67.5

4 300 200 100 0 50 107.5

5 400 300 200 100 0 185

EOL(1) = 0.1*0 + 0.2*50 + 0.3*100 + 0.25*150 + 0.15*200 = 107.5

EOL(2) = 72.5, EOL(3) = 67.5, EOL(4) = 107.5, EOL(5) = 185

Optimum decision corresponds to minimum EOL. Here, Min (EOL) = 67.5, hence
optimum decision is to keep a stock of 3 units.

EPPI and EVPI:

► Using the information in the decision problem, obtain pay-off table and compute
EMV for each decision alternatives (courses of action).
Next, compute Expected Pay-off with Perfect Information (EPPI) and
Expected Value of Perfect Information (EVPI).

EPPI: If the decision maker has perfect information before selecting a course of action, he
will select the best alternative (with highest pay-off) corresponding to each state of nature
(event). Suppose the dealer can buy market information that can accurately predict market
demand (state of nature), he can decide how many units to order. For this purpose, EPPI is
computed as follows:

EPPI = summation of product of probability of each event and maximum pay-off.

EPPI = ∑ (probability * maximum pay-off for each state of nature)

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 Next, EVPI is the difference of expected pay-off without and with perfect
information. It is the maximum amount the dealer should spend for obtaining perfect
information about the market demand (state of nature).

EVPI = Expected Value with perfect Information ▬ Expected Value without Perfect Inf
EVPI= EPPI ▬ Max (EMV).

Compute EVPI for the problem in illustration 1.

I – Decision Making Under Risk (with Probabilities)

1● Following table shows probability distribution of demand of cakes. Each cake costs Rs. 80
and unit selling price is Rs.100. Construct the ‘payoff’ table and ‘opportunity loss’ table.
Use Expected Monetary Value (EMV) and Expected Opportunity Loss (EOL) criteria to
suggest optimal stock of cakes. Also compute EVPI. [Self-test]

Daily 25 26 27 28
Demand
Probability 0.10 0.30 0.50 0.10

2● An investor is given the following investment alternatives and percentage rate of return are
based on the following information. Over the past 300 days, 150days have been medium market
conditions and 60 days have shown high market increases. On the basis of the data state the
optimum investment strategy. Also compute EVPI. [Self-test]

Market Conditions
Low Medium High
Regular Shares 7 10 15
Risky Shares ▬10 12 25
Property ▬12 18 30

► Refer to Text: Quantitative Analysis for Management

Chapter – 3 Decision Analysis
→ Decision theory is an analytic and systematic way to tackle problems.

→ Six Steps in Decision Making

1. Clearly define the problem at hand.

2. List the possible alternatives.

3. Identify the possible outcomes or states of nature.

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4. List the payoff (typically profit) of each combination of alternatives and outcomes.

5. Select one of the mathematical decision theory models.

6. Apply the model and make your decision.

► Sensitivity Analysis of ‘Probability [0,1]'

Q.1 Determine range of probability (p) for any solution to remain optimal and insensitive to
change.
{Perform sensitivity analysis on probability (p) in the following decision-problem.}

(0.25) Good Economy (p) Bad Economy (1-p)

Expansion 4 ▬1

No Expansion 1 0

What if the Probability is (i) 0.1 (ii) 0.8?

EMV(Exp) = p*4 + (1-p)(-1) = 5p – 1, Range of EMV (Ex) is [-1 , 4]

EMV(No Exp) = p, Range of EMV (No Ex) is [0 , 1]

EMV(Ex) = EMV(No Ex)

5p – 1 = p => p = 0.25, ie when p=0.25, both alternatives have equal EMV, hence both are
optimal solution. However, when p< 0.25 ‘No expansion’ is optimal decision, and when p>0.25
‘Expansion’ is optimal decision.

Q.2 Determine range of probability (p) for any solution to remain optimal and insensitive to
change.
{Perform sensitivity analysis on probability (p) in the following decision-problem.}

Good Economy (p) Bad Economy (1-p)

Expansion 4 3

No Expansion 5 ▬1

What if the Probability is (i) 0.6 (ii) 0.9? …… >>>

SLN:- When P(Good Economy) is in the range of 0 to 0.8, optimum solution is to Expand.
However, if p is in the range of 0.8 to 1, No Expansion is optimum solution.

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ILLUSTRATION-3 Mickey Lawson is considering investing some money that he inherited. The
following payoff table gives the profits that would be realized during the next year for
each of three investment alternatives Mickey is considering:

Decision Alternative State of Nature

Good Economy Bad Economy

Stock market 80 ▬20

Bonds 30 20

CDs 24 10

Probability 0.5 0.5

(a) What decision would maximize expected profits?

(b) What is the maximum amount that should be paid for a perfect forecast of the economy?
(c) Develop an opportunity loss table for the investment problem that Mickey Lawson faces. What
decision would minimize the expected opportunity loss? What is the minimum EOL?

ILLUSTRATION-3 Farm Grown, Inc., produces cases of perishable food products. Each case
contains an assortment of vegetables and other farm products. Each case costs $5 and sells for
$15. If there are any cases not sold by the end of the day, they are sold to a large food processing
company for $3 a case. The probability that daily demand will be 100 cases is 0.3, the probability
that daily demand will be 200 cases is 0.4, and the probability that daily demand will be 300 cases
is 0.3. Farm Grown has a policy of always satisfying customer demands. If its own supply of
cases is less than the demand, it buys the necessary vegetables from a competitor. The estimated
cost of doing this is $16 per case. Draw a decision table for this problem to find optimal
Decision. Also find EVPI. [Self-test]

Sln: - Cost of produced case = 5. Cost of purchased case = 16.

Selling price = 15; Money recovered from each unsold case=$3.

3● Use Expected Monetary Value (EMV) criterion to determine optimal decision for the
following problem using the following pay-off matrix. [Self-test]

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Nature of Demand Probability Strategies / Alternatives
Produce X Produce Y Produce Z
High 0.70 30,000 60,000 40,000
Moderate 0.20 20,000 30,000 10,000
Low 0.10 10,000 20,000 ▬15,000
EMV ??

4● A dealer buys a product from manufacturer at the unit cost of Rs. 70. He sells the
product to the retailers for Rs. 100. The product has expiry date of one year. At the end of
the year, unsold quantity of products can be sold at a price of Rs. 20. The market demand
fluctuates between 6 units to 10 units. The order for product should be placed at the
beginning of the year only. Prepare pay-off table. Suppose following is the probability
distribution of demand:

Demand E1: 6 units E2: 7 units E3: 8 units E4: 9 units E5: 10 units
Probability 0.10 0.20 0.30 0.25 0.15

Find (i) Expected Pay off (EMV) and Optimal Decision.

(ii) Expected Pay off with Perfect Information (EPPI)

(iii) Expected Value of Perfect Information (EVPI).

Also use MS Excel to solve the problem.

5● The manager of a flower shop promises its customers delivery within four hours on all the
flower orders. All the flower purchased on the previous day are delivered to Parker by 8 AM the
next morning. The daily demand for roses is as follows. The manager purchases roses for Rs. 10
per dozen and sells them for Rs. 30 per dozen. All unsold roses are donated to a local hospital.
How many dozens of roses should Parker Order each evening to maximize its profits? What is the
optimum expected profit? Also compute EVPI. [Self – Test]

Dozens of Roses 7 8 9 10
Probability 0.10 0.20 0.40 0.30

6● A retailer purchases cherry every morning at Rs. 50 a case and sells them for Rs. 80 a case.
Any case that remains unsold at the end of the day can be disposed off the next day at the salvage
value of Rs. 20 per case (there after they have no value). Past sales have ranged from 15 to 18
cases per day. The following is a record of sales for the past 120 days. Find out how many cases
should the retailer purchase per day to maximize his profit. Also compute EVPI. [Self – Test]

Cases Sold 15 16 17 18
Number of Days 12 24 48 36

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 II – Decision Making Under Uncertainty (withOUT Probabilities)
Maximax is criterion of optimism whereas Maximin is the criterion of pessimism.
Hurwicz α- criterion uses weighted approach. Here α is the coefficient of optimism
between 0 and 1. Laplace suggested equal probability criterion and Minimax
criterion is used with OL table.

7● In a toy manufacturing company, suppose the product acceptance probabilities are

not known but the following data is available as shown in the table. Determine optimal
decision under (i) Maximax, (ii) Maximin and (iii) equal probability criteria, (iv)
Minimax Regret criterion. (v) Hurwicz criterion (α = 0.75)

States of Nature Strategies / Alternatives

S1 S2 S3
N1 8 70 50
N2 50 45 40
N3 ▬25 ▬10 0

Solution: -

States of Nature Strategies / Alternatives

S1 S2 S3
N1 (1/3) 8 70 50
N2 (1/3) 50 45 40
N3 (1/3) ▬25 ▬10 0
Maximum (0.75) 50 70 50
Minimum (0.25) ▬25 ▬10 0

(i) Maximax = Max [Max (Payoff)] = 70, hence optimal decision is to select
S2.
(ii) Maximin = Max [Min (payoff)] = 0, hence optimal decision is to select S3.
(iii) Equal probability c: - here we assign equal probabilities (1/3) to each state
of nature.

EMV(S1) = 0.33*(8) + 0.33(50) + 0.33*( ▬25) = 10.89

EMV(S2) = 0.33*(70) + 0.33(45) + 0.33*( ▬10) = 34.6
EMV(S3) = 0.33*(50) + 0.33(40) + 0.33*( 0) = 29.7
Since max(EMV) = 34.6, using equal probability criterion, optimal dec is
to select S2.

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 Regret Table

States of Nature Strategies / Alternatives

S1 S2 S3
N1 62 0 20
N2 0 5 10
N3 25 10 0
Maxi(Reg) 62 10 20

Since MIN[MAX(Reg)] = 10, optimal decision is to select S2.

(iv) Hurwicz criterion (α = 0.75)

EMV = α*Max-payoff + (1▬α)*Min-payoff for each course of action.

EMV(S1) = 0.75*(50) + 0.25*( ▬25) = 31.25

EMV(S2) = 0.75*(70) + 0.25*( ▬10) = 50
EMV(S3) = 0.75*(50) + 0.25*( 0) = 37.5 Since max(EMV) = 50, using
hurwicz α criterion, optimal dec is to select S2.

8● The following is a payoff table for three strategies and two states of nature. Select a strategy
using each of the following decision criteria: (i) Maximax, (ii) Minimax Regret, (iii) Maximin,
(iv) Equal Probability [Self – Test]

Strategy State of Nature

N1 N2
S1 40 60
S2 10 ▬20
S3 ▬40 150

9 ● The Lake Placid Town Council has decided to build a new community center to be used for
conventions, concerts, and other public events, but considerable controversy surrounds the
appropriate size. Many influential citizens want a large center that would be a showcase for the
area, but the mayor feels that if demand does not support such a center, the community will lose a
large amount of money. To provide structure for the decision process, the council narrowed the
building alternatives to three sizes: small, medium, and large. Everybody agreed that the critical
factor in choosing the best size is the number of people who will want to use the new facility. A
regional planning consultant provided demand estimates under three scenarios: worst case, base
case, and best case. The worst-case scenario corresponds to a situation in which tourism drops
significantly; the base-case scenario corresponds to a situation in which Lake Placid continues to
attract visitors at current levels; and the best-case scenario corresponds to a significant increase in
tourism. The consultant has provided probability assessments of .10, .60, and .30 for the worst-
case, base-case, and best-case scenarios, respectively. The town council suggested using net cash
flow over a five-year planning horizon as the criterion for deciding on the best size. A consultant

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developed the following projections of net cash flow (in thousands of dollars) for a five-year
planning horizon. All costs, including the consultant’s fee, are included.

Centre Size Demand Scenario

Worse Case Base Case Best Case
Small 400 500 660
Medium ▬250 660 800
Large ▬400 580 990

a. What decision should Lake Placid make using the expected value approach?

b. Compute the expected value of perfect information. Do you think it would be worth trying to
obtain additional information concerning which scenario is likely to occur?

c. Suppose the probability of the worst-case scenario increases to .2, the probability of the base-
case scenario decreases to .5, and the probability of the best-case scenario remains at .3. What
effect, if any, would these changes have on the decision recommendation? (EMV with change
probability values) Compare decisions in a with c.

III – Decision Tree

10● The marketing staff of a certain industrial organization has submitted the following
pay-off table, concerning a certain production proposal depending on the rate of
technological advance.

Technological Advance Probability Decision

Accept Reject
Much 0.20 20 30
Little 0.50 50 20
None 0.30 ▬10 40

Use EMV approach to determine optimal decision. Also use decision tree to find optimal
decision.

11●

12● The Gorman Manufacturing Company must decide whether to manufacture a

component part at its Milan, Michigan, plant or purchase the component part from a
supplier. The resulting profit is dependent upon the demand for the product. The following
payoff table shows the projected profit (in thousands of dollars).

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Decision State of Nature
Alternatives ↓ Low Demand (s1) Medium Demand High Demand (s3)
(s2)
Manufacture, d1 ▬ 20 40 100
Purchase, d2 10 45 70

The state-of-nature probabilities are P(s1) = 0.35, P(s2) = 0.35, and P(s3) = 0.30.

a. Use EMV criteria to recommend a decision. {Decision TREE approach}

b. Use EVPI to determine whether Gorman should attempt to obtain a better estimate of
demand.

13● A glass factory specializing in crystal is developing substantial backlog and firm’s management is
considering three courses of action. Arrange for subcontract (A1), begin overtime production (A2) and
construct a new facility (A3). The correct choice largely depends on future demand which may be Low,
Medium or High with respective probabilities 0.10, 0.50 and 0.40. Using the following pay-off table
construct a Decision TREE and suggest the best course of action. [Self-test]

Alternatives State of Economy

Low Medium High
A1 10 50 50
A2 ▬20 60 100
A3 ▬150 20 200
Sln: Optimal Decision is to Construct New Facility.

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 Unit – 1 Linear Programming Problem (LPP)
Introduction to Linear Programming, Requirements, Assumptions and Limitations and Application of
LPP, LPP Model Formulation – Maximization Problems and Minimization Problems (Max 4-
Variables and 4-Constraints), General Structure of Linear Programming Problems

Linear Programming Problem (LPP) 2 – Graphical Method:

Concept of Feasible Region, Solution of LP Problems using Graphical Method, Maximization and
Minimization Problems (Max 4-Constraints),

Special Cases in LPP – Multiple or Alternate Optimum Solutions, Redundant Constraint, Unbounded
Solution, and Infeasible Solution

Note: Constraints of all types (Less than type, Greater than type and combination of both the types)
should be covered

1.1 LINEAR PROGRAMMING PROBLEM

LINEAR PROGRAMMING:

“It is the analysis of problems in which a linear function of a number of variables

(activities) is to be optimized (maximized / minimized) when those variables are subject to
(conditional on) a number of constraints (restrictions / limitations) in the form of linear
equations or inequalities.”

Decision Variables: Decision variables are entities (eg products, advertisements,

investments, services, etc.) whose values are to be determined from the solution. An
optimal solution is the one for which the values of individual variables are such that total
profit is maximum or total cost is minimum. They compete against each other for sharing
the available limited resources. They are denoted by X1, X2, X3 … etc.

Objective Function: It specifies the goal of finding the solution to the stated problem and
it is expressed in terms of decision variables. Coefficients of decision variables in the
objective function represent the profit per unit or cost per unit for each variable.

Constraints: Constraints are the limitations or restrictions imposed on the problem. They
are of three types (1) Less than or equal to (<),
(2) Greater than or equal to (>)
(3) Equality (=)

< type constraint is associated with availability of resources whereas > constraint is
generally associated with minimum requirement or consumption conditions.

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 FORMULATION OF LPP:

STEPS: -
1) Identify the decision variables, 2) Define Objective function, 3) Formulate constraints

 Example: A company produces two products A and B. For manufacturing A and B

three raw materials P, Q and R are used. Profit per unit is Rs. 5 for A and Rs. 3 for B.
Resources requirement per unit is as shown below:

↓ Raw material / Product → A B Availability

P 3 2 80 units
Q 2 3 100 units
R 4 - 150 units
Solution: Decision variables: x1 = No of units of A and x2 = No of units of B
Objective function: Max Z = 5x1 + 3x2
Constraints: 3x1 + 2x2 < 80 (Raw-material P),
2x1 + 3x2 < 100 (Raw-material Q)
4x1 + 0x2 < 150 (Raw-material R);
x1 , x2>0 (Non-negativity condition)

Q.1 REQUIREMNET & ASSUMPTIONS, ADVANTAGES AND

LIMITATIONS OF LPP:

Requirements & Assumptions of LP:-

1) Single objective to achieve, 2) One or more constraints, 3) Alternative course of actions,

Linearity: Objective function and constraints are linear functions of decision variables,

Additive: Total consumption of resources is additive effect of consumption of resources

by individual variables,

Certainty: Availability of resources and unit consumption from resources is known exactly
with certainty

Continuity: Decision variables are (non-negative) continuous variables.

Advantages of LP:- Scientific decision making and efficient resource allocation.

Limitation of LP:- 1) Linearity is necessary in objective function and constraints. If any

one of them is not linear then problem is known as Non-linear programming problem, 2)
If multiple objectives to be achieved then it is known as Goal programming problem 3) All
data values many not be known with certainty 4) Decision variables are essentially
continuous variables; if this assumption is violated then LPP is called Integer LPP.

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 Solution of LPP: There are two methods available to find optimal solution to LPP. One is
‘Graphical method’ and other is ‘Simplex method’. Graphical method has a limitation that
it can be used to solve LPP involving only two variables. Simplex method can be used to
solve any LPP.

GRAPHICAL METHOD: -
STEPS:
1) Finding coordinates of constraint lines to represent on the graph, 2) Plotting constraint
lines on the graph, 3) Identification of feasible region, 4) Finding Optimal Solution.

STEPS of Solution using Graphical method: – Rewrite constraints as equations, Determine

coordinates on X-axis and Y-axis to draw the equations. Determine scales on X-axis and Y-axis.
Draw straight line for each equation. Determine feasible region for each constraint and hence
common feasible region of all constraints of the problem. Next, determine coordinates of corner
point of the feasible region. Check value of objective (profit /cost) function at each corner point.
Coordinates corresponding to Optimum value of corner point is optimum solution.

Q.2 Explain the concept of Duality.

Associated with any LPP is another LPP, call its Dual. Given LPP is called Primal problem
and the second way of stating (writing) the same problem is called Dual LPP. In other
words, each Maximization (Minimization) LP problem has its corresponding dual, a
Minimization (Maximization) problem. It is important to note that Optimum solution of
the primal and the dual problem are always same. A necessary condition for finding dual
of a Maximization (Minimization) problem is that all the constraints should be of ≤ (≥)
type.

The various primal-dual relationship is summarized below:

Primal .. then Dual

Objective is to Maximize (Minimize) Objective is to Minimize (Maximize)

Number of Variables (Constraints) Number of Constraints (Variables)

Variable x is unrestricted in sign Constraint is = type (vis-à-vis is also true)

< (>) type constraint > (< ) type constraint

RHS constants for the ith constraint Coefficient of Jth variable in objective
function

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1.1.1 Glossary:

• Alternate Optimum Solution: - A situation in which more than one optimal solution is
possible.
• Constraint: - A restriction on the resource available to the firm, stated in the form of
inequality or equation.
• Feasible Region: - The area satisfying all the restrictions (constraints) of a problem, i.e.
the area common to all the constraints of a problem is called FR. All possible solution to
the problem lie in the feasible region.
• Solution: - Values of decision variables that satisfy non-negativity condition is called
solution.
• Feasible Solution: - Values of decision variables that satisfy constraints are called Feasible
Solution and the region (area) of all possible solutions in the graph is called Feasible
Region.
• Optimum Solution: - Values of Decision variables that result in optimum (Minimum or
Maximum) value of objective function is called Optimum Solution.
• Infeasible Solution: - If there is no common area satisfying all the constraints of a problem,
the problems is said to have Infeasible Solution.
• Nonnegativity Condition: - A condition that requires each decision variable to be either
Positive or Zero is called Nonnegativity Condition.
• Objective Function: - A mathematical statement (function) of the goal of an organization,
stated as an intent to Maximize Gain or Minimize Loss is called Objective Function.
• Redundancy: - The presence of one or more constraints in the problem that does not affect
the feasible region is called Redundancy.
• Unboundedness: - A condition that exists when a solution variable and the profit can be
made infinitely large in a maximization LPP is called unboundedness. In this case the
solution is called unbounded solution.
• Slack: - The difference between the left-hand side and the right-hand side of a ≤ types
constraint. This is the amount of unused resource.
• Slack Variables: - Variables that are used to convert LP with ≤ type constraints in standard
form are called slack variables. They represent unused amount of resource in the solution
of LPP.
• Cj ─ Zj row: -The row containing the net profit in the solution that will result by
introducing one unit of the variable in the column.
• Shadow Prices: - The coefficient of slack variables in the Cj ─ Zj row. They represent
value of one additional unit of resource.

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Linear Programming Problem (LPP) – Formulation and Graphical Solution
Illustration – 1: Mr. Pavankumar is production manager in a small manufacturing firm. The company
produces two products A and B. Production of A and B requires two resources, say, R1 and R2. To produce
A and B two resources are required, say, R1 and R2. 60 kg of R1 and 96 kg of R2 are available. To produce
1 unit of A, 2 kg of R1 and 4 kg of R2 are used, whereas to produce 1 unit of B, 3 kg of each resource are
required. Unit profit contribution of A and B are Rs. 40 and Rs. 32 respectively. Determine the Optimal
product-mix of A and B.

1. The Flair Furniture Company produces inexpensive tables and chairs. The production process for
each is similar, in that, both require a certain number of hours of carpentry work and a certain
number of labour hours in painting and vanishing shop. Each table requires 4 hours in carpentry
and 2 hours in painting and varnishing shop whereas each chair requires 3 hours in carpentry and
1 hour in the painting and varnishing shop. During the current production period, 240 hours of
carpentry time are available and 100 hours in panting and varnishing shop are available. Each table
sold yields a profit of Rs. 70 and each chair is sold for a profit of Rs. 50. Formulate the problem as
LPP and solve it using Graphical method. (30,40;4100)

2. The Outdoor Furniture Corporation manufactures two products. Benches and picnic tables, for use
in yard and parks. The firm has two main resources: its carpenters (labour force) and a supply of
redwood. During the next production cycle, 1200 hours of labour are available under a union
agreement. The firm also has a stock 3500 feet of good quality redwood. Each bench requires 4
labour hours and 10 feet of redwood; each picnic table takes 6 labour hours and 35 feet of redwood.
Completed benches will yield a profit of Rs. 9 each, and tables will result in a profit of Rs. 20 each.
How many benches and tables should Outdoor Furniture produce to obtain the largest possible
profit? Use graphical approach.

3. (A) A factory can manufacture 2 products A and B. Each product is manufactured by a two-stage
process which involves machines I and II and the time required is as follows:

Machine Processing Time (hr.)

A B
I 2 1
II 3 2
Available hours on machine I is 10 hours and machine II is 16 hours. Per unit contribution for
product A and B are respectively Rs. 4 and Rs.3. What should be the manufacturer’s policy to
maximize profit? Use Graphical method. At optimal product-mix what are the additional hours
available on machine I and II? [SELF TEST] (0, 8, 24)
(A) Max Z = 5x1 + 3x2 STC: 2x1 + 1x2 < 10; 3x1 + 2x2 < 16; x1 , x2 > 0 (0,8,24; 2,0)
(B) Max Z = 5x1 + 3x2 STC: 2x1 + 1x2 < 10; 3x1 + 2x2 < 16; x1 < 3; x1 , x2 > 0 (0,8,24; 2,0)
(C) Max Z = 5x1 + 3x2 STC: 2x1 + 1x2 < 10; 3x1 + 2x2 < 16; x1 > 3; x1 , x2 > 0 (3,3.5,22.5; 0.5,0)
(D) Max Z = 5x1 + 3x2 STC: 2x1 + 1x2 < 10; 3x1 + 2x2 < 16; x2 < 5; x1 , x2 > 0 (2,5,23; 1,0)
(E) Max Z = 5x1 + 3x2 STC: 2x1 + 1x2 < 10; 3x1 + 2x2 < 16; x1 > 1; x1 , x2 > 0 (0,8,24; 2,0)

MBA-Sem-2 Q.T.D.M_DrYZ Unit – 1 LPP Page 17 of 23

 4. The High Sound Company manufactures quality compact discs (CD) players and stereo receivers.
Each of these products requires a certain amount of skilled labourer, of which there is a limited
weekly supply. Unit profit contribution from each CD player and each stereo receiver is Rs. 50 and
Rs. 120 respectively. Each unit of CD player requires 2 hrs of electrician time and 3 hours of audio
technician time whereas the same figures for stereo receiver are 4 hrs and 1 hr respectively. 80
hours of electrician’s time and 60 hours of audio technician’s time are available for the coming
week. Also it is required to produce at-least 4 units of CD players. Formulate the problem as LPP
and solve it using Graphical method. (4,18;2360)

5. An electronic company is engaged in the production of two components C1 and C2 that are used
in the radio sets. Each unit of C1 costs the company Rs. 5 in wages and Rs. 5 in material, while
each of C2 costs the company Rs. 25 in wages and Rs 15 in material. The company sells both
products on one period credit terms, but the company’s labor and material expenses must be paid
in cash. The selling price of C1 is Rs 30 per unit and of C2 it is Rs 70 per unit. Because of the
company’s strong monopoly in these components, it is assumed that the company can sell, at the
prevailing prices, as many units as it produces. The company’s production capacity is however
limited by two considerations. First at the beginning of period 1, the company has an initial balance
of Rs 4,000 second the company has available in each period 2,000 hours of machine time and
1,400 hours of assembly time. The production of each C1 requires 3 hours of machine time and 2
hours of assembly time, whereas the production of each C2 requires 2 hours of machine time and
3 hours of assembly time. Formulate this problem as an LP model so as to maximize the total profit
of the company. [Do not solve]

6. The Electrocomp Corporation manufactures two electrical products: air conditioners (AC) and
large fans (F). The assembly process for each is similar in that both require a certain amount of
wiring and drilling. Each AC takes 3 hours of wiring and 2 hours of drilling. Each fan must go
through 2 hours of wiring and 1 hour of drilling. During next production period, 240 hours of wiring
time are available and up-to 140 hours of drilling time may be used. Each AC sold yields a profit
of Rs. 2500 and each fan may be solved at a profit of Rs. 1500. Formulate and solve the above
problem as LP production mix to find the best combination of air conditioners and fans that yields
the highest profit. Further, Electorcomp’s management realizes that it forgot to include two critical
constraints. In particular, management decides that there should be a minimum number of AC
produced in order to fulfil a contract. Also, due to an oversupply of fans in the preceding period, a
limit should be placed on the total number of fans produced.
If it is decided that at least 20 AC should be produced but no more than 80 fans should be produced,
what is the optimal product-mix? How much slack is there for each of the four constraints at the
optimal solution? Solve the problem using Graphical method.

7. A dealer wishes to purchase a number of fans and sewing machines. He has only Rs. 5,76,000 to
invest and has space for almost 20 items. A fan costs him Rs. 36,000 and a sewing machine costs
Rs. 24,000. His expectation is that he can sell a fan at a profit of Rs. 2,200 and a sewing machine
at a profit of Rs. 1,800. Assuming that he can all items that he can buy, how should he invest his
money in order to maximize profit. Formulate it as LPP and solve using graphical method.

MBA-Sem-2 Q.T.D.M_DrYZ Unit – 1 LPP Page 18 of 23

 8. A candidate for mayor in a small town has allocated Rs. 40,000 for last minute advertising in the
days preceding the election. Two types of ads will be used: radio and television. Each radio ad costs
Rs. 200 and reaches an estimated 3000 people. Each TV ads costs Rs. 500 and reaches an estimated
7000 people. In planning the advertising campaign, the campaign manager would like to reach as
many people as possible, but (s)he has stipulated that at least 10 ads of each type must be used.
Also, the number of radio ads must be at least as greater as the number of TV ads. How many ads
of each type should be used? How many people will this reach? Use Graphical Method to solve
the LPP.

9. A firm produce two products P and Q. Using available raw material, a total maximum 600 units
of production is possible; however, a total minimum 300 units are to be produced. An electronic
machine is used to produce P and Q. Product ‘P’ consume 6 hours per unit and product ‘Q’
consumes 2 hours per unit of the electronic machine. The machine can work for at least 1200 hours.
Manufacturing costs per unit are Rs. 50 for P and Rs. 20 for Q. Formulate the problem as Linear
Programming Problem (LPP) and solve it by Graphical method to find total minimum cost of
producing P and Q.

➔ Solve Minimization LPP using graphical method.

➔ Four special cases and difficulties arise at times when using the graphical approach to
solving LP problems: (1) infeasibility, (2) unboundedness, (3) redundancy, and (4)
alternate optimal solutions. As a further graphic illustration of this, let us consider the
following illustrations:

(1) Maximize profit = $1X1 + $2X2; subject to X1 + 2X2 ≤ 6, 2X1 + X2 ≤8, X1 <7,
X1,X2 ≥ 0
If X1 <7, then find optimum solution.
(2) Maximize profit = $3X1 + $5X2; subject to X1 ≥ 5, X2 ≤ 10, X1 + 2X2 ≥ 10
(3) Maximize profit = $1X1 + $2X2; subject to X1 + X2 ≤ 20, 2X1 + X2 ≤ 30, X1 ≤
25
(4) Maximize profit = $3X1 + $2X2; subject to 6X1 + 4X2 ≤ 24, X1 ≤ 3, X1, X2 ≥ 0

➔ Maximize P = 50x1 + 100x2 50 / 100 = 0.5

STC 2x1 + 4x2 ≤ 80, 3x1 + x2 ≤ 60, x1, x2 ≥ 0

OABC is feasible region. 2 /4 = 0.5, 3 / 1 = 3

 Infinite optimum solution exists.

MBA-Sem-2 Q.T.D.M_DrYZ Unit – 1 LPP Page 19 of 23

Q. (Theory) State general Structure of a 2-variable 2-constraints LPP.

Maximize P = c1*x1 + c2*x2

STC a11*x1 + a12*x2 ≤ b1 [Electrician Time]

a21*x1 + a22*x2 ≤ b2 [Aud Tech Time] , here a22 = 1

x1, x2 ≥ 0

(c1, c2) are objective (profit / cost) coefficients, whereas (b1, b2) are RHS constants (≥ 0)

Constraint matrix A =

a11 a12

a21 a22

NOTE: LPP is Not optimum unitization of resources, it is optimum approach of

using them.

Download the software QM for windows using the following link...

Click on 'download' option shown at the end of the following web-page.

https://wps.prenhall.com/bp_taylor_introms_11/220/56508/14466195.cw/content/

Unit- 2 Dual LPP

(i) Dual of Max. LP, (ii) Dual of Min. LP, (iii) Dual of Max. LP with mixed
constraints, (iv) Dual of Min. LP with mixed constraints.

MBA-Sem-2 Q.T.D.M_DrYZ Unit – 1 LPP Page 20 of 23

 Module – III

Transportation Problem (TP)

➢ Various Sources (Factories) and Availability / Supply
➢ Various Destinations (Warehouses) and Requirement / Demand
➢ Matrix Structure / Table
➢ Initial Solution using (i) Maximum Demand Method (MDM)
(ii) Least Cost Method (LCM)
(iii) Vogel’s Approximation Method (VAM) (Penalty Method)
(IBFS – Initial Basic Feasible Solution)

➢ Testing Optimal Solution using Modified Distribution Method (MODI)

➢ Solution of Transportation Problem – Case of Minimization
➢ Special Cases – Maximization Problem, Unbalanced Problem, Restricted
(prohibited) problems, Unique Optimum vs Multiple (alternate) Optimum
Solution, degenerate solution
NOTE: Necessary condition for solution of a TP is it has to be balanced,
ie ∑D = ∑S.
Illustration: The Executive Furniture Corporation is faced with the transportation problem
shown in table- 1 below: The company would like to minimize the transportation
costs while meeting the demand at each destination and not exceeding the supply
at each source. Determine the initial solution of transportation problem using
(i) Least cost method,
(ii) Maximum Demand Method
(iii) Vogel’s Approximation Method (VAM – Penalty Method) [3900]
(Find IBFS using all methods)

Table – 1

↓FROM TO→ A B C FACTORY

CAP.
D $5 $4 $3 100
E $8 $4 $3 300
F $9 $7 $5 300
WAREHOUE
RQ. 300 200 200

Solution: Here ∑D = ∑S = 700. {Necessary condition for Solution}

MBA-Sem-2 Q.T.D.M_DrYZ Unit – 1 LPP Page 21 of 23

 Theory – Explain steps of VAM:

VAM: Find penalty for each row and each column. Select the row or column with highest penalty.
Find minimum cost in the row or column with highest penalty. Make allocation = MIN (S,D).
Cancel the row (column) if supply (demand) is exhausted. Adjust the supply and demand. Repeat
these steps till all demand and supply are complete.

1. Mr. I. M. Contractor is a builder and owner of Ashiana Construction Company. Currently

he has three large housing projects in hand. They are located at Andheri, Bandra and Kurla.
His engineers have worked out the requirement of cement at each site. Mr. Contractor
requires 70 tons of cement at Andheri (A), 90 tons at Bandra (B) and 180 tons at Kurla (C).
He procures cement from four plants located at P1, P2, P3 and P4. The plant at P1 can
supply 50 tons of cement within the timeframe stipulated by him. The plants at P2, P3 and
P4 can similarly supply 80, 70 and 140 tons, respectively. Mr. Contractor has the option of
transporting cement from any plant to any project site. Cement is purchased from all plant
at the same price but since the distances of different sites from each plant vary, the
transportation costs per ton of cement from any plant to any project site are different. Mr.
Contractor collected data on transportation costs (in 1000 Rs. per unit ton), which is shown
in the table below. Mr. Contractor wants to plan movement of cement in such a manner
that the transportation costs are minimized. Find initial solution using (I) VAM (ii) MDM
and (iii) LCM.
[MDM = ?] [LCM=790] [VAM=760] [Optimum Solution = 760,000]

↓Plant / Project -> Andheri (A) Bandra (B) Kurla (C) Supply

P1 2 5 4 50

P2 3 3 1 80

P3 5 4 7 70

P4 1 6 2 140

Demand 70 90 180 ??

2. Find initial feasible solution of following transportation problem using Maximum

Demand Method (MDM) and Least Cost Method (LCM).

3. Find initial feasible solution of following transportation problem using Vogel’s

Approximation Method (VAM).

MBA-Sem-2 Q.T.D.M_DrYZ Unit – 1 LPP Page 22 of 23

 Table – 2
Warehouses
Plants W X Y Z Supply
A 50 150 70 60 50
B 80 70 90 10 60
C 15 87 79 81 40
Demand 20 70 50 10

4. Find optimum solution using Modified Distribution (MODI) method where initial
solution is based on VAM.

5. IBFS of Unbalanced Transportation problem using VAM.

6. Degenerate IBFS.

7.

MBA-Sem-2 Q.T.D.M_DrYZ Unit – 1 LPP Page 23 of 23