OPERATIONS RESEARCH

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.

Features of Operations Research:

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.
2

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

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 activity 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 productional 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. The main features
of OR are:

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.

Definition and Explanation:

Linear programming is a mathematical technique which permits determination
of the best use of available resources.
It is a valuable aid to management because it provides a systematic and efficient
procedure which can be used as a guide in decision making. The heart of
management's responsibility is the best or optimum use of limited resources that
include money, personnel, materials, facilities, and time.

Basic Concept of Linear Programming Problem

The Objective Function is a linear function of variables which is to be optimised i.e.,
maximised or minimised. e.g., profit function, cost function etc. The objective function
may be expressed as a linear expression
Constraints

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.

Linear Programming Problems Formulation

Linear Programming is a mathematical technique for optimum allocation of limited or
scarce resources, such as labour, material, machine, money, energy and so on , to several
competing activities such as products, services, jobs and so on, on the basis of a given
criteria of optimality.
The term Linear is used to describe the proportionate relationship of two or more
variables in a model. The given change in one variable will always cause a resulting
proportional change in another variable.

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

10

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
Then its Dual is
Minimize G = b1W1 + b2W2+ b3W3 + .......+ bmWm
Subject to constraints,
a11W 1 + a21W2 + a31W3 +................+ am1Wm > C1
a12W 1 + a22W2 + a32W3 +................+ am2Wm > C2
a13W 1 + a23W2 + a33W3 +................+ am3Wm > C3
a1nW 1 + a2nW2 + a3nW3 +................+ amnWm > Cn
W 1, W2, W3 ......Wm > 0
Example.1
Write the Dual of the following LPP
Min Z = 2X2+ 5X3
X1+ X2 > 2
2X1+ X2 + 6X3 < 6
X1- X2 +3X3 = 4
and X1, X2,X3 > 0
Rearrange the constraints into a standard form, we get
Min Z = 0X1 + 2X2+ 5X3
Subject to constraints,
X1+ X2 + 0X3> 2
-2X1- X2 - 6X3 > -6
X1- X2 +3X3 > 4
-X1 + X2 -3X3 > -4
and X1, X2,X3 > 0
The Dual of the above primal is as follows
Max.G = 2W1 -6W2+ 4W3 4W4
Subject to constraints,
W 1 -2W2 + W3 W4< 0
W 1 - W2 - W3 + W4 < 2
0W 1 - 6W2 + 3W3- 3W4 < 5
W 1, W2, W3,W4 > 0
Max.G = 2W1 -6W2+ 4(W3 W4)
Subject to constraints,
W 1 -2W2 + (W3 W4 ) < 0

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

12

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:

13

Linear programming is a considerable field of optimization for several reasons. Many

practical problems in operations research can be expressed as linear programming
problems. Certain special cases of linear programming, such as network flow problems
and multi commodity flow problems are considered important enough to have generated
much research on specialized algorithms for their solution. A number of algorithms for
other types of optimization problems work by solving LP problems as sub-problems.
Historically, ideas from linear programming have inspired many of the central concepts
of optimization theory, such as duality, decomposition, and the importance of convexity
and its generalizations. Likewise, linear programming is heavily used in microeconomics
and company management, such as planning, production, transportation, technology and
other issues. Although the modern management issues are ever-changing, most
companies would like to maximize profits or minimize costs with limited resources.
Therefore, many issues can boil down to linear programming problems.
Standard form:
Standard form is the usual and most intuitive form of describing a linear
programming problem. It consists of the following three parts:

A linear function to be maximized

E.g. maximize

Problem constraints of the following form

e.g.

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

14

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.

16

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

17

 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.

Distinction between PERT and CPM

18

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.

PROJECT SCHEDULING: PERT/CPM

A project is made up of a series of tasks called activities

Some activities must be completed before other activities can be started
o Some activities (say B) that must be started immediately before another
activity (say D) that is, no other activities must be done after B and before D
Activity B is an immediate predecessor for Activity D

19

 Activity D is an immediate successor to Activity B

o A network can be drawn that has nodes representing the activities (with their
estimated completion times) and arcs showing the precedence relations.

The goal of many project scheduling models is to complete the project in

minimum time
o PERT/CPM (Program Evaluation and Review Technique/Critical Path
Method) is a solution approach for solving for this minimum time
It determines a set of earliest start (ES) and earliest finish (EF)
times by making a forward pass through the network
For activities with no predecessors: ES = 0
For all other activities: ES = max (EF of immediate predecessors)
For all activities: EF = ES + time to do the activity
The expected project completion time E(T) = max EF
It determines a set of latest finish (LF) and latest start (LS) times
by making a backwards pass through the network
For activities with no successors: LF = E(T)
For all other activities: LF = min (LS of immediate succesors)
For all activities: LS = LF time to do the activity
Slack time for an activity = LS ES or LF EF
If an activity is delayed by more than its slack time, the project
is delayed by the difference between the delay and the slack
Activities with slack = 0 cannot be delayed without delaying
the project and are called critical activities
The set of critical activities forms a critical path through the network
A delay in any activity on the critical path delays the project
The sum of the completion times on the critical path is the
expected project completion time = E(T)

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.

20

The PERT/CPM Three-Time Estimate Approach

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

activity is its Range/6 or

o The variance of an activitys completion time is the square of the standard
deviation =

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

21

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

Basic Difference between PERT and CPM

Though there are no essential differences between PERT and CPM as both of them share
in common the determination of a critical path. Both are based on the network
representation of activities and their scheduling that determines the most critical activities
to be controlled so as to meet the completion date of the project.
PERT
Some key points about PERT are as follows:

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.

It is an event-oriented network because in the analysis of a network, emphasis is

given on the important stages of completion of a task rather than the activities
required to be performed to reach a particular event or task.

PERT is normally used for projects involving activities of non-repetitive nature in

which time estimates are uncertain.

It helps in pinpointing critical areas in a project so that necessary adjustment can

be made to meet the scheduled completion date of the project.

CPM

CPM was developed in connection with a construction project, which consisted of

routine tasks whose resource requirements and duration were known with
certainty. Therefore, it is basically deterministic.

CPM is suitable for establishing a trade-off for optimum balancing between

schedule time and cost of the project.

CPM is used for projects involving activities of repetitive nature.

PROJECT SCHEDULING BY PERT-CPM

It consists of three basic phases: planning, scheduling and controlling.
Phases of PERT-CPM
1. Project Planning: In the project planning phase, you need to perform the following
activities:

23

Identify various tasks or work elements to be performed in the project.

Determine requirement of resources, such as men, materials, and machines, for

carrying out activities listed above.

Estimate costs and time for various activities.

Specify the inter-relationship among various activities.

Develop a network diagram showing the sequential inter-relationships between

the various activities.

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

A simulation is the imitation of the operation of a real-world process or system

over time. Steps include
o

Generating an artificial history of a system

Observing the behavior of that artificial history

24

Drawing inferences concerning the operating characteristics of the real

system

Use the operation of a bank as an example:

o

Counting how many people come to the bank; how many tellers, how long
each customer is in service; etc.

Establishing a model and its corresponding computer program.

Executing the program, varying parameters (number of tellers, service

time, arrival intervals) and observing the behavior of the system.

Drawing conclusions: increasing number of tellers; reducing service time;

changing queueing strategies; etc.

The behavior of a system as it evolves over time is studied by developing a

simulation model.

A model is a set of entities and the relationship among them.

For the bank example: entities would include customers, tellers, and queues.
Relations would include customers entering a queue; tellers serving the customer;
customers leaving the bank.

Once developped, a model has to be validated. There are many different ways to
validate a model: observation (measurement); analytical model comparison
(analysis).

Systems and System Environment

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 entity is an object of interest in the system. E.g. customers in a bank.

An attribute is a property of an entity. E.g. the checking account balance of the

customer.

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.

The state of a system is defined to be that collection of variables necessary to

describe the system at any time, relative to the objectives of the study. E.g.
number of busy tellers, number of customers waiting in line.

An event is defined as an instantaneous occurrence that may change the state of

the system. E.g. customer arrival, addition of a new teller, customer departure.

Discrete and Continuous Systems

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.

A continuous system is one in which the state variable(s) change continuously

over time. E.g. the amount of water flow over a dam.

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.

Deterministic vs. stochastic: A deterministic simulation contains no random

variable(s). e.g. patients arrvie in a doctor's office at a pre-scheduled time. A
stochastic simulation involves one or more randome variables as input.

26

Discrete vs. continuous: (already discussed).

Steps in a Simulation Study

Problem formulation
Clearly state the problem.
Setting of objectives and overall project plan
How we should approach the problem.
Model conceptualization
Establish a reasonable model.
Data collection
Collect the data necessary to run the simulation (such as arrival rate, arrival
process, service discipline, service rate etc.).
Model translation
Convert the model into a programming language.
Verification
Verify the model by checking if the program works properly. Use common sense.
Validation
Check if the system accurately represent the real system.
Experimental design
How many runs? For how long? What kind of input variations?
Production runs and analysis
Actual running the simulation, collect and analize the output.
Repeatition
Repeat the experiments if necessary.
Document and report
Document and report the results.

Advantages and Disadvantages

Main advantages of simulation include:

Study the behavior of a system without building it.

Results are accurate in general, compared to analytical model.

Help to find un-expected phenomenon, behavior of the system.

Easy to perform ``What-If'' analysis.

Main disadvantages of simulation include:

27

Expensive to build a simulation model.

Expensive to conduct simulation.

Sometimes it is difficult to interpret the simulation results.

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

Application of Simulation in finance & Accounting.

The range of application of simulation in business is extremely wide. Unlike other
mathematical models, simulation can be easily understood by the users and thereby
facilitates their active involvement. This makes the results more reliable and also ensures
easy acceptance for implementation. The degree to which a simulation model can be
made close to reality is dependent upon the ingenuity of the OR team who identifies the
relevant variables as well as their behavior.
.It can also be employed for a wide variety of problems encountered in production
systems the policy for optimal maintenance in terms of frequency of replacement of
spares or preventive maintenance, number of maintenance crews, number of equipment
for handling materials, job shop scheduling, routing problems, stock control and so forth.
The other areas of application include dock facilities, facilities at airports to minimize
congestion, hospital appointment systems and even management games.
In case of other OR models, simulation helps the manager to strike a balance between
opposing costs of providing facilities (usually meaning long term commitment of funds)
and the opportunity and costs of not providing them.

ASSIGNMENT AND TRANSPORTATION PROBLEM

What is an Assignment Problem?

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

This can be compared to demand equals supply condition in a balanced

transportation problem. In the optimal solution there should be only one
assignment in each row and columns of the given assignment table. one can

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.

When assignment is a problem it becomes a typical optimization problem it can

therefore be compared to a transportation problem. The cost elements are given
and is a square matrix and requirement at each destination is one and availability
at each origin is also one.

In addition we have number of origins which equals the number of destinations

hence the total demand equals total supply . There is only one assignment in each
row and each column .However If we compare this to a transportation problem we
find that a general transportation problem does not have the above mentioned
limitations. These limitations are peculiar to assignment problem only.

2) What is a Balanced and Unbalanced Assignment Problem?

A balanced assignment problem is one where the number of rows = the number of
columns (comparable to a balanced transportation problem where total demand =total
supply)

Balanced assignment problem: no of rows = no of columns

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.

Unbalanced assignment problem: no of rows not equal to no of columns

31

3) What is a Prohibited Assignment Problem?

A usual assignment problem presumes that all jobs can be performed by

all individuals there can be a free or unrestricted assignment of jobs and individuals. A
prohibited assignment problem occurs when a machine may not be in, a position to
perform a particular job as there be some technical difficulties in using a certain
machine for a certain job. In such cases the assignment is constrained by given facts.
To solve this type problem of restriction on job assignment we will have
to assign a very high cost M This ensures that restricted or impractical combination does
not enter the optimal assignment plan which aims at minimization of total cost.
4) What are the methods to solve an Assignment Problem (Hungarian Method)?

DIFFERENT METHODS OF ASSIGNMENT PROBLEM

Transportation
Problem

Complete Enumeration

Simplex Method
Hungarian method

There are different methods of solving an assignment problem:

32

1)Complete Enumeration Method: This method can be used in case of assignment.

problems of small size. In such cases a complete enumeration and evaluation of all
combinations of persons and jobs is possible.
One can select the optimal combination. We may also come across more than one optimal
combination The number of combinations increases manifold as the size of the problem
increases as the total number of possible combinations depends on the number of say,
jobs and machines. Hence the use of enumeration method is not feasible in real world
cases.
2) Simplex Method: The assignment problem can be formulated as a linear programming
problem and hence can be solved by using simplex method.However solving the problem
using simplex method can be a tedious job.
3)Transportation Method: The assignment problem is comparable to a transportation
problem hence transportation method of solution can be used to find optimum allocation.
Howver the major problem is that allocation degenerate as the allocation is on basis one
to one per person per person per job Hence we need a method specially designed to solve
assignment problems.
4 )Hungarian Assignment Method (HAM):
This method is based on the concept of opportunity cost and is more efficient in solving
assignment problems.
Method in case of a minimization problem.
As we are using the concept opportunity this means that the cost of any opportunity that
is lost while taking a particular decision or action is taken into account while making
assignment. Given below are the steps involved to solve an assignment problem by using
Hungarian method.

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

To make an optimal assignment in a say 3 x 3 table. We should be in a position to

locate 3 zeros in the table. Such that 3 jobs are assigned to 3 persons and the total
opportunity cost is zero .A very convenient way to determine such an optimal
assignment is as follows:

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.

If the number of straight lines at least equals number of rows (columns) an

optimum assignment is possible.
35

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.

Traveling salesman problem is a routine problem. It can be considered as a typical

assignment problem with certain restrictions. Consider a salesman who is assigned the
job of visiting n different cities. He knows (is given) the distances between all pairs of
cities. He is asked to visit each of the cities only once. The trip should be continuous and
he should come back to the city from where he started using the shortest route. It does not
matter, from which city he starts. These restrictions imply.
(1) No assignment should be made along the diagonal.
(2) No city should be included on the route more than once
This type of problem is quite simple but there is no general algorithm available for its
solution. The problem is usually solved by enumeration method, where the number of
enumerations is very large.
For example for a salesman who is instructed to visit five cities we shall have to consider
more than 100 possible routes. The method is therefore impractical for large size
problems and it also implies approximations in finding route with minimum distance.

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?

A transportation problem is concerned with transportation methods or selecting

routes in a product distribution network among the manufacturing plants and
distribution warehouses situated in different regions or local outlets.

In applying the transportation method, management is searching for a distribution

route, which can lead to minimization of transportation cost or maximization of
profit.

The problem involved belongs to a family of specially structured LPP called

network flow problems.

7) What is a Balanced and Unbalanced Transportation Problem?

Balanced transportation problem
Transportation problems that have the supply and demand equal is a balanced
transportation problem. In other words requirements for the rows must equal the
requirements for the columns.
Unbalanced transportation problem
An Unbalanced transportation problem is that in which the supply and demand are
unequal. There are 2 possibilities that make the problem unbalanced which are

38

2 Possibilities That Make The Problem Unbalanced

Aggregate supply exceeds the aggregate demand

Aggregate demand exceeds the aggregate supply

(i)

Aggregate supply exceeds the aggregate demand or

(ii)

Aggregate demand exceeds the aggregate supply.

Such problems are called unbalanced problems. It is necessary to balance them before
they are solved.
Balancing the transportation problem

Where total Supply exceeds total demand.

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

When aggregate demand exceeds aggregate supply in a transportation problem a dummy

row is added to restore the balance. This row has an availability equal to the excess
demand and each cell of this row has a zero transportation cost per unit. Once the
problem is balanced it can be solved by the procedures normally used to solve a
transportation problem.
8) What is a Prohibited Transportation Problem?
Sometimes in a given transportation problem some route(s) may not be available.
This could be due to a variety of reasons like-

REASONS FOR UNAVAILABILITY OF ROUTES

Strikes in certain region

Unfavorable weather conditions on a particular route

(i)

Strikes in certain region

(ii)

Unfavorable weather conditions on a particular route

(iii)

Entry restriction.

Entry restriction.

In such situations there is a restriction on the routes available for transportation. To

overcome this difficulty we assign a very large cost M or infinity to such routes. When a
large cost is added to these routes they are automatically eliminated form the solution.
The problem then can be solved using usual methods.

9) What is Degeneracy in a Transportation Problem?

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

(rim requirements minus 1) i.e. the number of stone squares in insufficient

(ii)

When two or more cells are vacated simultaneously

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

(2) Vogels Approximation Method (VAM)

(1) Northwest Corner Rule:

Start with the northwest corner of the transportation tableau and consider the cell in the
first column and first row. We have values a1 and b1 at the end on the first row and
column i.e. the availability at row one is a1 and requirement of column 1 is b1.
(i) If al > b1 assign quantity b1 in the cell, i.e. x1 b1. Then proceed horizontally to the
next column in the first row until a1 is exhausted i.e. assign the remaining number a1 - b1
in the next column.
(ii) If al < b1 then put Xl al and then proceed vertically down to the next row until b1 is
satisfied. i.e. assign b1 a1 in the next row.
(iii) If a1 = b1 then put XII = a1 and proceed diagonally to the next cell or square
determined by next row and next column.
In this way move horizontally until a supply source is exhausted, and vertically down
until destination demand is completed and diagonally when a1 = b1, until the south-east
corner of the table is reached.
(2) Vogels Approximation Method (VAM):
The north-west corner rule for initial allocation considers only the requirements and
availability of the goods. It does not take into account shipping costs given in the tableau.
It is therefore, not a very sound method as it ignores the important factor, namely cost
whih we seek to minimize. The VAM, on the other hand considers the cost in each cell
while making the allocations we explain below this method.

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.

PHASE II TEST FOR OPTIMALITY

Before we enter phase II, the following two conditions should be fulfilled in that order.
(i) Obtaining a basic feasible solution implies finding a minimum number of ij values.
This minimum number is m + n - 1. Where m is the number of origins n is the number of
destinations. Thus initial assignment should occupy m + n - I cells i.e. requirements of
demand and supply cells minus 1.
(ii) These ij should be at independent positions
These requirements are called RIM requirements.

Test for optimality (or improvement):

After obtaining the initial feasible solution, the next step is to test whether it is optimal or
not.

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

The differences between AP and TP are the following:

1. TP has supply and demand constraints while AP does not have the same.
2. The optimal test for TP is when all cell evaluation \s are greater than or equal to
zero whereas in AP the number of lines must be equal to the size of matrix.
3. A TP sum is balanced when demand is equal to supply and an AP sum is balanced
when number of rows are equal to the number of columns.
4. for AP. We use Hungarian method and for transportation we use MODI method
5. In AP. We have to assign different jobs to different entities while in transportation
we have to find optimum transportation cost.
Q12) What are the advantages and disadvantages of LPP?
A LPP is concerned with the use of allocation of resources such as time, capital,
materials, etc.
THE ADVANTAGES LPP ARE:
1. It helps the sale manager to negotiate prices with customers. He can price on the basis
of customer demand and price on the basis of supply and demand of them market.
2. Production manager can formulate optimal maximum product mix.
3. it helps manager improve his decision making abilities.
4. it helps make the best decision for cost minimization and profit maximization.
THE DISADVANTAGES OF LPP ARE:
1. A primary requirement for LPP is the objective function and every consistent must be
linear. In practical situation it is not possible to state all coefficients in the objective
function and constraints with certainty.
2. There is no guarantee that LPP will give an integer value solution.
eg. a solution may call for 9.3 trucks or 8.7 units of product.
3. It does not take into consideration the effect of time and uncertainty.
4. There may be cases of infeasibility and unbounded ness.

48

What do you understand by the transportation problem? What is the basic

assumption behind the transportation problem? Describe the MODI method of
solving transportation problem.
Answer:
Transportation Problem & its basic assumption:
This model studies the minimization of the cost of transporting a commodity from
a number of sources to several destinations. The supply at each source and the demand at
each destination are known. The transportation problem involves m sources, each of
which has available an i (i = 1, 2, m) units of homogeneous product and n destinations,
each of which requires bj (j = 1, 2., n) units of products. Here a
i and bj are positive integers. The cost cij of transporting one unit of the product from the
ith source to the
jth destination is given for each i and j. The objective is to develop an integral
transportation schedule that meets all demands from the inventory at a minimum total
transportation cost. It is assumed that the total supply and the total demand are equal i.e.

Condition (1) The condition (1) is guaranteed by creating either a fictitious

destination with a demand equal to the surplus if total demand is less than the total supply
or a (dummy) source with a supply equal to the shortage if total demand exceeds total
supply. The cost of transportation from the fictitious destination to all sources and from
all destinations to the fictitious sources are assumed to be zero so that total cost of
transportation will remain the same.
Formulation of Transportation Problem:
The standard mathematical model for the transportation problem is as follows. Let
xij be number of units of the homogenous product to be transported from source i to the
destination j. Then objective is to-

49

 Theorem:
A necessary and sufficient condition for the existence of a feasible solution to the
transportation problem (2) is that

The Transportation Algorithm (MODI Method):

The first approximation to (2) is always integral and therefore always a
feasible solution. Rather than determining a first approximation by a direct
application of the simplex method it is more efficient to work with the table given
below called the transportation table. The transportation algorithm is the simplex
method specialized to the format of table it involves: i. finding an integral basic
feasible solution ii. testing the solution for optimality iii. improving the solution,
when it is not optimal iv. Repeating steps (ii) and (iii) until the optimal solution is
obtained.

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

 The Initial basic Feasible solution using North-West corner rule:

Let us consider a T.P involving m-origins and n-destinations. Since the sum of
origin capacities equals the sum of destination requirements, a feasible solution
always exists. Any feasible solution satisfying m + n 1 of the m + n constraints
is a redundant one and hence can be deleted. This also means that a feasible
solution to a T.P can have at the most only m + n 1 strictly positive component,
otherwise the solution will degenerate.
It is always possible to assign an initial feasible solution to a T.P. in such a
manner that the rim requirements are satisfied. This can be achieved either by
inspection or by following some simple rules. We begin by imagining that the
transportation table is blank i.e. initially all xij = 0. The simplest procedures for
initial allocation discussed in the following section.
North West Corner Rule:

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.

If the no. of sources is equal to no. of destinations, go to step 3.

If the no. of sources is not equal to the no. of destination, go to step2.

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

Conditional opportunity loss (decision alternatives)

A1

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

The maximax consist of the following steps:

Step1: Determine the maximum possible payoff for each alternative.
Step 2: Select that alternative which corresponds to the maximum of the above maximum
payoffs.
4.THE HURWIEZ CRITERION
:Hurwiez Criterion stipulates that a decision maker`s view may fall somewhere between
the extreme pessimism o maximum criterion and the extreme optimism of the maximum
criterion. The criterion provides a mechanism by which a balance between extreme
pessimism and extreme optimism is made b y weighing them with certain degrees of
optimism and pessimism.
The basic steps for this criterion is summarized as
Step1: Choose an appropriate degree of optimism (or pessimism) of the decision-maker.
Step2 : Determine the maximum as well as minimum payoff for each alternative and
obtain the quantities.
DECISION UNDER RISK:
When a decision maker chooses from among several options whose probabilities of
occurrence can stated, he is said to take decision under risk. The probability of various
outcomes may be determined objectively from past data. However, past records may not
be available to arrive at the objective probabilities. In many cases the decision-maker
may, on the basis of his experience and judgment, be able to assign subjective
probabilities to the various outcomes. The problem can then be solved as decision
problem under risk.
Under condition o risk, the most popular decision criterion for evaluating the alternatives
is the expected monetary value or expected opportunity loss of the expected payoff.
Expected Monetary Value (EMV) Criterion:
The EMV for a given course of action is the expected value of conditional payoff for that
action. The conditional payoffs are obtained for each action by considering various actevent combinations. The EMV criterion may be summarized as :
Step1: List conditional profit for each act-event combinations, along with the
corresponding event probabilities.
Step2: For each act determine the expected conditional profits.
Step3: Determine EMV for each act.
Step4: Choose the act which corresponds to the optimal EMV.

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
62

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

STEPS OF DECISION MAKING PROCESS

The decision making process involves the following steps:
1. Identify and define the problem.

64

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

Type 2 - Decision-Making under Risk

In this case the decision-maker has less than complete knowledge with certainty of the
consequence of every decision choice (course of action) because it is not definitely
known which outcome will occur. This means there is more than one state of nature
(future) and for which he makes an assumption of the probability with which each state
of nature will occur. For example, probability of getting head in the toss of a coin is 0.5.
Decision-making under risk is a probabilistic decision situation, in which more than one
state of nature exists and the decision-maker has sufficient information to assign
probability values to the likely occurrence of each of these states. The probabilities of
various outcomes may be determined objectively from the past data. Knowing the
probability distribution of the states of nature, the best decision is to select that course of
action which has the largest expected payoff value. The expected (average) payoff of an
alternative is the sum of all possible payoffs of that alternative weighted by the
probabilities of those payoffs occurring. However, past records may not be available to
arrive at the objective probabilities. In many cases the decision-maker may, on the basis
of his experience and judgment, be able to assign subjective probabilities to the various
outcomes. The problem can then be solved as decision problem under risk.
Under conditions of risk, the most popular decision criterions for evaluating the
alternative is the expected monetary value/expected opportunity loss of the expected
payoff.
(i)

Expected monetary value (EMV)

More generally, the decision-making in situations of risk is on the basis of the
expectation principle, with the event probabilities assigned, objectively or
subjectively as the case may be, the expected pay-off for each strategy is
calculated by multiplying the pay-off values with their respective probabilities
and then adding up these products. The strategy with the highest expected pay-off
represents the optimal choice. It goes without saying that in problems involving
pay-off matrix in terms of costs, optimal strategy is that corresponding to which
the expected value is the least.

(ii)

Expected Opportunity Loss (EOL)

66

An alternative approach to maximizing expected monetary value (EMV) is to

minimize the expected opportunity loss (EOL), also called expected value of
regret. The EOL is defined as the difference between the highest profit (or payoff)
for a state of nature and the actual profit obtained for the particular course of
action taken. In other words, EOL is the amount of payoff that is lost by not
selecting the course of action that has the greatest payoff for the state of nature
that actually occurs. The course of action due to which EOL is minimum, is
recommended.
Since EOL is an alternative decision criterion for decision-making under
risk, therefore, the results will always be the same as those obtained by EMV
criterion discussed earlier.
The steps for calculating EOL are summarized as follows:
(a) Prepare a profit (cost) table for each course of action and state of nature
combination along with the associated probabilities.
(b) For each state of nature calculate the opportunity loss (OL) values by
subtracting each payoff from the maximum payoff for that outcome. (For each
state of nature calculate the opportunity loss (OL) values by subtracting the
minimum payoff for that outcome from each payoff.)
(c) Calculate EOL for each course of action by multiplying the probability of
each state of nature with the OL value and then adding the values.
(d) Select a course of action for which the EOL value is minimum.
(iii)

Expected value of perfect information (EVPI)

The expected profit with perfect information is the expected return, in the long
run, if we have perfect information before a decision is made. The Expected Value
of Perfect Information (EVPI) may be defined as the maximum amount one
would be willing to pay, to acquire perfect information as to which event would
occur. EPPI represents the maximum obtainable EMV with perfect information as
to which event will actually occur (as calculated before information is received).
If EMV represents the maximum obtainable EMV without perfect information,

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)

Optimism (Maximax (Profit) or Minimin (Cost)) Criterion

In this criterion the decision-maker ensures that he should not miss the
opportunity to achieve the largest possible profit (maximax) or lowest possible
cost (minimin). Thus, he selects the alternative (decision choice or course of
action) that represents the maximum of the maxima (or minimum of the minima)
payoffs (consequences or outcomes). The working method is summarized as
follows:
(a) Locate the maximum (or minimum) payoff values corresponding to each
alternative (or course of action), then

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)

Pessimism (Maximin (Profit) or Minimax (Cost)) Criterion

This principle is adopted by pessimistic decision-makers who are conservative in
their approach. Using this approach, the minimum pay-offs resulting from
adoption of various strategies are considered and among these values the
maximum one is selected. It involves, therefore, choosing the best (the maximum)
profit from the set of worst (the minimum) profits.
When dealing with the costs, the maximum cost associated with each alternative
is considered and the alternative which minimizes this maximum cost is chosen.
In this context, therefore, the principle is used minimax-the best (the minimum
cost) of the worst (the maximum cost).
The working method is summarized as follows:
(a) Locate the minimum (or maximum in case of profit) payoff value in case of
loss (or cost) data corresponding to each alternative, then
(b) Select an alternative with best anticipated payoff value (maximum for profit
and minimum for loss or cost).
Since in this criterion the decision-maker is conservative about the future and
always anticipates worst possible outcome (maximum for profit and minimum for
loss or cost), it is called a pessimistic decision criterion. This criterion is also
known as Walds criterion.

(iii)

Equal probabilities (Laplace) Criterion

Since the probabilities of states of nature are not known, it is assumed that all
states of nature will occur with equal probability, i.e. each state of nature is
assigned an equal probability. As states of nature are mutually exclusive and
collectively exhaustive, so the probabilities of each of these must be
1
number of states of nature . The working method is summarized as follows:

(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:

(Probability of state of nature j) (Payoff value for the combination of alternative, i

and state of nature j)

(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)

Coefficient of optimism (Hurwicz) Criterion

This criterion suggests that a rational decision-maker should be neither
completely optimistic nor pessimistic and, therefore must display a mixture of
both. Hurwicz, who suggested this criterion, introduced the idea of a coefficient of
optimism (denoted by ) to measure the decision-makers degree of optimism.
This coefficient lies between 0 and 1, where 0 represents a complete pessimistic
attitude about the future and 1 a complete optimistic attitude about the future.
Thus, if is the coefficient of optimism, then (1 ) will represent the
coefficient of pessimism.
In case of profits, the Hurwicz approach suggests that the decision-maker must
select an alternative that maximizes H (Criterion of realism) = (Maximum in
column) + (1 ) (Minimum in column)
The working method is summarized as follows:
(a) Decide the coefficient of optimism (alpha) and then coefficient of
pessimism (1 ).
(b) For each alternative select the largest and lowest payoff value and multiply
these with and (1 ) values, respectively. Then calculate the weighted
average, H by using above formula.
70

(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)

Regret savage criterion

This criterion is also known as opportunity loss decision criterion or minimax
regret decision criterion because decision-maker feels regret after adopting a
wrong course of action (or alternative) resulting in an opportunity loss of payoff.
Thus, he always intends to minimize this regret. The working method is
summarized as follows:
(a) From the given payoff matrix, develop an opportunity loss (or regret) matrix
as follows:
(i) Find the best payoff corresponding to each state of nature, and
(ii)Subtract all other entries (payoff values) corresponding to each state of
nature from this value.
(b) For each course of action (strategy or alternative) identify the worst or
maximum regret value. Record this number in a new row.
(c) Select the course of action (alternative) with the smallest anticipated
opportunity loss value.
In the case of costs, the principle works like this.
(a) From the given payoff matrix, develop an opportunity loss (or regret) matrix
as follows:
(i) Find the worst payoff corresponding to each state of nature, and
(ii)Subtract all other entries (payoff values) corresponding to each state of
nature from this value.
(b) For each course of action (strategy or alternative) identify the best or
minimum regret value. Record this number in a new row.

71

(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

(b) Maximax criterion

(c) Minimax regret criterion

(d) Laplace criterion

Solution: The payoff matrix is rewritten as follows:

(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

Expected Return (Rs)

(7,00,000 + 3,00,000 + 1,50,000)/3 = 3,83,333.33
(5,00,000 + 4,50,000 + 0)/3 = 3,16,666.66
(3,00,000 + 3,00,000 + 3,00,000)/3 = 3,00,000

73

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

minimax criterion (iii) minimin criterion?

(b) Now consider payoff matrix as profit matrix then which level of inventory is
chosen on the basis of Hurwicz criterion
Solution: (a) (i) Laplace Criterion
Since, we do not know the probabilities of states of nature, assume that they
are equal. For this question, we would assume that each state of nature has a
probability 1/4 of occurrence. Thus,
Strategy

Expected Return (Rs)

A1

(7 + 10 + 23 + 32)/4 = 18

A2

(12 + 9 + 20 + 24)/4 = 16.25

A3

(20 + 10 + 14 + 21)/4 = 16.25

A4

(27 + 25 + 23 + 17)/4 = 23

74

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.

(b) In the context of profit data, Hurwicz Criterion, HC = (Max Value) + (1

) (Min Value). Its value for various strategies is as follows:
State of Profit from optimal Course of
Nature
Action(thousand Rs)
(1 (2 (3 (4 (5)
(6)
(7)
)
)
)
)
A1 A2 A3 A4 Profit (Max 0.5 x Profit (Min in
in
columns (5)
columns (1,
(1, 2, 3 & 4))
2, 3 & 4))
E1
7
12 20 27 32
16
7
E2
10 9
10 25 24
12
9
E3
23 20 14 23 21
10.5 10
E4
32 24 21 17 27
13.5 17
Since, maximum is 22, so, it is optimal to adopt strategy A4.

(8)
0.5
x
(7)
3.5
4.5
5
8.5

(6) +
(8)
19.5
16.5
15.5
22

75

A toy manufacturer is considering a project of manufacturing a dancing doll

with three different movement designs. The doll will be sold at an average of
Rs 10. The first movement design using gears and levels will provide the
lowest tooling and set up cost of Rs 1,00,000 and Rs 5 per unit of variable cost.
A second design with spring action will have a fixed cost of Rs. 1, 60,000 and
variable cost of Rs 4 per unit. Yet another design with weights and pulleys will
have a fixed cost of Rs. 3, 00,000 and variable cost of Rs 3 per unit. One of the
following demand events can occur for the doll with the probabilities:
Light demand
Moderate demand
Heavy demand

Demand (units)
25,000
1,00,000
1,50,000

Probability
0.10
0.70
0.20

(a) Construct a payoff table for the above project.

(b) Which is the optimum design?
(c) How much can be decision-maker afford to pay to obtain perfect
information about the demand?
Solution: Payoff (Profit) = Revenue Cost
= (Selling Price x no. of units demanded) (fixed cost + variable cost)
= (Selling Pricexno. of units demanded)(fixed cost+(no. of units demandedxper
unit cost))
State
of
Nature
(Demand)

Probabilit
y

Profit (Rs) Due to Course of

Action

Expected Payoff (Rs) Due to

Course of Action

(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

Expected monetary value (EMV)

4,12,500

4,55,000

4,17,500

Since, EMV is largest for spring action, it must be selected.

State

of

Nature

Probabilit

Profit (Rs) Due to Course of Action

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

in (2, 3 & 4))

25,000
4,40,000
7,50,000

(Max

(1) x (4)
Weighted
Profit
2,500
3,08,000
1,50,000
4,60,500

The maximum amount of money that the decision-maker would be willing to

pay to obtain perfect information regarding demand for the doll will be EVPI =
EPPI EMV
=4,60,000 4,55,000 = Rs 5,500
DECISION TREE ANALYSIS
Decision-making problems discussed so far have been limited to a single
decision over one period of time, because the payoffs, states of nature,
courses of action and probabilities associated with the occurrence of states of
nature are not subject to change.
However, situations may arise when a decision-maker needs to revise his
previous decisions on getting new information and make a sequence of several
interrelated decisions over several future periods. Thus he should consider the
whole series of decisions simultaneously. Such a situation is called a sequential
or multi period decision process.
Decision tree is a network which exhibits graphically the logical
relationship between the different parts of the complex decision process. It is a
77

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 (

) is used to represent a decision point or decision node at

which the decision maker has to decide about one of the various acts or
alternatives available to him.
(ii)

Each act or alternative is shown as a line, representing a branch of the

tree emanating from the square.

(iii)

A circle ( ) is used to represent a chance event or chance node at which

various events or states of nature are represented by lines, which depict
the sub-branches of the tree emanating from the circle.

(iv)

Each branch of the tree (corresponding to each act or strategy) has as

many sub-branches as the number of events or states of nature.

(v)

Along the branches/sub-branches are also shown the probabilities of

various states of nature and the payoffs for each combination (S i, Aj); I =
1, 2, , m; j = 1, 2, , n along with the EMV or EOL for each act.

(vi)

As a branch can sub-branch again, we obtain a tree like structure, which

represents the various steps in a decision problem.

Roll Back Technique of Analyzing a Decision Tree

A decision tree is extremely useful in multistage situations which involve a
number of decisions, each depending on the preceding one. At any stage, to
decide about any strategy or act, the decision maker has to take into
consideration all future outcomes that may result from choosing the said act.

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

Return from Sales (ooo Rs.)

Product X
Product Y
75
100
55
80
35
70

Construct the appropriate decision tree. What decision the company should
take?
Solution:

79

55000

Medium Demand (0.4)

80000

Net Payoff (Rs.)

75000-30000=45000
55000-30000=25000
35000-30000=5000
Total
100000-50000=50000
80000-50000=30000
70000-50000=20000
Total

Expected Payoff (Rs.)

45000 0.4=18000
25000 0.4=10000
5000 0.2=1000
29000 (EMV)
50000 0.3=15000
30000 0.4=12000
20000 0.3=6000
33000 (EMV)

80