Stochastic Programming:

introduction and examples

Amina Lamghari

COSMO – Stochastic Mine Planning Laboratory

Department of Mining and Materials Engineering
Outline

• What is Stochastic Programming?

• Why should we care about Stochastic

Programming?
• The farmer’s problem
• General formulation of two-stage stochastic
programs with recourse
 Introduction

• Mathematical Programming, alternatively

Optimization, is about decision making

• Decisions must often be taken in the face of the

unknown or limited knowledge (uncertainty)
• Market related uncertainty
• Technology related uncertainty
(breakdowns)
• Weather related uncertainty….
 How to deal with uncertainty?

• Ignore it?
• The uncertain “factors” might interact with
our decision in a meaningful way…

• “Carefully” determine the problem parameters?

• No matter how careful we are, we cannot get
rid of the inherent randomness…

Stochastic Programming is the way !

 What is Stochastic Programming?

• Mathematical Programming, alternatively

Optimization, is about decision making

• Stochastic Programming is about decision making

under uncertainty

• Can be seen as Mathematical Programming

with random parameters
 Reference

Birge, J. R., and F. Louveaux, 1997

Introduction to stochastic programming

Springer-Verlag, New York

 Why should we care about Stochastic
Programming? An example…

The farmer’s problem (from Birge and Louveaux, 1997)

•Farmer Tom can grow wheat, corn, and sugar

beets on his 500 acres.

How much land to devote to each crop?

 What Farmer Tom knows about wheat and corn

• He requires 200 tons of wheat and 240 tons of

corn to feed his cattle
• These can be grown on his land or bought
from a wholesaler
• Any production in excess of these amounts
can be sold for $170/ton (wheat) and
$150/ton (corn)
• Any shortfall must be bought from the
wholesaler at a cost of $238/ton (wheat) and
$210/ton (corn)
 What Farmer Tom knows about sugar beets

• He can also grow sugar beets on his 500 acres

• Sugar beets sell at $36/ton for the first 6000
tons
• Due to economic quotas on sugar beets,
sugar beets in excess of 6000 tons can only
be sold at $10/ton
 What Farmer Tom knows about his land

• Based on experience, the mean yield is roughly:

• Wheat: 2.5 tons/acre
• Corn: 3 tons/acre
• Sugar beets: 20 tons/acre

• And the planting costs are:

• Wheat: $150/acre
• Corn: $230/acre
• Sugar beets: $260/acre
 The data

Wheat Corn Sugar Beets

Yield (tons/acre) 2.5 3 20
Planting cost ($/acre) 150 230 260

Selling Price ($/ton) 170 150 36 (<= 6000 T)

10 (> 6000 T)
Purchase Price ($/ton) 238 210 -
Minimum Requirement (ton) 200 240 -
500 acres available for planting
 Linear Programming (LP) formulation
Decision variables

1. x1,2,3: acres of wheat, corn, sugar beets

planted (x1: wheat, x2: corn, x3: sugar beets)
2. w1,2,3: tons of wheat, corn, sugar beets sold at
favorable price
3. w4: tons of sugar beets sold at lower price
4. y1,2: tons of wheat, corn purchased (y1: wheat,
y2: corn)
 LP formulation

Objective function

Maximize
170 w1 - 238 y1 – 150 x1 Wheat

+ 150 w2 - 210 y2 - 230 x2 Corn

+ 36 w3+ 10 w4 – 260 x3 Sugar beets

Equivalent to

Min 150x1+230x2+260x3+238y1-170w1+210y2
-150w2 - 36w3- 10w4
 Constraints
• Acres available for planting
x1+x2+x3 <= 500
• Minimum requirement for wheat
2.5x1+ y1 - w1 >= 200
• Minimum requirement for corn
3x2+ y2-w2 >= 240
• Maximum that can be sold at favorable price (sugar B)
w3 <= 6000
• Logical link (production sugar beets)
20x3 >= w3 + w4
• Non-negativity
x1,x2,x3,y1,y2, w1,w2,w3,w4>=0
 Putting it all together

Maximize
-150x1-230x2-260x3-238y1+170w1- 210y2
+150w2+ 36w3+ 10w4
Subject to
x1+x2+x3 <= 500
2.5x1+y1-w1 >= 200
3x2+ y2-w2 >= 240
20x3-w3-w4 >= 0
w3 <= 6000
x1,x2,x3, ,y1,y2,w1,w2,w3,w4>=0
 Solution with expected yields (mean yields)

Culture Wheat Corn Sugar

Beets
Plant area (acres) 120 80 300
Production (tons) 300 240 6000
Sales (tons) 100 0 6000
Purchase (tons) 0 0 0
Profit:$118,600

Solution corresponds to Tom’s intuition!

• Plant land necessary to grow sugar beets up the quota limit
• Plant land to meet the production requirements for wheat and corn
• Plant remaining land with wheat and sell the excess.
 But the weather…

• The mean yield is roughly

• Wheat: 2.5 tons/acre
• Corn: 3 tons/acre
• Sugar beets: 20 tons/acre

• But farmer Tom knows that his yields aren’t that

precise

• Two scenarios
• Good weather: 1.2 Yield
• Bad weather: 0.8 Yield
 Formulation - Good Weather

Maximize
-150x1-230x2-260x3 - 238y1+170w1- 210y2
+150w2+ 36w3+ 10w4
Subject to
x1+ x2+ x3<=500
3 x1+ y1- w1 >= 200 (2.5 * 1.2 = 3)
3.6 x2+ y2- w2 >= 240 (3 * 1.2 = 3.6)
24 x3- w3- w4 >= 0 (20 *1.2 = 24)
w3 <= 6000
x1,x2,x3, y1,y2,w1,w2,w3,w4, >=0
 Solution if Good Weather

Culture Wheat Corn Sugar Beans

Plant area (acres) 183.33 66.67 250

Production (ton) 550 240 6000
Sales (ton) 350 0 6000
Purchase (ton) 0 0 0

Profit:$167,667
 Formulation - Bad Weather
Maximize
-150x1-230x2-260x3 - 238y1+170w1- 210y2
+150w2+ 36w3+ 10w4
Subject to
x1+ x2+ x3<=500
2 x1+ y1- w1>=200 (2.5 * 0.8 = 2)
2.4 x2+ y2- w2>=240 (3 * 0.8 = 2.4)
16 x3- w3- w4>=0 (20 * 0.8 = 16)
w3<=6000
x1,x2,x3,y1,y2, w1,w2,w3,w4 >= 0
 Solution if Bad Weather

Culture Wheat Corn Sugar Beans

Plant area (acres) 100 25 375
Production (ton) 200 60 6000
Sales (ton) 0 0 6000
Purchase (ton) 0 180 0

Profit:$59,950
 What should Tom do?
• The optimal solution is very sensitive to change on
the weather and the respective yields. The overall
profit ranges from $59,950 to $167,667
• Main issue sugar beets production: without knowing
the weather, he cannot determine how much land to
devote to this crop?
• Large surface: Might have to sell some at the
unfavorable price
• Small surface: Might miss the opportunity to sell
the full quota at the favorable price
 What should Tom do?
• Long term weather forecasts would be very helpful: If
only he can predict the weather conditions 6 months
ahead….

• Tom realizes that it is impossible to make a perfect

decision: The planting decisions must be made
now, but purchase and sales decisions can be
made later.
 Maximizing the Expected Profit
(long-run profit, risk-neutral decisions )
• Assume three scenarios occur with equal probability
We use a scenario subscript 1, 2, 3 to represent good
weather, average weather and bad weather,
respectively, and add it to each of the purchase and
sale variables.
For example,
w32: the amount of sugar beet sold @ favorable price if
yields is average.
w21: the amount of corn sold @ favorable price if yields
is above average.
w13: the amount of wheat sold @ favorable price if
yields is below average.
 The objective function

Tom’s expected profit can be expressed as follows:

-150x1-230x2-260x3
+1/3(170w11+150w21+36w31+10w41-238y11-210y21)
+ 1/3(170w12+150w22+36w32+10w42-238y12-210y22)
+ 1/3(170w13+150w23+36w33+10w43-238y13-210y23)
 The constraints

x1+ x2+ x3<=500

3x1+y11-w11>=200; 2.5x1+ y12- w12>=200; 2x1+ y13- w13>=200

3.6x2+ y21- w21>=240; 3x2+ y22- w22>=240; 2.4x23+y23-w23>=240
24x31- w3- w4>=0; 20x32- w3- w4>=0; 16x33- w3- w4>=0
w31,w32, w33 <=6000

All variables >=0

 Solution of the resulting model
Wheat Corn Sugar Beets
First Stage Area (Acres) 170 80 250
S=1 Production (t) 510 288 375
Above Sales (t) 310 48 6000(Favor.price)
Purchase (t) 0 0 0
S=2 Production (t) 425 240 5000
Average Sales (t) 225 0 5000(Favor.price)
Purchase 0 0 0
S=3 Production (t) 340 192 4000
Below Sales (t) 140 0 4000(Favor.price)
Purchase (t) 0 48 0
Expected Profit = $108,390
Top line: planting decisions which must be determined before knowing the weather
(now) are called first stage decisions. Production, sales, and purchases decisions for
the three scenarios are termed the second stage decisions (later)
 What is this solution telling us?
• Allocate land for sugar beets to always avoid having
to sell them at the unfavorable price (the 3 scenarios)
• Plant the corn so that to meet the production
requirement in the average scenario
• Plant the remaining land with wheat. This area is
large enough to cover minimum requirement and
sales always occur
• The solution is not ideal under all scenarios (it is
impossible to find one). The solution is
“hedged/balanced” against the various
scenarios
 Expected Value of Perfect Information
• Now assume yields vary over the years, but on a random
basis. If the farmer gets the information on the yields before
planting (HFT), he will choose one of the following solutions.
Good yields: (183.33, 66, 67, 250) or Profit: $167,667
Average yields: (120, 80, 67, 300) or Profit: $118,600
Bad yields: (100,25,375) or Profit: $59,950
• In the long run, if each yield is realized one third of the years
(each of the scenarios occurs with probability 1/3), Tom’s
average profit would be $115,406.
• As we all know, the farmer doesn’t get prior information on
the yields. The best he can do in the long run is take the
solution as given in the last table, and this case he would
have an expected profit of $108,390.
Expected Value of Perfect Information (EVPI)

• The difference
$115,406 - $108,390 = $7,016
is called expected value of perfect information

• It represents how much farmer Tom would be willing

to pay for the perfect information
Expected Value of Perfect Information (EVPI)

• EVPI = how much it is “worth” to invest in better

or perfect forecasting technology

• What is the “value” of including the uncertainty?

The Value of the Stochastic Solution (VSS)
Another approach farmer may have is to assume
expected yields and allocate the optimum planting
surface according to this yields. Would we get the
same expected profit?
• Solve the “mean value” problem to get a first
stage solution x or “a policy”
• Mean yields: (2.5, 3, 20)
• Solution: x1:120, x2:80, x3:300.
• Fix the first stage solution at that value x, and
then solve all the scenarios to see farmer’s profit
in each
 Profits based on Mean Value
Yield Profit($)
Good 148,000
Average 118,600
Bad 55,120

• If Tom implements the policy based on using only

the average yields, in the long run, he would expect
to make an average profit of:
1/3(148,000)+1/3*(118,600)+1/3*(55,120)=$107,240
• If Tom implements the policy based on the
solution of the stochastic programming problem
(x1=170, x2= 80, x3=250), he would expect to make
$108,390.
 The value of the Stochastic Solution (VSS)

• The difference of the values $108,390-

$107,240=$1,150 is the value of the stochastic
solution.

• If Tom uses the stochastic solution rather than the

mean value solution, he would get $1,150 more every
season!
 Thursday

• Mine production scheduling with uncertain

mineral supply

It is worth to model uncertainty!

 General Model Formulation

• We have a set of decisions to be taken without

full information on some random events, which
we call first-stage decisions (x)
• Later, full information is received on the
realization of some random vector ξ, and second-
stage or corrective actions (recourse) y are
taken
• We assume that the probabilistic property of ξ is
known a priori
 Two-stage stochastic program
with recourse – Implicit form
min cT x  E Q( x,  )
Ax  b,
x0

Minimum cost way to

“correct” so that the First stage deviation
constraints hold again

Where Q( x ,  )  min{q T
y | Wy  h  Tx, y  0} , 
is the
vector formed by the components of qT, hT, and T and
E denote the mathematical expectation with respect to ξ
 Back to the farmer’s example

• The random vector is a discrete variable with only three

different values (the three scenarios)
• A second stage problem for one particular scenario s can be
written as:
Q(x,s) = min{238y1-170w1+210y2-150w2-36w3-10w4}
s.t. t1(s)X1+y1-w1≥200,
t2(s)X2+y2-w2≥240,
w3+w4≤t3(s)X3,
w3≤6000, y, w >= 0
 Two-stage stochastic program
with recourse – Explicit form
• Less condensed

• Associate one decision vector in the second-stage to

each possible realization of the random vector
 Two-stage stochastic program
with recourse – Explicit form
Farmer’s problem
Minimize 150x1+230x2+260x3+1/3(-170w11-150w21-36w31-
10w41+238y11+210y21)+ 1/3(-170w12-150w22-36w32-
10w42+238y12+210y22)+ 1/3(-170w13-150w23-36w33-
10w43+238y13+210y23)
Subject to
3x1+y11-w11>=200; 2.5x1+ y12- w12>=200; 2x1+ y13- w13>=200
3.6x2+ y21- w21>=240; 3x2+ y22- w22>=240; 2.4x23+y23-w23>=240
24x31- w3- w4>=0; 20x32- w3- w4>=0; 16x33- w3- w4>=0
x1+ x2+ x3<=500; W31,w32, w33 <=6000; All variables >=0
 Solution methods

• The ease of solving the problem depends on the

properties of Q(x) = Eξ[Q(x,ξ)] , known as the
recourse function or the value function

• Problems where some variables (x and/or y) are

integer (Stochastic Integer Programming), are
generally more difficult to solve