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Chapter
8 Linear Programming
CHAPTER OUTLINE

KEY TERMS 8-1 Meaning, Assumptions, and Applications of Linear Programming •

The Meaning and Assumptions of Linear Programming • Applications
Linear programming of Linear Programming
Production process
8-2 Some Basic Linear Programming Concepts • Production Processes
Feasible region
and Isoquants in Linear Programming • The Optimal Mix of Production
Optimal solution
Processes
Objective function
Inequality constraints 8-3 Procedure Used in Formulating and Solving Linear Programming
Nonnegativity constraints Problems
Decision variables
8-4 Linear Programming: Profit Maximization • Formulation of the
Binding constraints
Profit Maximization Linear Programming Problem • Graphic Solution of
Slack variable
the Profit Maximization Problem • Extreme Points and the Simplex
Simplex method
Method • Algebraic Solution of the Profit Maximization Problem •
Primal problem
Case Study 8-1: Maximizing Profits in Blending Aviation Gasoline and
Dual problem
Military Logistics by Linear Programming • Case Study 8-2: Linear
Shadow price
Programming as a Tool of Portfolio Management
Duality theorem
Logistic management 8-5 Linear Programming: Cost Minimization • Formulation of the Cost
Minimization Linear Programming Problem • Graphic Solution of the
Cost Minimization Problem • Algebraic Solution of the Cost
Minimization Problem • Case Study 8-3: Cost Minimization Model for
Warehouse Distribution Systems and Supply Chain Management
8-6 The Dual Problem and Shadow Prices • The Meaning of Dual and
Shadow Prices • The Dual of Profit Maximization • The Dual of Cost
Minimization • Case Study 8-4: Shadow Prices in Closing an Airfield in
a Forest Pest Control Program
8-7 Linear Programming and Logistics in the Global Economy • Case
Study 8-5: Measuring the Pure Efficiency of Operating Units • Case
Study 8-6: Logistics at National Semiconductor, Saturn, and Compaq
8-8 Actual Solution of Linear Programming Problems on Personal
Computers
Summary • Discussion Questions • Problems • Supplementary Readings •
Internet Site Addresses
Integrating Case Study Three: Production and Cost Functions in the Petroleum
Industry, Duality, and Linear Programming

336
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Chapter 8 Linear Programming 337

n this chapter we introduce linear programming. This is a powerful technique

I that is often used by large corporations, not-for-profit organizations, and gov-
ernment agencies to analyze complex production, commercial, financial, and other
activities. The chapter begins by examining the meaning of “linear programming,”
the assumptions on which it is based, and some of its applications. We then pre-
sent the basic concepts of linear programming and examine its relationship to the
production and cost theories discussed in Chapters 6 and 7. Subsequently, we
show how linear programming can be used to solve complex constrained profit
maximization and cost minimization problems, and we estimate the economic
value or shadow price of each input. The theory is reinforced with six case stud-
ies of real-world applications of linear programming. Also discussed in this chap-
ter is the use of linear programming and logistics in the world economy today.
Finally, we show how to solve linear programming problems on personal comput-
ers using one of the simplest and most popular software programs.

8-1 MEANING, ASSUMPTIONS, AND

APPLICATIONS OF LINEAR PROGRAMMING
In this section we define linear programming and examine its origin, specify
the assumptions on which it rests, and examine some of the situations to
which it has been successfully applied.

The Meaning and Assumptions of Linear Programming

Linear programming is a mathematical technique for solving constrained
maximization and minimization problems when there are many constraints
and the objective function to be optimized, as well as the constraints faced, are
linear (i.e., can be represented by straight lines). Linear programming was de-
veloped by the Russian mathematician L. V. Kantorovich in 1939 and ex-
tended by the American mathematician G. B. Dantzig in 1947. Its acceptance
and usefulness have been greatly enhanced by the advent of powerful com-
puters, since the technique often requires vast calculations.
Firms and other organizations face many constraints in achieving their
goals of profit maximization, cost minimization, or other objectives. With
only one constraint, the problem can easily be solved with the traditional
techniques presented in the previous two chapters. For example, we saw in
Chapter 6 that in order to maximize output (i.e., reach a given isoquant) sub-
ject to a given cost constraint (isocost), the firm should produce at the point
where the isoquant is tangent to the firm’s isocost. Similarly, in order to min-
imize the cost of producing a given level of output, the firm seeks the lowest
isocost that is tangent to the given isoquant. In the real world, however, firms
and other organizations often face numerous constraints. For example, in the
short run or operational period, a firm may not be able to hire more labor
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338 Part 3 Production and Cost Analysis

with some type of specialized skill, obtain more than a specified quantity of
some raw material, or purchase some advanced equipment, and it may be
bound by contractual agreements to supply a minimum quantity of certain
products, to keep labor employed for a minimum number of hours, to abide
by some pollution regulations, and so on. To solve such constrained opti-
mization problems, traditional methods break down and linear programming
must be used.
Linear programming is based on the assumption that the objective func-
tion that the organization seeks to optimize (i.e., maximize or minimize), as
well as the constraints that it faces, are linear and can be represented graphi-
cally by straight lines. This means that we assume that input and output prices
are constant, that we have constant returns to scale, and that production can
take place with limited technologically fixed input combinations. Constant
input prices and constant returns to scale mean that average and marginal
costs are constant and equal (i.e., they are linear). With constant output
prices, the profit per unit is constant, and the profit function that the firm may
seek to maximize is linear. Similarly, the total cost function that the firm may
seek to minimize is also linear.1 The limited technologically fixed input com-
binations that a firm can use to produce each commodity result in isoquants
that are not smooth as shown in Chapter 6 but will be made up of straight line
segments (as shown in the next section). Since firms and other organizations
often face a number of constraints, and the objective function that they seek
to optimize as well as the constraints that they face are often linear over the
relevant range of operation, linear programming is very useful.

Applications of Linear Programming

Linear programming has been applied to a wide variety of constrained opti-
mization problems. Some of these are
1. Optimal process selection. Most products can be manufactured by using a
number of processes, each requiring a different technology and combina-
tion of inputs. Given input prices and the quantity of the commodity that
the firm wants to produce, linear programming can be used to determine
the optimal combination of processes needed to produce the desired level
and output at the lowest possible cost, subject to the labor, capital, and
other constraints that the firm may face. This type of problem is examined
in Section 8-2.
2. Optimal product mix. In the real world, most firms produce a variety of
products rather than a single one and must determine how to best use
their plants, labor, and other inputs to produce the combination or mix of

1
The total profit function is obtained by multiplying the profit per unit of output by the number of units of out-
put and summing these products for all the commodities produced. The total cost function is obtained by mul-
tiplying the price of each input by the quantity of the input used and summing these products over all the inputs
used.
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Chapter 8 Linear Programming 339

products that maximizes their total profits subject to the constraints they
face. For example, the production of a particular commodity may lead to
the highest profit per unit but may not use all the firm’s resources. The
unused resources can be used to produce another commodity, but this
product mix may not lead to overall profit maximization for the firm as a
whole. The product mix that would lead to profit maximization while sat-
isfying all the constraints under which the firm is operating can be deter-
mined by linear programming. This type of problem is examined in
Section 8-3, and a real-world example of it is given in Case Study 8-1.
3. Satisfying minimum product requirements. Production often requires that cer-
tain minimum product requirements be met at minimum cost. For exam-
ple, the manager of a college dining hall may be required to prepare meals
that satisfy the minimum daily requirements of protein, minerals, and vita-
mins at a minimum cost. Since different foods contain various proportions
of the various nutrients and have different prices, the problem can be com-
plex. This problem, however, can be solved easily by linear programming
by specifying the total cost function that the manager seeks to minimize and
the various constraints that he or she must meet or satisfy. The same type of
problem is faced by a chicken farmer who wants to minimize the cost of
feeding chickens the minimum daily requirements of certain nutrients; a
petroleum firm that wants to minimize the cost of producing a gasoline of
a particular octane subject to its refining, transportation, marketing, and ex-
ploration requirements; a producer of a particular type of bolt joints who
may want to minimize production costs, subject to its labor, capital, raw
materials, and other constraints. This type of problem is examined in Sec-
tion 8-4, and a real-world example of it is given in Case Study 8-2.
4. Long-run capacity planning. An important question that firms seek to answer
is how much contribution to profit each unit of the various inputs makes.
If this exceeds the price that the firm must pay for the input, this is an in-
dication that the firm’s total profits would increase by hiring more of the
input. On the other hand, if the input is underused, this means that some
units of the input need not be hired or can be sold to other firms without
affecting the firm’s output. Thus, determining the marginal contribution
(shadow price) of an input to production and profits can be very useful to
the firm in its investment decisions and future profitability.
5. Other specific applications of linear programming. Linear programming has also
been applied to determine (a) the least-cost route for shipping commodities
from plants in different locations to warehouses in other locations, and
from there to different markets (the so-called transportation problem);
(b) the best combination of operating schedules, payload, cruising altitude,
speed, and seating configurations for airlines; (c) the best combination of
logs, plywood, and paper that a forest products company can produce from
given supplies of logs and milling capacity; (d) the distribution of a given ad-
vertising budget among TV, radio, magazines, newspapers, billboards, and
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340 Part 3 Production and Cost Analysis

other forms of promotion to minimize the cost of reaching a specific num-

ber of customers in a particular socioeconomic group; (e) the best routing
of millions of telephone calls over long distances; (f ) the best portfolio of
securities to hold to maximize returns subject to constraints based on liq-
uidity, risk, and available funds; (g) the best way to allocate available
personnel to various activities, and so on.
Although these problems are different in nature, they all basically involve
constrained optimization, and they can all be solved and have been solved by
linear programming. This clearly points out the great versatility and useful-
ness of this technique. While linear programming can be complex and is usu-
ally conducted by the use of computers, it is important to understand its basic
principles and how to interpret its results. To this end, we present next some
basic linear programming concepts before moving on to more complex and
realistic cases.

8-2 SOME BASIC LINEAR

PROGRAMMING CONCEPTS
Though linear programming is applicable in a wide variety of contexts, it has
been more fully developed and more frequently applied in production deci-
sions. Production analysis also represents an excellent point of departure for
introducing some basic linear programming concepts. We begin by defining
the meaning of a production process and deriving isoquants. By then bringing
in the production constraints, we show how the firm can determine the opti-
mal mix of production processes to use in order to maximize output.

Production Processes and Isoquants in

Linear Programming
As pointed out in Section 8-1, one of the basic assumptions of linear pro-
gramming is that a particular commodity can be produced with only a limited
number of input combinations. Each of these input combinations or ratios is
called a production process or activity and can be represented by a straight
line ray from the origin in the input space. For example, the left panel of Fig-
ure 8-1 shows that a particular commodity can be produced with three
processes, each using a particular combination of labor (L) and capital (K ).
These are: process 1 with K/L  2, process 2 with K/L  1, and process 3 with
K/L  12. Each of these processes is represented by the ray from the origin
with slope equal to the particular K/L ratio used. Process 1 uses 2 units of cap-
ital for each unit of labor used, process 2 uses 1K for each 1L used, and
process 3 uses 0.5K for each 1L used.
By joining points of equal output on the rays of processes, we define the
isoquant for the particular level of output of the commodity. These isoquants
will be made up of straight-line segments and have kinks (rather than being
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Chapter 8 Linear Programming 341

FIGURE 8-1 The Firm’s Production Processes and Isoquants

Capital K
(K ) Process 1
(K/ L = 2) Process 1

D
12 12
Process 2
(K/ L = 1) Process 2

8 8 20
0Q Process 3
E
6 6 A
Process 3 F
(K/ L = 12 )
10
4 4 0Q
3 B
C
2

0 0
Labor (L) L
0 2 4 6 8 10 12 0 3 4 6 8 12

The left panel shows production process 1 using K/L  2, process 2 using K/L  1, and process 3 using K/L  12 that a firm
can use to produce a particular commodity. The right panel shows that 100 units of output (100Q) can be produced with
6K and 3L (point A), 4K and 4L (point B), or 6L and 3K (point C). Joining these points, we get the isoquant for 100Q. Be-
cause of constant returns to scale, using twice as many inputs along each production process (ray) results in twice as much
output. Joining such points, we get the isoquant for 200Q.

smooth as in Chapter 6). For example, the right panel of Figure 8-1 shows
that 100 units of output (100Q) can be produced with process 1 at point A
(i.e., by using 3L and 6K), with process 2 at point B (by using 4L and 4K), or
with process 3 at point C (with 6L and 3K). By joining these points, we get the
isoquant for 100Q. Note that the isoquant is not smooth but has kinks at
points A, B, and C.2 Furthermore, since we have constant returns to scale, the
isoquant for twice as much output (that is, 200Q) is determined by using twice
as much of each input with each process. This defines the isoquant for 200Q
with kinks at points D (6L, 12K), E (8L, 8K), and F (12L, 6K). Note that cor-
responding segments on the isoquant for 100Q and 200Q are parallel.

The Optimal Mix of Production Processes

If the firm faced only one constraint, such as isocost line GH in the left panel
of Figure 8-2, the feasible region, or the area of attainable input combina-
tions, is represented by shaded triangle 0JN. That is, the firm can purchase
any combination of labor and capital on or below isocost line GH. But since

2
The greater the number of processes available to produce a particular commodity, the less pronounced are
these kinks and the more the isoquants approach the smooth curves assumed in Chapter 6.
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342 Part 3 Production and Cost Analysis

FIGURE 8-2 Feasible Region and Optimal Solution

G K
16
1 1

12 D 12 D

J 2 R S 2
10

8 E E
200 3 200 3
Q Q
A
6 6
F F
N
4 4
B
T
2
H
0 0
L L
0 2 4 6 8 12 16 0 3 4 7 12

With isocost line GH in the left panel, the feasible region is shaded triangle 0J N, and the optimal solution is at point E
where the firm uses 8L and 8K and produces 200Q. The right panel shows that if the firm faces no cost constraint but has
available only 7L and 10K, the feasible region is shaded area 0RST and the optimal solution is at point S where the firm
produces 200Q. To reach point S, the firm produces 100Q with process 1 (0A) and 100Q with process 2 (0B  AS).

no production process is available that is more capital intensive than process

1 (i.e., which involves a K/L higher than 2) or less capital intensive than
process 3 (i.e., with K/L smaller than 12), the feasible region is restricted to the
shaded area 0JN. The best or optimal solution is at point E where the feasi-
ble region reaches the isoquant for 200Q (the highest possible). Thus, the
firm produces the 200 units of output with process 2 by using 8L and 8K.
The right panel of Figure 8-2 extends the analysis to the case where the
firm faces no cost constraint but has available only 7L and 10K for the period of
time under consideration. The feasible region is then given by shaded area
0RST in the figure. That is, only those labor-capital combinations in shaded
area 0RST are relevant. The maximum output that the firm can produce is
200Q and is given by point S. That is, the isoquant for 200Q is the highest that
the firm can reach with the constraints it faces. To reach point S, the firm will
have to produce 100Q with process 1 (0A) and 100Q with process 2 (0B  AS).3
Note that when the firm faced the single isocost constraint (GH in the
left panel of Figure 8-2), the firm used only one process (process 2) to reach
the optimum. When the firm faced two constraints (the right panel), the firm

3
0A and 0B are called “vectors.” Thus, the above is an example of vector analysis, whereby vector 0S (not
shown in the right panel of Figure 8-2) is equal to the sum of vectors 0A and 0B.
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Chapter 8 Linear Programming 343

required two processes to reach the optimum. From this, we can generalize
and conclude that to reach the optimal solution, a firm will require no more
processes than the number of constraints that the firm faces. Sometimes fewer
processes will do. For example, if the firm could use no more than 6L and
12K, the optimum would be at point D (200Q), and this is reached with
process 1 alone (see the left panel of Figure 8-2).4
From the left panel of Figure 8-2 we can also see that if the ratio of the
wage rate (w) to the rental price of capital (r) increased (so that isocost line
GH became steeper), the optimal solution would remain at point E as long as
the GH isocost (constraint) line remained flatter than segment DE on the iso-
quant for 200Q. If w/r rose so that isocost GH coincided with segment DE,
the firm could reach isoquant 200Q with process 1, process 2, or any combi-
nation of process 1 and process 2 that would allow the firm to reach a point
on segment DE. If w/r rose still further, the firm would reach the optimal so-
lution (maximum output) at point D (see the figure).

8-3 PROCEDURE USED IN FORMULATING

AND SOLVING LINEAR PROGRAMMING
PROBLEMS
The most difficult aspect of solving a constrained optimization problem by lin-
ear programming is to formulate or state the problem in a linear programming
format or framework. The actual solution to the problem is then straightfor-
ward. Simple linear programming problems with only a few variables are eas-
ily solved graphically or algebraically. More complex problems are invariably
solved by the use of computers. It is important, however, to know the process
by which even the most complex linear programming problems are formulated
and solved and how the results are interpreted. To show this, we begin by
defining some important terms and then using them to outline the steps to fol-
low in formulating and solving linear programming problems.
The function to be optimized in linear programming is called the objec-
tive function. This usually refers to profit maximization or cost minimiza-
tion. In linear programming problems, constraints are given by inequalities
(called inequality constraints). The reason is that the firm can often use up
to, but not more than, specified quantities of some inputs, or the firm must
meet some minimum requirement. In addition, there are nonnegativity
constraints on the solution to indicate that the firm cannot produce a nega-
tive output or use a negative quantity of any input. The quantities of each

4
To reach any point on an isoquant between two adjacent production processes, we use the process to which
the point is closer, in proportion to 1 minus the distance of the point from the process (ray). For example, if
point S were one-quarter of the distance DE from point D along the isoquant for 200Q, the firm would pro-
duce 1  14  34 of the 200Q (that is, 150Q) with process 1 and the remaining 14 with process 2 (see the figure).
The amount of each input that is used in each process is then proportional to the output produced by each
process.
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344 Part 3 Production and Cost Analysis

product to produce in order to maximize profits or inputs to use to minimize

costs are called decision variables.
The steps followed in solving a linear programming problem are:
1. Express the objective function of the problem as an equation and the con-
straints as inequalities.
2. Graph the inequality constraints, and define the feasible region.
3. Graph the objective function as a series of isoprofit (i.e., equal profit) or
isocost lines, one for each level of profit or costs, respectively.
4. Find the optimal solution (i.e., the values of the decision variables) at the
extreme point or corner of the feasible region that touches the highest iso-
profit line or the lowest isocost line. This represents the optimal solution
to the problem subject to the constraints faced.
In the next section we will elaborate on these steps as we apply them to
formulate and solve a specific profit maximization problem. In the following
section, we will apply the same general procedure to solve a cost minimization
problem.

8-4 LINEAR PROGRAMMING: PROFIT

MAXIMIZATION
In this section, we follow the steps outlined in the previous section to formu-
late and solve a specific profit maximization problem, first graphically and
then algebraically. We will also examine the case of multiple solutions.

Formulation of the Profit Maximization

Linear Programming Problem
Most firms produce more than one product, and a crucial question to which
they seek an answer is how much of each product (the decision variables) the
firm should produce in order to maximize profits. Usually, firms also face
many constraints on the availability of the inputs they use in their production
activities. The problem is then to determine the output mix that maximizes
the firm’s total profit subject to the input constraints it faces.
In order to show the solution of a profit maximization problem graphi-
cally, we assume that the firm produces only two products: product X and
product Y. Each unit of product X contributes $30 to profit and to covering
overhead (fixed) costs, and each unit of product Y contributes $40.5 Suppose
also that in order to produce each unit of product X and product Y, the firm

5
The contribution to profit and overhead costs made by each unit of the product is equal to the difference be-
tween the selling price of the product and its average variable cost. Since the total fixed costs of the firm are
constant, however, maximizing the total contribution to profit and to overhead costs made by the product mix
chosen also maximizes the total profits of the firm.
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Chapter 8 Linear Programming 345

TABLE 8-1 Input Requirements and Availability for Producing

Products X and Y

Quantities of Inputs Quantities of Inputs

Required per Available per
Unit of Output Time Period

Input Product X Product Y Total

A 1 1 7
B 0.5 1 5
C 0 0.5 2

requires inputs A, B, and C in the proportions indicated in Table 8-1. That is,
each unit of product X requires 1 unit of input A, one-half unit of input B, and
no input C, while 1 unit of product Y requires 1A, 1B, and 0.5C. Table 8-1 also
shows that the firm has available only 7 units of input A, 5 units of input B,
and 2 units of input C per time period. The firm then wants to determine how
to use the available inputs to produce the mix of products X and Y that maxi-
mizes its total profits.
The first step in solving a linear programming problem is to express the
objective function as an equation and the constraints as inequalities. Since
each unit of product X contributes $30 to profit and overhead costs and each
unit of product Y contributes $40, the objective function that the firm seeks
to maximize is
  $30QX  $40QY (8-1)
where  is the total contribution to profit and overhead costs faced by the
firm (henceforth simply called the “profit function”), and QX and QY refer, re-
spectively, to the quantities of product X and product Y that the firm pro-
duces. Thus, Equation 8-1 postulates that the total profit (contribution)
function of the firm equals the per-unit profit contribution of product X times
the quantity of product X produced plus the per-unit profit contribution of
product Y times the quantity of product Y that the firm produces.
Let us now go on to express the constraints of the problem as inequalities.
From the first row of Table 8-1, we know that 1 unit of input A is required to
produce each unit of product X and product Y and that only 7 units of input
A are available to the firm per period of time. Thus, the constraint imposed
on the firm’s production by input A can be expressed as
1QX  1QY  7 (8-2)
That is, the 1 unit of input A required to produce each unit of product X
times the quantity of product X produced plus the 1 unit of input A required
to produce each unit of product Y times the quantity of product Y produced
must be equal to or smaller than the 7 units of input A available to the firm.
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346 Part 3 Production and Cost Analysis

The inequality sign indicates that the firm can use up to, but no more than,
the 7 units of input A available to it to produce products X and Y. The firm
can use less than 7 units of input A, but it cannot use more.
From the second row of Table 8-1, we know that one-half unit of input B
is required to produce each unit of product X and 1 unit of input B is required
to produce each unit of product Y, and only 5 units of input B are available to
the firm per period of time. The quantity of input B required in the produc-
tion of product X is then 0.5QX, while the quantity of input B required in the
production of product Y is 1QY and the sum of 0.5QX and 1QY can be equal to,
but it cannot be more than, the 5 units of input B available to the firm per
time period. Thus, the constraint associated with input B is
0.5QX  1QY  5 (8-3)
From the third row in Table 8-1, we see that input C is not used in the
production of product X, one-half unit of input C is required to produce each
unit of product Y, and only 2 units of input C are available to the firm per time
period. Thus, the constraint imposed on production by input C is
0.5QY  2 (8-4)
In order for the solution to the linear programming problem to make
economic sense, however, we must also impose nonnegativity constraints on
the output of products X and Y. The reason for this is that the firm can pro-
duce zero units of either product, but it cannot produce a negative quantity of
either product (or use a negative quantity of either input). The requirement
that QX and QY (as well as that the quantity used of each input) be nonnega-
tive can be expressed as
QX  0 QY  0
We can now summarize the linear programming formulation of the
above problem as follows:
Maximize   $30QX  $40QY (objective function)
Subject to 1QX  1QY  7 (input A constraint)
0.5QX  1QY  5 (input B constraint)
0.5QY  2 (input C constraint)
QX, QY  0 (nonnegativity constraint)

Graphic Solution of the Profit Maximization Problem

The next step in solving the linear programming problem is to treat the in-
equality constraints of the problem as equations, graph them, and define the
feasible region. These are shown in Figure 8-3. Figure 8-3a shows the graph
of the constraint imposed on the production of products X and Y by input A.
Treating inequality constraint 8-2 for input A as an equation (i.e., disregard-
ing the inequality sign for the moment), we have 1QX  1QY  7. With 7
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Chapter 8 Linear Programming 347

FIGURE 8-3 Feasible Region, Isoprofit Lines, and Profit Maximization

QY
7 7
Constraint on input A Constraint on input A
6 1QX + 1QY  7 6 1QX + 1QY  7

5 5
G F Constraint on input C
Quantity of Y (QY)

4 4
0.5QY  2
E
3 3

2 2 Constraint on input B
Feasible region 0.5QX + 1QY  5
1 1
D
0 0
0 1 2 3 4 5 6 7 0 1 2 3 4 5 6 7 8 9 10 QX
Quantity of X (QX)
(a) (b)

QY

7.5
QY

H
6 6

π=
4.5 $3
00 G F
4
π=
$2
40 3 E
π=
$1
80
2

D J
0 0
0 2 4 6 8 10 0 2 4 7 8
QX QX
(c) (d)

The shaded area in part a shows the inequality constraint from input A. The shaded area in part b shows the feasible re-
gion, where all the inequality constraints are simultaneously satisfied. Part c shows the isoprofit lines for   $180,
  $240, and   $300. All three isoprofit lines have an absolute slope of $30/$40 or 34, which is the ratio of the contri-
bution of each unit of X and Y to the profit and overhead costs of the firm. Part d shows that  is maximized at point E
where the feasible region touches isoprofit line HJ (the highest possible) when the firm produces 4X and 3Y so that
  $30(40)  $40(3)  $240.
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348 Part 3 Production and Cost Analysis

units of input A available, the firm could produce 7 units of product X (that is,
7X) and no units of product Y, 7Y and 0X, or any combination of X and Y on
the line joining these two points. Since the firm could use an amount of input
A equal to or smaller than the 7 units available to it, inequality constraint 8-2
refers to all the combinations of X and Y on the line and in the entire shaded
region below the line (see Figure 8-3a).
In Figure 8-3b we have limited the feasible region further by considering
the constraints imposed by the availability of inputs B and C. The constraint
on input B can be expressed as the equation 0.5QX  1QY  5. Thus, if
QX  0, QY  5, and if QY  0, QX  10. All the combinations of product X
and product Y falling on or to the left of the line connecting these two points
represent the inequality constraint 8-3 for input B. The horizontal line at
QY  4 represents the constraint imposed by input C. Since input C is not
used in the production of product X, there is no constraint imposed by input
C on the production of product X. Since 0.5 unit of input C is required to pro-
duce each unit of product Y and only 2 units of input C are available to the
firm, the maximum quantity of product Y that the firm can produce is 4 units.
Thus, the constraint imposed by input C is represented by all the points on or
below the horizontal line at QY  4. Together with the nonnegativity con-
straints on QX and QY, we can, therefore, define the feasible region as the
shaded region of 0DEFG, for which all the inequality constraints facing the
firm are satisfied simultaneously.
The third step in solving the linear programming problem is to graph the
objective function of the firm as a series of isoprofit (or equal) profit lines.
Figure 8-3c shows the isoprofit lines for  equal to $180, $240, and $300. The
lowest isoprofit line in Figure 8-3c is obtained by substituting $180 for  into
the equation for the objective function and then solving for QY. Substituting
$180 for  in the objective function, we have
$180  $30QX  $40QY
Solving for QY, we obtain

 
$180 $30
QY   Q (8-5)
$40 $40 X
Thus, when QX  0, QY  $180/$40  4.5 and the slope of the isoprofit line
is $30/$40, or 43. This isoprofit line shows all the combinations of products
X and Y that result in   $180. Similarly, the equation of the isoprofit line
for   $240 is

 
$240 $30
QY   Q (8-6)
$40 $40 X
for which QY  6 when QX  0 and the slope is 34. Finally, the isoprofit equa-
tion for   $300 is

 
$300 $30
QY   Q (8-7)
$40 $40 X
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Chapter 8 Linear Programming 349

for which QY  7.5 when QX  0 and the slope is 34. Note that the slopes of
all isoprofit lines are the same (i.e., the isoprofit lines are parallel) and are
equal to 1 times the ratio of the profit contribution of product X to the
profit contribution of product Y (that is, $30/$40  34).
The fourth and final step in solving the linear programming problem is
to determine the mix of products X and Y (the decision variables) that the firm
should produce in order to reach the highest isoprofit line. This is obtained
by superimposing the isoprofit lines shown in Figure 8-3c on the feasible re-
gion shown in Figure 8-3b. This is done in Figure 8-3d, which shows that the
highest isoprofit line that the firm can reach subject to the constraints it faces
is HJ. This is reached at point E where the firm produces 4X and 3Y and the
total contribution to profit () is maximum at $30(4)  $40(3)  $240. Note
that point E is at the intersection of the constraint lines for inputs A and B but
below the constraint line for input C. This means that inputs A and B are fully
utilized, while input C is not.6 In the terminology of linear programming, we
then say that inputs A and B are binding constraints, while input C is non-
binding or is a slack variable.7

Extreme Points and the Simplex Method

In the previous section, we showed that the firm’s optimal or profit maxi-
mization product mix is given at point E, a corner of the feasible region.8 This
example illustrates a basic theorem of linear programming. This is that in
searching for the optimal solution, we need to examine and compare the lev-
els of  at only the extreme points (corners) of the feasible region and can ig-
nore all other points inside or on the borders of the feasible region. That is,
with a linear objective function and linear input constraints, the optimal solu-
tion will always occur at one of the corners. In the unusual event that the iso-
profit lines have the same slope as one of the segments of the feasible region,
then all the product mixes along that segment will result in the same maxi-
mum value, and we have multiple optimal solutions. Since these include the
two corners defining the segment, the rule that in order to find the optimal or
profit-maximizing product mix, we only need to examine and compare the
value of  at the corners of the feasible region holds up.
Figure 8-4 shows the case of multiple optimal solutions. In the figure, the
new isoprofit line HJ  ($240  $24QX  $48QY) has the absolute slope of
$24/$48  12, the same as segment EF of the feasible region. Thus, all the
product mixes along EF, including those at corner points E and F, result in
the same value of   $240. For example, at point M (3X, 3.5Y ) on EF,

6
From Figure 8-3b, we can see that at point E only 112 out of the 2 units of input C available to the firm per time
period are used.
7
We will return to this in the algebraic solution to this problem in the following subsection and in our discus-
sion of the dual problem and shadow prices in Section 8-6.
8
At the other corners of the feasible region, the values of  are as follows: at corner point D(7, 0),
  $30(7)  $210; at point F (2, 4),   $30(2)  $40(4)  $220; at point G (0, 4),   $40(4)  $160; and
at the origin (0, 0),   0.
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350 Part 3 Production and Cost Analysis

FIGURE 8-4 Multiple Optimal Solutions

QY

H
6
$240 = $30QX + $40QY
H’
5

G F
4
3.5
M E
3

$240 = $24QX + $48QY

2

G J J’
0
QX
0 2 3 4 7 8 10

The new isoprofit line HJ ($240  $24QX  $48QY) has the same absolute slope of $24/$48  12 as segment EF of the
feasible region. Thus, all the product mixes along EF, such as those indicated at point M and at corner points E and F, re-
sult in the same value of   $240.

  $24(3)  $48(3.5)  $240. Since   $240 at corner point E and at cor-

ner point F also, we can find the optimal solution of the problem by examin-
ing only the corners of the feasible region, even in a case such as this one
where there are multiple optimal points.9
The ability to determine the optimal solution by examining only the ex-
treme or corner points of the feasible region greatly reduces the calculations
necessary to solve linear programming problems that are too large to solve
graphically. These large linear programming problems are invariably solved
by computers. All the computer programs available for solving linear pro-
gramming problems start by arbitrarily picking one corner and calculating the
value of the objective function at that corner, and then systematically moving
to other corners that result in higher profits until they find no corner with
higher profits. This is referred to as the “extreme-point theorem,” and the

9
At corner point E (4, 3),   $24(4)  $48(3)  $240; at corner point F (2, 4),   $24(2)  $48(4)  $240.
Sometimes a constraint may be redundant. This occurs when the feasible region is defined only by the other
constraints of the problem. For example, if the constraint equation for input C had been 0.5QY  3, the con-
straint line for input C would have been a horizontal straight line at QY  6 and fallen outside the feasible re-
gion of the problem (which in that case would have been defined by the constraint lines for inputs A and B
only—see Figure 8-3b). There are other cases where a constraint may make the solution of the problem im-
possible. In that case (called “degeneracy”), the constraints have to be modified in order to obtain a solution to
the problem (see Problem 7).
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Chapter 8 Linear Programming 351

FIGURE 8-5 Algebraic Determination of the Corners of the Feasible Region

QY

Constraint on input A
1QX + 1QY 7

Constraint on input C
4 0.5QY 2
G (0,4)
F (2,4)
E (4,3)
3

Constraint on input B
0.5QX + 1QY 5

D (7,0)
0
QX
0 2 4 7 10

The quantity of products X and Y (that is, QX and QY) at corner point D is obtained by substituting QY  0 (along the QX
axis) into the constraint equation for input A. QX and QY at corner point E are obtained by solving simultaneously the con-
straint equations for inputs A and B. QX and QY at point F are obtained by solving simultaneously the equations for con-
straints B and C. Corner point G can be dismissed outright because it involves the same QY as at point F but has QX  0.
The origin can also be dismissed since QX  QY    0.

method of solution is called the simplex method. The algebraic solution to

the linear programming problem examined next provides an idea of how the
computer proceeds in solving the problem.10

Algebraic Solution of the Profit Maximization Problem

The profit maximization linear programming problem that was solved graph-
ically earlier can also be solved algebraically by identifying (algebraically) the
corners of the feasible region and then comparing the profits at each corner.
Since each corner is formed by the intersection of two constraint lines, the co-
ordinates of the intersection point (i.e., the value of ) QX and QY at the corner
can be found by solving simultaneously the equations of the two intersecting
lines. This can be seen in Figure 8-5 (which is similar to Figure 8-3b).

10
In 1984, N. Karmarkar of Bell Labs discovered a new algorithm or mathematical formula that solved very
large linear programming problems 50 to 100 times faster than with the simplex method. However, most rou-
tine linear programming problems are still being solved with the simplex method. See “The Startling Discov-
ery Bell Labs Kept in the Shadows,” Business Week, September 21, 1987, pp. 69–76, and C. E. Downing and
J. L. Ringuest, “An Experimental Evaluation of the Efficacy of Four Multiobjective Linear Programming
Algorithms,” European Journal of Operational Research, February 1998, pp. 549–558.
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352 Part 3 Production and Cost Analysis

In Figure 8-5, only corner points D, E, and F need to be considered.

While the origin is also a corner point of the feasible region, profits are zero
at this point because QX  QY  0. Corner point G (0X, 4Y ) can also be dis-
missed because it refers to the same output of product Y as at corner point F
but to less of product X. This leaves only corner points D, E, and F to be eval-
uated. Since corner point D is formed by the intersection of the constraint line
for input A with the horizontal axis (along which QY  0, see Figure 8-5), the
quantity of product X (that is, QX) at corner point D is obtained by substitut-
ing QY  0 into the equation for constraint A. That is, substituting QY  0 into
1QX  1QY  7
we get
QX  7
Thus, at point D, QX  7 and QY  0.
Corner point E is formed by the intersection of the constraint lines for
inputs A and B (see Figure 8-5), which are, respectively,
1QX  1QY  7
and
0.5QX  1QY  5
Subtracting the second equation from the first, we have
1QX  1QY  7
0.5QX  1QY  5
0.5QX 2
so that QX  4. Substituting QX  4 into the first of the two equations, we get
QY  3. Thus, QX  4 and QY  3 at corner point E. These are the same val-
ues of QX and QY determined graphically in Figure 8-3b.
Finally, corner point F is formed by the intersection of the constraint
lines for inputs B and C, which are, respectively,
0.5QX  1QY  5
and
0.5QY  2
Substituting QY  4 from the second equation into the first equation, we have
0.5QX  4  5
so that QX  2. Thus at corner point F, QX  2 and QY  4 (the same as ob-
tained graphically in Figure 8-3b).
By substituting the values of QX and QY (the decision variables) at each
corner of the feasible region into the objective function, we can then deter-
mine the firm’s total profit contribution () at each corner. These are shown
in Table 8-2, which (for the sake of completeness) also shows the levels of
profit at the origin and at point G. The optimal or profit-maximizing point is
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Chapter 8 Linear Programming 353

TABLE 8-2 Outputs of Products X and Y, and Profits at Each Corner

of the Feasible Region

Corner Point QX QY $30QX  $40QY Profit

0 0 0 $30(0)  $40(0) $ 0
D 7 0 $30(7)  $40(0) $210
*E 4 3 $30(4)  $40(3) $240
F 2 4 $30(2)  $40(4) $220
G 0 4 $30(0)  $40(4) $160

at corner E at which   $240 (the same as obtained in the graphical solution

in Figure 8-3d).
From the algebraic or graphical solution we can also determine which in-
puts are fully used (i.e., are binding constraints on production) and which are
not (i.e., are slack variables) at each corner of the feasible region. For exam-
ple, from Figure 8-5 we can see that since corner point D is on the constraint
line for input A but is below the constraint lines for inputs B and C, input A is
a binding constraint on production, while inputs B and C represent slack vari-
ables. Since corner point E is formed by the intersection of the constraint
lines for inputs A and B but is below the constraint line for input C, inputs A
and B are binding constraints while input C is a slack variable or input. Finally,
since corner point F is formed by the intersection of the constraint lines for
inputs B and C but is below the constraint line for input A, inputs B and C are
binding while input A is slack.11
Not only is a firm’s manager interested in knowing the quantities of prod-
ucts X and Y that the firm must produce in order to maximize profits, but he
or she is also interested in knowing which inputs are binding and which are
slack at the optimal or profit-maximizing point. This information is routinely
provided by the computer solution to the linear programming problem. The
computer solution will also give the unused quantity of each slack input. The
firm can use this information to determine how much of each binding input it
should hire in order to expand output by a desired amount, or how much of
the slack inputs it does not need to hire or it can rent out to other firms (if it
owns the inputs) at the profit-maximizing solution.

8-5 LINEAR PROGRAMMING:

COST MINIMIZATION
We now follow the steps outlined in Section 8-3 to formulate and solve a spe-
cific cost minimization problem, first graphically and then algebraically.

11
We can similarly determine that at corner point G, only input C is binding, while at the origin all three inputs
are slack.
sal11586_ch08.qxd 10/10/03 10:13 AM Page 354

CASE STUDY 8-1

Maximizing Profits in Blending Aviation Gasoline and

Military Logistics by Linear Programming

ne important application of linear programming is in the blending of aviation

O gasolines. Aviation gasolines are blended from carefully selected refined gasolines
so as to ensure that certain quality specifications, such as performance numbers (PN )
and Reid vapor pressure (RVP), are satisfied. Each of these specifications depends on a
particular property of the gasoline. For example, PN depends on the octane rating of
the fuel. Aircraft engines require a certain minimum octane rating to run properly and
efficiently, but using higher-octane gasoline results in greater expense without in-
creasing operating performance. In the problem at hand, three types of aviation gaso-
line, M, N, and Q, were examined, each with a stipulated minimum PN and maximum
RVP rating, generated by combining four fuels (A, B, D, and F) in various proportions.
The problem was to maximize the following objective function:
  0.36M  0.089N  1.494Q
subject to 32 inequality and nonnegativity constraints (based on the characteristics of
each input and their availability, as well as on the condition that all outputs and inputs
be nonnegative). The solution to the problem specified how each of the four inputs had
to be combined in order to produce the mix of aviation gasolines that maximized prof-
its. The maximum profit per day obtained was $15,249 on total net receipts of $69,067.
Linear programming is also used by the U.S. Air Force’s Airlift Air Mobility Com-
mand (AMC) for scheduling purposes and to minimize the cost of transporting mili-
tary personnel and cargo to its numerous bases served by 329 airports around the
world using roughly 1,000 planes of several types. The complexity of this type of prob-
lem defies imagination but can now be easily solved by linear programming. The same
type of scheduling problem is also routinely solved by linear programming by com-
mercial airlines.

Source: A. Charnes, W. W. Cooper, and B. Mellon, “Blending Aviation Gasolines—A Study in Programming
Interdependent Activities in an Integrated Oil Company,” Econometrica, April 1952, pp. 135–159; “The Star-
tling Discovery Bell Labs Kept in the Shadows,” Business Week, September 21, 1987, pp. 69–76; and “This
Computer System Could Solve the Unsolvable,” Business Week, March 13, 1989, p. 77.

Formulation of the Cost Minimization Linear

Programming Problem
Most firms usually use more than one input to produce a product or service,
and a crucial choice they face is how much of each input (the decision vari-
ables) to use in order to minimize the costs of production. Usually firms also
face a number of constraints in the form of some minimum requirement that
they or the product or service that they produce must meet. The problem is
then to determine the input mix that minimizes costs subject to the con-
straints that the firm faces.
In order to show how a cost minimization linear programming problem
is formulated and solved, assume that the manager of a college dining hall is

354
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CASE STUDY 8-2

Linear Programming as a Tool of Portfolio Management

inear programming is now being applied even in portfolio management. In fact,

L more and more computer programs are being developed to help investors maximize
their expected rates of return on their stock and bond investments subject to risk, div-
idend and interest, and other constraints. For example, one linear programming model
can be used to determine when a bond dealer or other investor should buy, sell, or sim-
ply hold a bond. The model can also be used to determine the optimal strategy for an
investor to follow in order to maximize portfolio returns for each level of risk exposure.
Another use of linear programming is to determine the highest return that an investor
can receive from holding portfolios with various proportions of different securities.
Still another use of the model is in determining which of the projects that satisfy some
minimum acceptance standard should be undertaken in the face of capital rationing
(i.e., when all such projects cannot be accepted because of capital limitations).
The most complex portfolio management problems involving thousands of variables
that leading financial management firms deal with, and that previously required hours
of computer time with the largest computers to solve with the simplex method, can now
be solved in a matter of minutes with the algorithm developed in 1984 by Karmarkar at
Bell Labs (see footnote 10). More important for the individual investor and small firms
is that more and more user-friendly computer programs are becoming available to help
solve an ever-widening range of financial management decisions on personal comput-
ers (see Section 8-8). While in the final analysis these computer programs can never re-
place financial acumen, they can certainly help all investors improve their planning.

Source: Martin R. Young, “A Minimax Portfolio Selection Rule with Linear Programming Solution,” Manage-
ment Science, May 1998, pp. 673–683; and E. I. Ronn, “A New Linear Programming Approach to Bond Port-
folio Management,” Journal of Financial and Quantitative Analysis, December 1987, pp. 439–466.

required to prepare meals that satisfy the minimum daily requirements of pro-
tein (P ), minerals (M ), and vitamins (V ). Suppose that the minimum daily re-
quirements have been established at 14P, 10M, and 6V. The manager can use
two basic foods (say, meat and fish) in the preparation of meals. Meat (food X )
contains 1P, 1M, and 1V per pound. Fish (food Y ) contains 2P, 1M, and 0.5V
per pound. The price of X is $2 per pound, and the price of Y is $3 per pound.
This information is summarized in Table 8-3. The manager wants to provide
meals that fulfill the minimum daily requirements of protein, minerals, and
vitamins at the lowest possible cost per student.
The above linear programming problem can be formulated as follows:
Minimize C  $2QX  $3QY (objective function)
Subject to 1QX  2QY  14 (protein constraint)
1QX  1QY  10 (minerals constraint)
1QX  0.5QY  6 (vitamins constraint)
QX, QY  0 (nonnegativity constraint)

355
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356 Part 3 Production and Cost Analysis

TABLE 8-3 Summary Data for the Cost Minimization Problem

Meat (Food X) Fish (Food Y )

Price per pound $2 $3

Minimum Daily
Units of Nutrients per Pound of Requirement

Nutrient Meat (Food X) Fish (Food Y) Total

Protein (P) 1 2 14
Minerals (M) 1 1 10
Vitamins (V) 1 0.5 6

Specifically, since the price of food X is $2 per pound and the price of
food Y is $3 per pound, the cost function (C ) per student that the firm seeks
to minimize is C  $2QX  $3QY. The protein (P) constraint indicates that 1P
(found in each unit of food X ) times QX plus 2P (found in each unit of food Y )
times QY must be equal to or larger than the 14P minimum daily requirement
that the manager must satisfy. Similarly, since each unit of foods X and Y con-
tains 1 unit of minerals (M) and meals must provide a daily minimum of 10M,
the minerals constraint is given by 1QX  1QY  10. Furthermore, since each
unit of food X contains 1 unit of vitamins (1V ) and each unit of food Y con-
tains 0.5V, and meals must provide a daily minimum of 6V, the vitamins con-
straint is 1QX  0.5QY  6. Note that the inequality constraints are now
expressed in the form of “equal to or larger than” since the minimum daily re-
quirements must be fulfilled but can be exceeded. Finally, nonnegativity con-
straints are required to preclude negative values for the solution.

Graphic Solution of the Cost Minimization Problem

In order to solve graphically the cost minimization linear programming prob-
lem formulated above, the next step is to treat each inequality constraint as an
equation and plot it. Since each inequality constraint is expressed as “equal to
or greater than,” all points on or above the constraint line satisfy the particu-
lar inequality constraint. The feasible region is then given by the shaded area
above DEFG in the left panel of Figure 8-6. All points in the shaded area si-
multaneously satisfy all the inequality and nonnegativity constraints of the
problem.
In order to determine the mix of foods X and Y (that is, QX and QY) that
satisfies the minimum daily requirements for protein, minerals, and vitamins
at the lowest cost per student, we superimpose cost line HJ on the feasible re-
gion in the right panel of Figure 8-6. HJ is the lowest isocost line that allows
the firm to reach the feasible region. Note that cost line HJ has an absolute
slope of 23, which is the ratio of the price of food X to the price of food Y and
is obtained by solving the cost equation for QY. Cost line HJ touches the
feasible region at point E. Thus, the manager minimizes the cost of satisfying
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Chapter 8 Linear Programming 357

FIGURE 8-6 Feasible Region and Cost Minimization

QY QY
G G
12 12
1QX + 0.5QY
6
10
Feasible region
F H F Feasible region
8 8
7 1QX + 1QY
10 C=
$2
Q
X +$
3Q
E 1QX + 2QY
14 Y E
4 4

D J D
0 0
QX QX
0 2 6 10 14 0 2 6 12 14

The shaded area in the left panel shows the feasible region where all the constraints are simultaneously satisfied. HJ in the
right panel is the lowest isocost line that allows the manager to reach the feasible region. The absolute slope of cost
line HJ is 23 , which is the ratio of the price of food X to the price of food Y. The manager minimizes costs by using 6 units
of food X and 4 units of food Y at point E at a cost of C  $2(6)  $3(4)  $24 per student.

the minimum daily requirements of the three nutrients per student by using 6
units of food X and 4 units of food Y at a cost of
C  ($2)(6)  ($3)(4)  $24
Costs are higher at any other corner or point inside the feasible region.12
Note that point E is formed by the intersection of the constraint lines for
nutrient P (protein) and nutrient M (minerals) but is above the constraint line
for nutrient V (vitamins). This means that the minimum daily requirements
for nutrients P and M are just met while the minimum requirement for nutri-
ent V is more than met. Note also that if the price of food X increases from $2
to $3 (so that the ratio of the price of food X to the price of food Y is equal to
1), the lowest isocost line that reaches the feasible region would coincide with
segment EF of the feasible region. In that case, all the combinations or mixes
of food X and food Y along the segment would result in the same minimum
cost (of $30) per student. If the price of food X rose above $3, the manager
would minimize costs at point F.

Algebraic Solution of the Cost Minimization Problem

The cost minimization linear programming problem solved graphically above
can also be solved algebraically by identifying (algebraically) the corners of

At corner point D, C  ($2)(14)  $28; at point F, C  ($2)(2)  ($3)(8)  $28; and at point G,
12

C  ($3)(12)  $36.
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358 Part 3 Production and Cost Analysis

the feasible region and then comparing the costs at each corner. Since each
corner is formed by the intersection of two constraint lines, the coordinates of
the intersection point (i.e., the values of QX and QY at the corner) can be found
by solving simultaneously the equations of the two intersecting lines, exactly
as was done in solving algebraically the profit maximization linear program-
ming problem.
For example, from the left panel of Figure 8-6, we see that corner point
E is formed by the intersection of the constraint lines for nutrient P (protein)
and nutrient M (minerals), which are, respectively,

1QX  2QY  14
and
1QX  1QY  10

Subtracting the second equation from the first, we have

1QX  2QY  14
1QX  1QY  10
1QY  4

Substituting QY  4 into the second of the two equations, we get QX  6.

Thus, QX  6 and QY  4 at corner point E (the same as we found graphically
above). With the price of food X at $2 and the price of food Y at $3, the cost
at point E is $24. The values of QX and QY and the costs at the other corners
of the feasible region can be found algebraically in a similar manner and are
given in Table 8-4. The table shows that costs are minimized at $24 at corner
point E by the manager using 6X and 4Y.
Since each unit of food X provides 1P, 1M, and 1V (see Table 8-3), the 6X
that the manager uses at point E provide 6P, 6M, and 6V. On the other hand,
since each unit of food Y provides 2P, 1M, and 0.5V, the 4Y that the manager
uses at point E provide 8P, 4M, and 2V. The total amount of nutrients pro-
vided by using 6X and 4Y are then 14P (the same as the minimum require-
ment), 10M (the same as the minimum requirement), and 8V (which exceeds
the minimum requirement of 6V ). This is the same conclusion that we
reached in the graphical solution.

TABLE 8-4 Use of Foods X and Y, and Costs at Each Corner of

the Feasible Region

Corner Point QX QY $2QX  $3QY Cost

D 14 0 $2(14)  $3(0) $28
*E 6 4 $2(6)  $3(4) $24
F 2 8 $2(2)  $3(8) $28
G 0 12 $2(0)  $3(12) $36
sal11586_ch08.qxd 10/10/03 10:13 AM Page 359

CASE STUDY 8-3

Cost Minimization Model for Warehouse Distribution

Systems and Supply Chain Management

cost minimization model for a warehouse distribution system was developed

A for a firm that produced six consumer products at six different locations and dis-
tributed the products nationally from 13 warehouses. The questions that the firm
wanted to answer were (1) how many warehouses should the firm use? (2) where
should these warehouses be located? and (3) which demand points should be serviced
from each warehouse? Forty potential warehouse locations were considered for de-
mand originating from 225 counties. While transportation costs represented the ma-
jor costs of distributing the products, the model also considered other costs such as
warehouse storage and handling costs, interest cost on inventory, state property taxes,
income and franchise taxes, the cost of order processing, and administrative costs.
The summary of the results comparing the distribution system in effect with the op-
timal distribution system is given in Table 8-5. The table shows that switching from
the distribution system in effect (which used 13 warehouses) to the optimal distribu-
tion system (which used 32 warehouses) would save the firm about $400,000 per
year. This cost reduction arises because the decline in the mean transportation dis-
tance and transportation costs resulting from using 32 warehouses exceeds the
increase in the fixed costs of operating 32 warehouses as compared with operating 13
warehouses.
In recent years, supply chain management is moving up the corporate chain, with
many large corporations appointing logistics specialists to senior positions. Increas-
ingly, supply chain management is seen not simply as a way to reduce transportation
costs, but as a source of competitive advantage. For example, one health care company
was able to substantially increase its market share by establishing overnight delivery to
the retailer and next-day service to the customer. Although lean production in an
international supply chain is more difficult than within the nation, it also can lead to
major benefits.

Source: D. L. Eldredge, “A Cost Minimization Model for Warehouse Distribution Systems,” Interfaces, August
1982, pp. 113–119; David L. Levy, “Lean Production in an International Supply Chain,” Sloan Management
Review, Winter 1997, pp. 94–102; and Richard R. McBride, “Advances in Solving the Multicommodity-Flow
Problem,” Interfaces, March/April 1998, pp. 32–41.

TABLE 8-5 Comparison of Distribution System in Effect with Optimal

Distribution System

Characteristic Old System Optimal System

Total variable cost (in millions) $3.458 $3.054
Mean service distance (miles) 174 100
Number of warehouses 13 32

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360 Part 3 Production and Cost Analysis

8-6 THE DUAL PROBLEM AND

SHADOW PRICES
In this section, we examine the meaning and usefulness of dual linear pro-
gramming and shadow prices. Then we formulate and solve the dual linear
programming problem and find the value of shadow prices for the profit max-
imization problem of Section 8-4 and for the cost minimization problem of
Section 8-5.

The Meaning of Dual and Shadow Prices

Every linear programming problem, called the primal problem, has a corre-
sponding or symmetrical problem called the dual problem. A profit maxi-
mization primal problem has a cost minimization dual problem, while a cost
minimization primal problem has a profit maximization dual problem.
The solutions of a dual problem are the shadow prices. They give the
change in the value of the objective function per unit change in each con-
straint in the primal problem. For example, the shadow prices in a profit max-
imization problem indicate how much total profits would rise per unit
increase in the use of each input. Shadow prices thus provide the imputed
value or marginal valuation or worth of each input to the firm. If a particular
input is not fully employed, its shadow price is zero because increasing the in-
put would leave profits unchanged. A firm should increase the use of the in-
put as long as the marginal value or shadow price of the input to the firm
exceeds the cost of hiring the input.
Shadow prices provide important information for planning and strategic
decisions of the firm. Shadow prices are also used (1) by many large corpora-
tions to correctly price the output of each division that is the input to another
division, in order to maximize the total profits of the entire corporation, (2) by
governments to appropriately price some government services, and (3) for
planning in developing countries where the market system often does not
function properly (i.e., where input and output prices do not reflect their true
relative scarcity). The computer solution of the primal linear programming
problem also provides the values of the shadow prices. Sometimes it is also
easier to obtain the optimal value of the decision variables in the primal prob-
lem by solving the corresponding dual problem.
The dual problem is formulated directly from the corresponding primal
problem as indicated below. We will also see that the optimal value of the ob-
jective function of the primal problem is equal to the optimal value of the ob-
jective function of the corresponding dual problem. This is called the duality
theorem.

The Dual of Profit Maximization

In this section, we formulate and solve the dual problem for the constrained
profit maximization problem examined in Section 8-4, which is repeated
below for ease of reference.
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Chapter 8 Linear Programming 361

Maximize   $30QX  $40QY (objective function)

Subject to 1QX  1QY  7 (input A constraint)
0.5QX  1QY  5 (input B constraint)
0.5QY  2 (input C constraint)
QX, QY  0 (nonnegativity constraint)
In the dual problem we seek to minimize the imputed values, or shadow
prices, of inputs A, B, and C used by the firm. Defining VA, VB, and VC as the
shadow prices of inputs A, B, and C, respectively, and C as the total imputed
value of the fixed quantities of inputs A, B, and C available to the firm, we can
write the dual objective function as
Minimize C  7VA  5VB  2VC (8-8)
where the coefficients 7, 5, and 2 represent, respectively, the fixed quantities
of inputs A, B, and C available to the firm.
The constraints of the dual problem postulate that the sum of the shadow
price of each input times the amount of that input used to produce 1 unit of a
particular product must be equal to or larger than the profit contribution of a
unit of the product. Thus, we can write the constraints of the dual problem as
1VA  0.5VB  $30
1VA  1VB  0.5VC  $40
The first constraint postulates that the 1 unit of input A required to produce
1 unit of product X times the shadow price of input A (that is, VA) plus 0.5
unit of input B required to produce 1 unit of input X times the shadow price
of input B (that is, VB) must be equal to or larger than the profit contribution
of the 1 unit of product X produced. The second constraint is interpreted in a
similar way.
Summarizing the dual cost minimization problem and adding the non-
negativity constraints, we have
Minimize C  7VA  5VB  2VC (objective function)
Subject to 1VA  0.5VB  $30
1VA  1VB  0.5VC  $40
VA, VB, VC  0
The dual objective function is given by the sum of the shadow price of each in-
put times the quantity of the input available to the firm. We have a dual con-
straint for each of the two decision variables (QX and QY) in the primal problem.
Each constraint postulates that the sum of the shadow price of each input times
the quantity of the input required to produce 1 unit of each product must be
equal to or larger than the profit contribution of a unit of the product. Note
also that the direction of the inequality constraints in the dual problem is op-
posite that of the corresponding primal problem and that the shadow prices
cannot be negative (the nonnegativity constraints in the dual problem).
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362 Part 3 Production and Cost Analysis

That is, we find the values of the decision variables (VA, VB, and VC) at
each corner and choose the corner with the lowest value of C. Since we have
three decision variables and this would necessitate a three-dimensional figure,
which is awkward and difficult to draw and interpret, we will solve the above
dual problem algebraically. The algebraic solution is simplified because in this
case we know from the solution of the primal problem that input C is a slack
variable so that VC equals zero. Setting VC  0 and then subtracting the first
from the second constraint, treated as equations, we get
1VA  1VB  $40
1VA  0.5VB  $30
0.5VB  $10
so that VB  $20. Substituting VB  $20 into the first equation, we get that
VA  $20 also. This means that increasing the amount of input A or input B
by 1 unit would increase the total profits of the firm by $20, so that the firm
should be willing to pay as much as $20 for 1 additional unit of each of these
inputs. Substituting the values of VA, VB, and VC into the objective cost func-
tion (Equation 8-8), we get
C  7($20)  5($20)  2($0)  $240
This is the minimum cost that the firm would incur in producing 4X and 3Y
(the solution of the primal profit maximization problem in Section 8-4). Note
also that the maximum profits found in the solution of the primal problem
(that is,   $240) equals the minimum cost in the solution of the correspon-
ding dual problem (that is, C  $240) as dictated by the duality theorem.

The Dual of Cost Minimization

In this section we formulate and solve the dual problem for the cost mini-
mization problem examined in Section 8-5, which is repeated below for ease
of reference.
Minimize C  $2QX  $3QY (objective function)
Subject to 1QX  2QY  14 (protein constraint)
1QX  1QY  10 (minerals constraint)
1QX  0.5QY  6 (vitamins constraint)
QX, QY  0 (nonnegativity constraint)
The corresponding dual profit maximization problem can be formulated
as follows:
Maximize   14VP  10VM  6VV
Subject to 1VP  1VM  1VV  $2
2VP  1VM  0.5VV  $3
VP, VM, VV  0
sal11586_ch08.qxd 10/10/03 10:13 AM Page 363

CASE STUDY 8-4

Shadow Prices in Closing an Airfield in a Forest Pest

Control Program

he Maine Forest Service conducts a large aerial spray program to limit the destruc-
T tion of spruce-fir forests in Maine by spruce bud worms. Until 1984, 24 aircraft of
three types were flown from six airfields to spray a total of 850,000 acres in 250 to 300
infested areas. Spray blocks were assigned to airfields by partitioning the map into re-
gions around each airfield. Aircraft types were assigned to blocks on the basis of the
block’s size and distance from the airfield. In 1984, the Forest Service started using a
linear programming model to minimize the cost of the spray program. The solution of
the model also provided the shadow price of using each aircraft and operating each air-
field. The spray project staff was particularly interested in the effect (shadow price) of
closing one or more airfields. The solution of the dual of the cost minimization primal
problem indicated that the total cost of the spray program of $634,000 for 1984 could
be reduced by $24,000 if one peripheral airfield were replaced by a more centrally lo-
cated airfield. The Forest Service, however, was denied access to the centrally located
airfield because of environmental considerations. This shows the conflict that some-
times arises between economic efficiency and noneconomic social goals.

Source: D. L. Rumpf, E. Melachrinoudis, and T. Rumpf, “Improving Efficiency in a Forest Pest Control Spray
Program,” Interfaces, September/October 1985, pp. 1–11; and Edwin H. Romeijn and Robert L. Smith,
“Shadow Prices in Infinite-Dimensional Linear Programming,” Mathematics of Operations Research, February
1998, pp. 239–256.

where VP, VM, and VV refer, respectively, to the imputed value (marginal cost)
or shadow price of the protein, mineral, and vitamin constraints in the primal
problem, and p is the total imputed value or cost of the fixed amounts of pro-
tein, minerals, and vitamins that the firm must provide. The first constraint of
the dual problem postulates that the sum of the 1 unit of protein, minerals, and
vitamins available in 1 unit of product X times the shadow price of protein
(that is, VP), minerals (that is, VM), and vitamins (that is, VV), respectively, must
be equal to or smaller than the price or cost per unit of product X purchased.
The second constraint can be interpreted in a similar way. Note that the direc-
tion of the inequality constraints in the dual problem is opposite those of the
corresponding primal problem and that the shadow prices cannot be negative.
Since we know from the solution of the primal problem that the vitamin
constraint is a slack variable, so that VV  0, subtracting the first from the sec-
ond constraint, treated as equations, we get the solution of the dual problem of
2VP  1VM  3
1VP  1VM  2
1VP 1
Substituting VP  $1 into the second equation, we get VM  $1, so that
  14($1)  10($1)  6($0)  $24

363
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364 Part 3 Production and Cost Analysis

This is equal to the minimum total cost (C ) found in the primal problem.
If the profit contribution resulting from increasing the protein and min-
eral constraints by 1 unit exceeds their respective marginal cost or shadow
prices (that is, VP and VM), the total profit of the firm (that is, ) would in-
crease by relaxing the protein and mineral constraints. On the other hand, if
the profit contribution resulting from increasing the protein and mineral con-
straints by 1 unit is smaller than VP and VM,  would increase by reducing the
protein and mineral constraints.

8-7 LINEAR PROGRAMMING AND

LOGISTICS IN THE GLOBAL ECONOMY
Linear programming is also being used in the emerging field of logistic man-
agement. This refers to the merging at the corporate level of the purchasing,
transportation, warehousing, distribution, and customer services functions,
rather than dealing with each of them separately at division levels. Monitor-
ing the movement of materials and finished products from a central place can
reduce the shortages and surpluses that inevitably arise when these functions
are managed separately. For example, it would be difficult for a firm to deter-
mine the desirability of a sales promotion without considering the cost of the
inventory buildup to meet the anticipated increase in demand. Logistic man-
agement can, thus, increase the efficiency and profitability of the firm.
The merging of decision making for various functions of the firm in-
volved in logistic management requires the setting up and solving of ever-
larger linear programming problems. Linear programming, which in the past
was often profitably used to solve specific functional problems (such as pur-
chasing, transportation, warehousing, distribution, and customer functions)
separately, is now increasingly being applied to solve all these functions to-
gether with logistic management. The new much faster algorithm developed
by Karmarkar at Bell Labs as well as the development of ever-faster comput-
ers are greatly facilitating the development of logistic management. Despite
its obvious merits, however, only about 10 percent of corporations now have
expertise and are highly sophisticated in logistics, but things are certainly
likely to change during this decade. Among the companies that are already
making extensive use of logistic management are the 3M Corporation, Alpo
Petfood Inc., Chrysler, Land O’Lakes Foods, and Bergen Brunswing.13
Besides the development of the faster algorithm and more powerful
computers, two other forces will certainly lead to the rapid spread of logis-
tics. One is the growing use of just-in-time inventory management, which
makes the buying of inputs and the selling of the product much more tricky
and more closely integrated with all other functions of the firm. The second
related reason is the increasing trend toward globalization of production and

13
“Logistics: A Trendy Management Tool,” The New York Times, December 24, 1989, Sec. 3, p. 12.
sal11586_ch08.qxd 10/10/03 10:13 AM Page 365

CASE STUDY 8-5

Measuring the Pure Efficiency of Operating Units

serious problem faced by any business with hundreds or thousands of units is how
A to measure and maximize the real performance or pure efficiency of each store,
branch, or office. There are, of course, many traditional methods of measuring and
comparing the efficiency of each unit, such as sales, sales growth, profits, market share,
labor and other costs per unit of the product or service, profit per employee, revenues
per square foot, and so on. All of these methods, however, use overall average per-
formance as the benchmark for comparison. It is much more useful to measure the real
performance or pure efficiency of each unit after adjusting for all important differences
between the specific unit and all the other units. For example, a particular unit may
earn more profit than another unit, but when its better location, new equipment, and
better trained labor force are taken into consideration, the unit may in fact be seen as
underperforming in relation to another unit earning less but operating under much
less favorable conditions.
The real performance or pure efficiency of a unit can be measured more accurately
with a relatively new operations research technique called data envelopment analysis
(DEA), which uses the technical apparatus of linear programming. DEA takes into ac-
count all the most important measurable factors under which each unit or branch op-
erates—the type of technology it uses, its level of capacity utilization, the degree of
competition it faces, the quality of its inputs, and so on—in measuring the real per-
formance or pure efficiency of each unit or branch. That is, DEA compares the per-
formance of each unit or branch to that of a standardized peer unit or branch with
similar attributes. Thus, DEA may show that a particular unit with high profits does
operate with high efficiency. Another unit may have high profits but be underper-
forming in relation to its potential. A third unit may be earning low profits because of
inefficiencies and, therefore, be a candidate for managerial help to bring it up to its po-
tential. Still another unit may be efficient and earning low profits and, thus, be a can-
didate for closing or disinvestment. DEA has been very profitably used by such
companies as Citibank, British Airways, and Pizza Hut, and it is increasingly being
used to identify the best site or location for new units or branches of a firm. Although
DEA was developed several decades ago, it is only with the advent of very powerful
PCs since the early 1990s that it has become feasible because of its very high compu-
tational intensity.

Source: “Which Offices or Stores Really Perform Best? A New Tool Tells,” Fortune, October 31, 1994, p. 38.

distribution. With production, distribution, marketing, and financing activi-

ties of the leading corporations scattered around the world, the need for lo-
gistic management becomes even more important—and beneficial. For
example, the 3M Corporation saved more than $40 million in 1988 by link-
ing its American logistic operations with those in Europe (in preparation for
the formation of the single market in 1992) and on the rapidly growing Pa-
cific Rim. By centralizing several logistic functions, companies achieve
greater flexibility in ordering inputs and selling products.

365
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CASE STUDY 8-6

Logistics at National Semiconductor,

Saturn, and Compaq

ince the early 1990s, National Semiconductor, the world’s thirteenth largest chip-
S maker, has become a logistics or supply-chain management expert, and, in the
process, it has cut delivery time by 47 percent and reduced distribution costs by 2.5
percent at the same time that its sales increased by 34 percent. National Semiconduc-
tor achieved this feat by closing six warehouses around the globe and air-freighting its
computer chips from its six production plants (four in the United States, one in Eng-
land, and one in Israel) to its new world distribution center in Singapore, where it fills
orders from IBM, Toshiba, Compaq, Ford, Siemens, and its other large customers.
Earlier, National Semiconductor’s distribution network was a nightmare of waste,
costly stockpiles, and an inefficient delivery system that often included as many as 10
stopovers for its chips on their way to customers.
From its very beginning Saturn has had a world-class logistics system that links sup-
pliers, factories, and customers so efficiently that it maintains almost no inventory. Its
central computer directs truck deliveries from its 339 suppliers in 39 states an average
distance of more than 500 miles to its 56 receiving docks, 21 hours per day, six days per
week, in a process that is so smooth that Saturn’s assembly line had to be shut down only
once and for only 18 minutes since it was started because of the lack of a component.
Compaq estimated it lost from $500 million to $1 billion in sales in 1994 because
its computers were not available in the location and at the time customers wanted
them. Now it has set up a new logistics system to sharply increase the efficiency of its
supply-chain management. For one thing, an on-board computer tells Compaq’s
truckers exactly where to go, the best route to take, and the time required.
In short, there seems to be today much greater opportunities to cut costs from in-
creasing supply-chain efficiency than from the manufacturing of the product in many
cases. More and more, logistics is regarded as a crucial strategy for survival and growth
in global competition.

Source: “Delivering the Goods,” Fortune, November 28, 1994, pp. 64–78; “Logistics Aspires to Worldly Wis-
dom,” Financial Times, June 17, 1999, p. 11; “Supply Chain Logistics Moving Up the Corporate Agenda,”
Financial Times, December 1, 1998, p. 1.

8-8 ACTUAL SOLUTION OF LINEAR

PROGRAMMING PROBLEMS ON PERSONAL
COMPUTERS
Linear programming problems in the real world are usually solved with com-
puters rather than with graphical or algebraic techniques. One of the simplest
and most popular software programs to solve linear programming problems
on personal computers is called LINDO (Linear Interactive Discrete Opti-
mizer). There is also a Windows-based version of LINDO that can be down-
loaded free from the Internet. In this section we show how to use LINDO to

366
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Chapter 8 Linear Programming 367

solve the maximization problem of Section 8-4. More complex problems are
solved just as easily. Other programs are nearly as easy to use to solve linear
programming problems.
On most computers, you access LINDO by simply typing “LINDO.”
The symbol “:” will appear in the left-hand part of your screen. There, type
“max” or “min,” followed by a space and the equation of the objective func-
tion that you seek to maximize or minimize. Then press the “enter” key. The
symbol “?” will appear. At that point write the equation of the first inequality
constraint and press the “enter” key. Note that in typing the equation of the
inequality constraints, LINDO allows you to use the symbol “” for equal or
smaller than and the symbol “” for equal or larger than, since most keyboards
do not have the symbols “” and “”. After you have entered the equation of
the first inequality constraint and pressed the “enter” key, another “?” ap-
pears. Type the second inequality constraint and press the “enter” key. Repeat
this process until you have entered all the inequality constraints. There is no
need to enter the nonnegativity constraints.
After you have entered all the inequality constraints, type “end” after the
new “?” and press the “enter” key. This indicates to LINDO that all the in-
formation for solving the linear programming problem has been entered. The
symbol “:” will appear. Type the word “look” and press the “return” key.
When “ROW: ?” appears, type “all” and press the “return” key. The objective
function and the inequality constraints that you entered followed by “END”
and the symbol “:” will appear. This allows you to check that you have made
no errors in entering the objective function and the inequality constraints. At
this point, type the word “go” to get the solution to the problem.
What follows is an actual printout for entering and solving the problem
of Section 8-4.

LINDO
: max 30x+40y
? 1x+ 1y<7
? .5x+ 1y<5
? .5y<2

? end
: look
ROW:
? all

MAX 30 X+40 Y
SUBJECT TO
2) 1 X+1 Y <= 7
3) .5 X+1 Y <= 5
4) .5 Y <= 2
END
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368 Part 3 Production and Cost Analysis

: go

LP OPTIMUM FOUND AT STEP 2

OBJECTIVE FUNCTION VALUE
1) 240.00000

VARIABLE VALUE REDUCED COST

X 4.000000 0.000000
Y 3.000000 0.000000

ROW SLACK DUAL PRICES

2) 0.000000 20.00000
3) 0.000000 20.00000
4) 0.500000 0.000000

NO. ITERATIONS= 2

DO RANGE (SENSITIVITY) ANALYSIS?

? no
: quit
STOP

Several clarifications are in order with regard to the printout. First, we

see that the results of the primal and dual problems are the same as those
found in Sections 8-4 and 8-6. Second, note that everything that we typed is
in lowercase letters (although this is not necessary), while everything done by
LINDO appears in capital letters. Third, the symbol “” that we entered is
printed as “” by LINDO after we entered “look” and “all.” Fourth, when
LINDO asks if you wish to do sensitivity analysis, we answered “no” because
we are not familiar with this advanced type of analysis. Fifth, you can ignore
the step at which the solution is found and the number of iterations per-
formed appears in the printout.
Finally, we can change the model without having to retype the entire
problem by typing “alter” instead of “quit” before the very end. Then the
word “ROW:” and “?” will appear on the screen. There, we enter the number
of the row in which we wish to make a change in the problem. For example, if
we wish to change the inequality constraint in row 3, we type “3” after the
symbol “?”. The symbols “VAR:” and “?” will appear. There, we type the vari-
able whose coefficient we wish to change. For example, if we want to change
the coefficient of the variable Y, we type “y” after the “?”. The words “NEW
COEFFICIENT:” and “?” will appear. There, we will enter the new coeffi-
cient. For example, if we wish to change the coefficient of Y from 1 to 2, we
type “2” after the “?”. The symbol “:” will appear. We enter “look” and con-
tinue exactly as above. LINDO will provide the new solution.
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Chapter 8 Linear Programming 369

1. Linear programming is a mathematical technique for solving constrained maxi- Summary

mization and minimization problems when there are many constraints and the ob-
jective function to be optimized as well as the constraints faced are linear (i.e., can
be represented by straight lines). Linear programming has been applied to a wide
variety of constrained optimization problems. Some of these are: the selection of
the optimal production process to use to produce a product, the optimal product
mix to produce, the least-cost input combination to satisfy some minimum product
requirement, the marginal contribution to profits of the various inputs, and many
others.
2. Each of the various input ratios that can be used to produce a particular commod-
ity is called a “production process” or “activity.” With only two inputs, production
processes can be represented by straight-line rays from the origin in input space. By
joining points of equal output on these rays or processes, we define the isoquant for
a particular level of output of the commodity. These isoquants are formed by
straight-line segments and have kinks rather than being smooth. A point on an iso-
quant that is not on a ray or process can be reached by the appropriate combination
of the two adjacent processes. By adding the linear constraints of the problem, we
can define the feasible region or all the input combinations that the firm can pur-
chase and the optimal solution or highest isoquant that it can reach with the given
constraints.
3. The function optimized in linear programming is called the “objective function.”
This usually refers to profit maximization or cost minimization. To solve a linear
programming problem graphically, we (1) express the objective function as an equa-
tion and the constraints as inequalities; (2) graph the inequality constraints and de-
fine the feasible region; (3) graph the objective function as a series of isoprofit or
isocost lines; and (4) find the optimal solution at the extreme point or corner of the
feasible region that touches the highest isoprofit line or lowest isocost line.
4. Most firms produce more than one product, and the problem is to determine the
output mix that maximizes the firm’s total profit subject to the many constraints on
inputs that the firm usually faces. Simple linear programming problems with only
two decision variables (which product mix to produce) can be solved graphically.
More complex problems with more than three decision variables can be solved only
algebraically (usually with the use of computers by the simplex method). According
to the extreme-point theorem of linear programming, the optimal solution can be
found at a corner of the feasible region, even when there are multiple solutions.
The computer solution also indicates the binding constraints and the unused quan-
tity of each slack variable.
5. Most firms usually use more than one input to produce a product or service, and a
crucial choice they face is how much of each input (the decision variables) to use
in order to minimize costs of production subject to the minimum requirement
constraints that it faces. In cost minimization linear programming problems, the
inequality constraints are expressed in the form of “equal to or larger than” since
the minimum requirements must be fulfilled but can be exceeded. Cost minimiza-
tion linear programming problems are solved graphically when there are only two
decision variables and algebraically (usually with computers) when there are more
than two decision variables. The solution is usually found at a corner of the feasi-
ble region.
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370 Part 3 Production and Cost Analysis

6. Every linear programming problem, called the “primal problem,” has a correspon-
ding or symmetrical problem called the “dual problem.” A profit maximization pri-
mal problem has a cost minimization dual problem, while a cost minimization
primal problem has a profit maximization dual problem. The solutions of a dual
problem are the shadow prices. They give the change in the value of the objective
function per unit change in each constraint in the primal problem. The dual prob-
lem is formulated directly from the corresponding primal problem. According to
duality theory, the optimal value of the primal objective function equals the optimal
value of the dual objective function.
7. Logistic management refers to the merging at the corporate level of the purchas-
ing, transportation, warehousing, distribution, and customer services functions,
rather than dealing with each of them separately at division levels. This increases
the efficiency and profitability of the firm. Logistic management requires the set-
ting up and solving of ever-larger linear programming problems. The growing use
of just-in-time inventory management and the increasing trend toward globaliza-
tion of production and distribution in today’s world are likely to lead to the rapid
spread of logistic management in the future.
8. Linear programming problems are usually solved with computers rather than with
graphical or algebraic techniques in the real world. One of the simplest and most
popular software programs to solve linear programming problems on personal
computers is LINDO. LINDO is fairly easy to master, as shown on the computer
program reproduced in Section 8-8.

Discussion 1. (a) In what way does linear programming differ from the optimization techniques
Questions examined in Chapter 2? (b) Why is the assumption of linearity important in linear
programming? Is this assumption usually satisfied in the real world?
2. What three broad types of problems can linear programming be used to solve?
3. (a) In what way do the isoquants in linear programming differ from those of tra-
ditional production theory? (b) How can we determine the number of processes
required to reach an optimal solution in linear programming?
4. Determine how much of the output of 200Q would be produced with each process
in the right panel of Figure 8-2 if point S had been (a) one-quarter of distance DE
from point D or (b) halfway between points E and F on EF.
5. (a) Why do only the corners of the feasible solution need to be examined in solv-
ing a linear programming problem? (b) Under what conditions is it possible to
have multiple solutions? (c) Does this invalidate the extreme-point theorem?
6. (a) What is meant by the “profit contribution” in a linear programming problem?
(b) Will maximizing the total profit contribution also maximize the total net prof-
its of the firm? Why?
7. Suppose that a fourth constraint in the form of 1QX  1QY  10 were added to the
profit maximization linear programming problem examined in Section 8-4.
Would you be able to solve the problem? Why?
8. (a) Starting from the profit-maximizing solution at point E in Figure 8-3d, can the
firm expand the production of both products by relaxing only one of the binding
constraints? (b) How much should the firm be willing to pay to hire an additional
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Chapter 8 Linear Programming 371

unit of an input that represents a binding constraint on the solution? (c) What is
the opportunity cost of a unit of the input that is slack at the optimal solution?
9. (a) In what way is the definition of the feasible region in a cost minimization lin-
ear programming problem different from that in a profit maximization problem?
(b) What would happen if we added a fourth constraint in the left panel of Figure
8-6 that would be met by all points on or above a straight line connecting points
D and G?
10. Starting from the left panel of Figure 8-6, what are the optimal solution and min-
imum cost if the price of food X remains at $2 per unit but the price of food Y
changes to (a) $1, (b) $2, (c) $4, and (d) $6?
11. What are the objective function and the constraints of the dual problem corre-
sponding to the primal problem of (a) profit maximization subject to constraints
on the availability of the inputs used in production? (b) cost minimization to pro-
duce a given output mix? (c) cost minimization to generate a given level of profits?
12. (a) Why is the solution of the dual problem useful? (b) What is the usefulness of
shadow prices to the firm in a profit maximization problem? (c) What is the use-
fulness of shadow prices to the firm in a cost minimization problem? (d) What is
meant by “duality theory”?
13. (a) What is logistic management? (b) What is the relationship of logistic manage-
ment to linear programming? (c) What are the forces that are likely to lead to the
rapid spread of logistic management in the future?

*1. Mark Oliver is bored with his job as a clerk in a department store and decides to Problems
open a dry-cleaning business. Mark rents dry-cleaning equipment that allows
three different processes: Process 1 uses capital (K) and labor (L) in the ratio of 3
to 1; process 2 uses K/L  1; and process 3 uses K/L  13. The manufacturer of the
equipment indicates that 50 garments can be dry-cleaned by using 2 units of labor
and 6 units of capital with process 1, 3 units of labor and 3 units of capital with
process 2, or 6 units of labor and 2 units of capital with process 3. The manufac-
turer also indicates that in order to double the number of garments dry-cleaned,
inputs must be doubled with each process. The wage rate (w) for hired help for 1
day’s work (a unit of labor) is $50, and the rental price of capital (r) is $75 per day.
Suppose that Mark cannot incur expenses of more than $750 per day. Determine
the maximum number of garments that the business could dry-clean per day and
the production process that Mark should use.
2. Starting from the solution to Problem 1 (shown at the end of the book), suppose
that (a) the wage rate rises from $50 to $62.50 and the rental price of capital de-
clines from $75 to $62.50. What would be the maximum output that Mark could
produce if expenditures per day must remain at $750? What process would he use
to produce that output? (b) What would the value of w and r have to be in order
for Mark to be indifferent between using process 1 and process 2? Draw a figure
showing your answer. What would w and r have to be for Mark to use only process
1 to produce 100Q? (c) If Mark could not hire more than 9 workers and rent more
than 5 units of capital per day, what would be the maximum output that Mark
could produce? What process or processes would he have to use in order to reach
this output level? How many units of labor and capital would Mark use in each
process if he used more than one process?
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372 Part 3 Production and Cost Analysis

*3. The Petroleum Refining Company uses labor, capital, and crude oil to produce
heating oil and automobile gasoline. The profit per barrel is $20 for heating oil
and $30 for gasoline. To produce each barrel of heating oil, the company uses 1
unit of labor, 21 unit of capital, and 13 unit of crude oil, while to produce 1 barrel of
gasoline, the company uses 1 unit of labor, 1 unit of capital, and 1 unit of crude oil.
The company cannot use more than 10 units of labor, 7 units of capital, and 6.5
units of crude oil per time period. Find the quantity of heating oil and gasoline
that the company should produce in order to maximize its total profits.
4. (a) Solve Problem 3 algebraically. (b) Which are the binding constraints at the op-
timal solution? Which is the slack input? How much is the unused quantity of the
slack input? (c) What would the profit per barrel of heating oil and gasoline have
to be in order to have multiple solutions along the segment of the feasible region
formed by the constraint line from the capital input?
5. The Portable Computer Corporation manufactures two types of portable com-
puters, type X, on which it earns a profit of $300 per unit, and type Y, on which it
earns a profit of $400 per unit. In order to produce each unit of computer X, the
company uses 1 unit of input A, 12 unit of input B, and 1 unit of input C. To pro-
duce each unit of computer Y, the company uses 1 unit of input A, 1 unit of input
B, and no input C. The firm can use only 12 units of input A and only 10 units of
inputs B and C per time period. (a) Determine how many computers of type X and
how many computers of type Y the firm should produce in order to maximize its
total profits. (b) How much of each input does the firm use in producing the prod-
uct mix that maximizes total profits? (c) If the profit per unit of computer X re-
mains at $300, how much can the profit per unit of computer Y change before the
firm changes the product mix that it produces to maximize profits?
6. The National Ore Company operates two mines, A and B. It costs the company
$8,000 per day to operate mine A and $12,000 per day to operate mine B. Each mine
produces ores of high, medium, and low qualities. Mine A produces 0.5 ton of high-
grade ore, 1 ton of medium-grade ore, and 3 tons of low-grade ore per day. Mine B
produces 1 ton of each grade of ore per day. The company has contracted to provide
local smelters with a minimum of 9 tons of high-grade ore, 12 tons of medium-
grade ore, and 18 tons of low-grade ore per month. (a) Determine graphically the
minimum cost at which the company can meet its contractual obligations. (b) How
much are the company’s costs at the other corners of the feasible region? (c) Which
of the company’s obligations are just met at the optimal point? Which is more than
met? (d) If the cost of running mine A increased to $12,000 per day, how many days
per month should the company run each mine in order to minimize the cost of
meeting its contractual obligations? What would be the company’s costs?
7. The Tasty Breakfast Company is planning a radio and television advertising cam-
paign to introduce a new breakfast cereal. The company wants to reach at least
240,000 people, with no fewer than 90,000 of them having a yearly income of at
least $40,000 and no fewer than 60,000 of age 50 or below. A radio ad costs
$2,000 and is estimated to reach 10,000 people, 5,000 of whom have annual in-
comes of at least $40,000 and 10,000 of age 50 or lower. A TV ad costs $6,000 and
is estimated to reach 40,000 people, 10,000 of whom have annual incomes of at
least $40,000 and 5,000 of age 50 or lower. (a) Determine algebraically the mini-
mum cost that allows the firm to reach its advertising goals. (b) Calculate how
many in the targeted audience are reached by the radio ads and how many by the
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Chapter 8 Linear Programming 373

TV ads at the optimum point. Which advertising goals are just met? Which are
more than met?
*8. (a) Formulate and (b) solve the dual for Problem 3 (the solution of which is pro-
vided at the end of the book).

9. For Problem 5, (a) formulate the dual problem and (b) solve it. (c) Indicate how the
shadow prices could have been obtained from the primal solution.

10. For Problem 6, (a) formulate the dual problem and (b) solve it. (c) Indicate how the
shadow prices could have been obtained from the primal solution.

11. For Problem 7, (a) formulate the dual problem and (b) solve it. (c) Indicate how the
firm can use this information to plan its advertising campaign.

12. Integrating Problem

The Cerullo Tax Service Company provides two types of tax services: type X and
type Y. Each involves 1 hour of a tax expert’s time. With service X, the customer
comes in or phones, asks questions, and is given answers. With tax service Y, the
customer also gets tax material and a small-computer tax package. The tax firm
charges $200 for service X and $300 for service Y. Service X requires 1 unit of la-
bor, 12 unit of capital, and no tax material. Service Y requires 1 unit of labor, 1 unit
of capital, and 12 unit of tax material. The firm can use no more than 9 units of la-
bor (L), 6 units of capital (K ), and 2.5 units of tax material (R) per hour. Suppose
that the firm wants to know what combination of tax services X and Y to supply in
order to maximize its total profits. (a) Formulate a linear programming problem;
(b) solve it graphically; (c) check your answer algebraically; (d ) determine which
are the binding constraints and which is the slack constraint at the optimal point;
(e) determine how much labor, capital, and tax materials are used to supply serv-
ices X and Y at the optimal point; ( f ) indicate what would happen if the firm in-
creased the price of service Y to $400; ( g ) formulate the dual problem; (h) solve
the dual problem; (i ) show how the same results could have been obtained from
the original primal problem; and ( j ) indicate the usefulness to the firm of the re-
sults obtained from parts (h) and (i) in planning its expansion.

For a problem-solving approach to linear programming, see: Supplementary

Dowling, Edward: Introduction to Mathematical Economics (New York: McGraw-Hill, Readings
1991), Chaps. 13–15.
Salvatore, Dominick: Theory and Problems of Managerial Economics, Schaum Outline
Series (New York: McGraw-Hill, 1989), Chap. 9.
An excellent text on linear programming is:
Hillier, F., and G. J. Lieberman: Introduction to Mathematical Programming (New
York: McGraw-Hill, 1990).
Simple versions of linear programming are found in:
Lotus Solver in Lotus 1-2-3 for Windows and in Microsoft Excel.
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374 Part 3 Production and Cost Analysis

For the use of personal and mainframe computers for linear programming, see:
Deniniger, R. A.: “Teaching Linear Programming on the Microcomputer,” Interfaces,
August 1982, pp. 30–33.
Harrison, T. P.: “Micro versus Mainframe Performance for a Selected Class of Math-
ematical Programming Problems,” Interfaces, July–August 1985, pp. 14–19.
Llewellyn, J., and R. Sharda: “Linear Programming for Personal Computers: 1990
Survey,” OR/OS Today, October 1990, pp. 35–46.
For some applications of linear programming, see:
Burman, Mitchell, Stanley B. Gershwin, and Curtis Suyematsu: “Hewlett-
Packard Uses Operations Research to Improve the Design of a Printer Production
Line,” Interfaces, January/February 1998, pp. 24–36.
Downing, C. E., and J. L. Ringuest: “An Experimental Evaluation of the Efficacy of
Four Multiobjective Linear Programming Algorithms,” European Journal of Opera-
tional Research, February 1998, pp. 549–558.
Hurley, W. J.: “An Efficient Objective Technique for Selecting an All-Star Team,”
Interfaces, March/April 1998, pp. 51–57.
Levy, David L.: “Lean Production in an International Supply Chain,” Sloan Manage-
ment Review, Winter 1997, pp. 94–102.
McBride, Richard D.: “Advances in Solving the Multicommodity-Flow Problem,”
Interfaces, March/April 1998, pp. 32–41.
Ronn, E. I.: “A New Linear Programming Approach to Bond Portfolio Manage-
ment,” Journal of Financial and Quantitative Analysis, December 1987, pp. 439–466.
Small, K. A.: “Trip Scheduling in Urban Transportation Analysis,” American Economic
Review, May 1992, pp. 482–486.
Young, Martin R.: “A Minimax Portfolio Selection Rule with Linear Programming
Solution,” Management Science, May 1998, pp. 673–683.

Internet Site You can download free versions of LINDO at:

Addresses http://www.lindo.com

Interesting applications of linear programming are found on the Internet at:

http://www2.lindo.com/library.html

Anyone can have a linear programming problem solved for free on the Internet using
a number of programs, each of which stresses a different aspect of the solution. Go to
the Remote Interactive Optimization Testbed (RIOT):
http://riot.ieor.berkeley.edu/riot/index.html
sal11586_ch08.qxd 10/10/03 10:13 AM Page 375

Integrating
Case Study

Production and Cost Functions 3

in the Petroleum Industry,
Duality, and Linear
Programming
Introductory Comment. In this part of the text we have examined
production theory and estimation (Chapter 6), cost theory and estima-
tion (Chapter 7), and linear programming (Chapter 8). We now inte-
grate these topics by starting with production theory, proceeding to cost
theory, showing the duality or symmetry between production theory
and cost theory, and, finally, examining how all these topics are related
to linear programming.

As indicated in Chapter 6, the production function most commonly used in

empirical estimation is the Cobb-Douglas of the form:
Q  AKaLb
where Q, K, and L refer, respectively, to the quantities of output, capital, and
labor, and A, a, and b are the parameters to be estimated. In order to use re-
gression analysis for the estimation of the parameters, the Cobb-Douglas pro-
duction function is transformed into
ln Q  ln A  a ln K  b ln L
which is linear in logarithms. Such a production function has been estimated
for many industries, one of which is the petroleum industry. For the petro-
leum industry, a  0.31 and b  0.64.1 Since a  b  0.31  0.64  0.95 and
is smaller than 1, it seems that the petroleum industry operates under slight
diseconomies of scale. However, the difference in the estimated value of a  b
from 1 was not statistically significant at the 5 percent level, so that the hy-
pothesis of constant returns to scale cannot be rejected.
The marginal product of labor and capital functions for the general for-
mulation of the Cobb-Douglas production function are2

1
The labor input measures both production and nonproduction workers. They have been aggregated into a
single labor input in order to simplify the analysis and deal with only two inputs, L and K.
2
Those who do not know calculus can simply accept these results since
Q Q Q Q
  MPK and   MPL
K K L L

375
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376 Part 3 Production and Cost Analysis

Q
MPK   aAKa1Lb
K
Q
MPL   bAKaLb1
L
For production efficiency,
MPK MPL

r w
where r is the rental price of capital and w is the wage rate of labor. Substitut-
ing the values of MPK and MPL for the Cobb-Douglas into the above condi-
tion, we get
aAKa1Lb bAKaLb1

r w
Solving for K, we have
awL
K
br
This is the equation of the expansion path for the Cobb-Douglas and shows
all efficient combinations of K and L. For the petroleum industry,
0.31w
K L
0.64r
By substituting the market values of w and r for the petroleum industry into
the above equation, we get the equation of the expansion path for this indus-
try. For example, if w  $20 and r  $10, K  L, which means that the ex-
pansion path is a straight line through the origin with slope of about 1.
We can derive the corresponding cost functions and show the duality be-
tween production and cost theory. The general equation of the total cost
function can be written as
TC  rK  wL
Substituting the general equation of the expansion path (showing production
efficiency) into the TC function, we have

TC  r  ab  wr L   wL
which can be rewritten as

TC   ab  1  wL
The TC function, however, is usually expressed as a function of output (Q)
rather than as a function of L. In order to remove L from the TC function and
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Chapter 8 Linear Programming 377

express TC as a function of Q, we substitute the general equation for the ex-

pansion path into the general equation of the Cobb-Douglas and obtain

 aw
br   aw
br 
aLb aL ab
QA L A

Solving for L, we get

a
 
Q aw
Lab 
A br
so that
1/(ab) a/(ab)
L  QA   aw
br 
Substituting the above value of L into the TC function, we get
1/(ab) a/(ab) 1/(ab)
 aw
br 
L  w   aw
br   QA 
Q
TC  r c
A
where c  constant. Thus,
1/(ab)
TC  c  QA 
is the TC function associated with the Cobb-Douglas Q  AKaLb.
For the petroleum industry, a  b  1, thus,
Q
TC  c  cQ
A
where c  C/A  constant. This means that TC is a linear function of Q, and
TC
AC   c
Q
and
d(TC) TC
MC    c
dQ Q
Thus, AC  MC  c (i.e., the AC and MC curves are horizontal and coincide)
and we have (near) constant returns to scale and constant costs in this industry.
Since we have near-constant returns to scale and costs, petroleum prices
remained fairly constant over long periods of time (especially before 1973);
the petroleum industry faced many constraints on the inputs it used and the
output mix to produce, so linear programming seemed a natural technique to
apply in this industry in order to minimize production costs and maximize
profits, subject to the many constraints faced by petroleum companies. In fact,
one of the first successful applications of linear programming was in the pe-
troleum industry. Large petroleum firms engage in exploration, extraction, re-
fining, and marketing of petroleum products. Each phase can be approached
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378 Part 3 Production and Cost Analysis

as a linear programming problem. In each phase, the firm seeks to optimize an

objective function, such as maximizing the chance of finding petroleum de-
posits, minimizing extraction and production costs, and maximizing profits
from sales. Each phase is subject to certain constraints, such as the availability
of funds, technical personnel, and specialized capital equipment in exploration
and extraction, and refining capacity, transportation, and marketing outlets in
the other phases. For example, in refining, more than 10 chemically distinct
blending stocks (semirefined oils) are mixed together to produce gasoline of
various knock ratings, vapor pressures, sulphur contents, and so on. The firm
wants to minimize the cost of producing the various types of gasoline subject
to the availability of the blending stocks, refining capacity, transportation net-
work, contract requirements, and so on. The problem is too complicated for
traditional (graphical) analysis, but it is easily solved by linear programming
with the use of computers.

Source: J. Moroney, “Cobb-Douglas Production Functions and Returns to Scale in U.S. Manufacturing Indus-
try,” Western Economic Journal, December 1967, pp. 39–51; A. Charnes, W. Cooper, and B. Mellon, “Blending
Aviation Gasoline,” Econometrica, April 1952; A. Manne, Scheduling of Petroleum Refining Operations (Cambridge,
Mass.: Harvard University Press, 1956); “Delivering the Goods,” Fortune, November 28, 1994, pp. 64–78; and
“The New Economics of Oil,” Business Week, November 3, 1997, pp. 140–144.