1

Chapter-1
Problem Solving and Decision Making
Problem solving can be defined as the process of identifying a difference
between the actual and the desired state of affairs and then taking action to
resolve this difference.
The problem-solving process involves the following seven steps:
1. Identify and define the problem.
2. Determine the set of alternative solutions.
3. Determine the criteria that will be used to evaluate the alternatives.
4. Evaluate the alternatives.
5. Choose an alternative.
6. Implement the selected alternative.
7. Evaluate the results to determine whether a satisfactory solution has been
obtained.
Decision making is the term generally associated with the first five steps of the
problem-solving process.
Alternatives for decision problem
1. Accept the position in Rochester. 2. Accept the position in Dallas.
3. Accept the position in Greensboro. 4. Accept the position in Pittsburgh.
Decision making process involves five steps:
1. Define the problem. 2. Identify the alternatives.
3. Determine the criteria. 4. Evaluate the alternatives.
5. Choose an alternative.
Economic Order Quantity (EOQ) Model
The cost associated with developing and maintaining inventory is larger than
many people think. Models such as the ones presented in this chapter can be
used to develop cost-effective inventory management decisions.
The economic order quantity (EOQ) is a company's optimal order quantity that
meets demand while minimizing its total costs related to ordering, receiving,
and holding inventory.
Holding costs are the costs associated with maintaining or carrying a given
level of inventory; these costs depend on the size of the inventory.
 2

THE ROLE OF QUALITATIVE AND QUANTITATIVE ANALYSIS

Quantitative methods are especially helpful with large, complex problems. For
example, in the coordination of the thousands of tasks associated with landing
the Apollo 11 safely on the moon, quantitative techniques helped to ensure
that more than 300,000 pieces of work performed by more than 400,000
people were integrated smoothly.

Some of the reasons why a quantitative approach might be used in the

decision-making process include the following:
1. The problem is complex, and the manager cannot develop a good solution
without the aid of quantitative analysis.
2. The problem is critical (e.g., a great deal of money is involved), and the
manager desires a thorough analysis before making a decision.
3. The problem is new, and the manager has no previous experience from
which to draw.
4. The problem is repetitive, and the manager saves time and effort by relying
on quantitative procedures to automate routine decision recommendations.
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Quantitative Analysis
1. Model Development
Models are representations of real objects or situations and can be presented
in various forms.
1.iconic models. 2.analog models. 3.mathematical models
TRANSFORMING MODEL INPUTS INTO OUTPUT

Data Preparation
Another step in the quantitative analysis of a problem is the preparation of
the data required by the model. Data in this sense refer to the values of the
uncontrollable inputs to the model. All uncontrollable inputs or data must be
specified before we can analyze the model and recommend a decision or
solution for the problem.
Model Solution
Once the model development and data preparation steps are completed, we
proceed to the model solution step. In this step, the analyst attempts to
identify the values of the decision variables that provide the “best” output for
the model. The specific decision-variable value or values providing the “best”
output are referred to as the optimal solution for the model.
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Models of Cost, Revenue, and Profit

1.Cost and Volume Models
Fixed cost is the portion of the total cost that does not depend on the
production volume;
Variable cost, on the other hand, is the portion of the total cost that depends
on and varies with the production volume.
C(x) =3000 +2x
Marginal cost is defined as the rate of change of the total cost with respect to
production volume;

2.Revenue and Volume Models

R(x) =5x
x=sales volume in units
R(x) =total revenue associated with selling x units
Marginal revenue is defined as the rate of change of total revenue with
respect to sales volume, that is, the increase in total revenue resulting from a
one-unit increase in sales volume.

3.Profit and Volume Models

One of the most important criteria for management decision making is profit.
Managers need to know the profit implications of their decisions. If we
assume that we will only produce what can be sold, the production volume
and sales volume will be equal. P(x) =R(x) -C(x)

4.BEP
The volume that results in total revenue equaling total cost (providing $0
profit) is called the breakeven point.
If the breakeven point is known, a manager can quickly infer that a volume
above the breakeven point will generate a profit, whereas a volume below the
breakeven point will result in a loss.
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Chapter-7
A Simple Maximization Problem
Problem formulation is the process of translating a verbal statement of a
problem into a mathematical statement. The mathematical statement of the
problem is referred to as a mathematical model.
RMC’s objective is to maximize the total contribution to profit.
Describe Each Constraint Three
constraints limit the number of tons of
fuel additive and the number of tons
of solvent base that can be produced.
Constraint 1: The number of tons of material 1 used must be less than or
equal to the 20 tons available.
Constraint 2: The number of tons of material 2 used must be less than or
equal to the 5 tons available.
Constraint 3: The number of tons of material 3 used must be less than or
equal to the 21 tons available.
Mathematical Model for the RMC Problem

Graphical Solution Procedure

GRAPH
SHOWING TWO
SOLUTIONS FOR
THE TWO-
VARIABLE
RMC PROBLEM
 6

OPTIMAL
SOLUTION FOR
THE RMC
PROBLEM

A Note on Graphing Lines

An important aspect of the graphical method is the ability to graph lines
showing the constraints and the objective function of the linear program. The
procedure we used for graphing the equation of a line is to find any two points
satisfying the equation and then draw the line through the two points. For the
RMC constraints, the two points were easily found by setting F=0 and solving
the constraint equation for S. Then we set S= 0 and solved for F.
Summary of the Graphical Solution Procedure for Maximization Problems
1. Prepare a graph for each constraint that shows the solutions that satisfy the
constraint.
2. Determine the feasible region by identifying the solutions that satisfy all
the constraints simultaneously.
3. Draw an objective function line showing the values of the decision variables
that yield a specified value of the objective function.
4. Move parallel objective function lines toward larger objective function
values until further movement would take the line outside the region.
5. Any feasible solution on the objective function line with the largest value
is an optimal solution.
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Slack variable
A slack variable is a variable that is added to an inequality constraint to
transform it into an equality constraint.
Often variables, called slack variables, are added to the formulation of a linear
programming problem to represent the slack, or unused capacity, associated
with a constraint. Unused capacity makes no contribution to profit, so slack
variables have coefficients of zero in the objective function. More generally,
slack variables represent the difference between the right-hand side and the
left-hand side of a constraint.
Extreme Points and the Optimal Solution
Extreme Points: An extreme point of a feasible region is a point where the
feasible region changes direction, forming a vertex of the polytope. In
mathematical terms, these are points that cannot be represented as a convex
combination of other points in the feasible region.
Extreme points, also known as vertices or corner points, are specific points in
the feasible region of an optimization problem where the feasible region
"corners" or "peaks."
Optimal Solution: The optimal solution refers to the best possible solution to
an optimization problem, based on the objective function and subject to the
given constraints.
This is the function that you are trying to optimize (either maximize or
minimize). For example, in a cost minimization problem, the objective
function might be to minimize costs, while in a profit maximization problem,
it would be to maximize profit.
Computer Solution of the RMC Problem
In January 1952 the first successful computer solution of a linear programming
problem was performed on the SEAC (Standards Eastern Automatic
Computer). The SEAC, the first digital computer built by the National Bureau
of Standards under U.S. Air Force sponsorship, had a 512 -word memory and
magnetic tape for external storage This Determines what you want to
optimize. For instance, you might want to minimize costs, maximize resource
utilization, or balance multiple objectives.
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Chapter-10
Supply Chain Models
A supply chain describes the set of all interconnected resources involved in
producing and distributing a product. For instance, a supply chain for
automobiles could include raw material producers, automotive-parts
suppliers, distribution centers for storing automotive parts, assembly plants,
and car dealerships. Those that control the supply chain must make decisions
such as where to produce the product, how much should be produced, and
where it should be sent.
Transportation Problem
The transportation problem arises frequently in planning for the distribution
of goods and services from several supply locations to several demand
locations. Typically, the quantity of goods available at each supply location
(origin) is limited, and the quantity of goods needed at each of several
demand locations (destinations) is known. The usual objective in a
transportation problem is to minimize the cost of shipping goods from the
origins to the destinations.
Problem Variations 1. Total supply not equal to total demand
2. Maximization objective function
3. Route capacities or route minimums
4. Unacceptable routes
Transshipment Problem
The transshipment problem is an extension of the transportation problem in
which inter mediate nodes, referred to as transshipment nodes, are added to
account for locations such as warehouses.
Problem Variations 1. Total supply not equal to total demand
2. Maximization objective function
3. Route capacities or route minimums
4. Unacceptable routes
Shortest-Route Problem
In this section we consider a problem in which the objective is to determine
the shortest route, or path, between two nodes in a network.
 9

Chapter-14
Economic Order Quantity (EOQ) Model
The cost associated with developing and maintaining inventory is larger than
many people think. Models such as the ones presented in this chapter can be
used to develop cost-effective inventory management decisions.
Holding costs are the costs associated with maintaining or carrying a given
level of inventory; these costs depend on the size of the inventory.
Ordering cost. This cost, which is considered fixed regardless of the order
quantity, covers the preparation of the voucher; and the processing of the
order, including payment, postage, telephone, transportation, invoice
verification, receiving, and so on.
The reorder point is expressed in terms of inventory position, the amount of
inventory on hand plus the amount on order. Some people think that the
reorder point is expressed in terms of inventory on hand. With short lead
times, inventory position is usually the same as the inventory on hand.
THE EOQ MODEL ASSUMPTIONS
1. Demand D is deterministic and occurs at a constant rate.
2. The order quantity Q is the same for each order. The inventory level
increases by Q units each time an order is received.
3. The cost per order, Co, is constant and does not depend on the quantity
ordered.
4. The purchase cost per unit, C, is constant and does not depend on the
quantity ordered.
5. The inventory holding cost per unit per time period, Ch, is constant. The
total inventory holding cost depends on both Ch and the size of the inventory.
6. Shortages such as stock-outs or backorders are not permitted.
7. The lead time for an order is constant.
8. The inventory position is reviewed continuously. As a result, an order is
placed as soon as the inventory position reaches the reorder point.
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Sheet-1
EXCHANGE-TRADED MARKETS vs OVER-THE-COUNTERMARKETS
OVER-THE-COUNTERMARKETS EXCHANGE-TRADED MARKETS
A market where securities are traded A centralized platform where buyers
directly between two parties, and sellers can trade securities, such
without the use of an exchange. as stocks and derivatives, according
to pre-established rules and
regulations.
Market Participants are Typically Retail and institutional investors,
financial institutions, hedge funds, market makers, and authorized
and large investors. participants.
Trading Hours Continuous, 24/7 Limited to specific exchange hours
Transparency Low High
Liquidity Depends on the size and Generally higher, due to the large
frequency of trades between parties. number of market participants.
Costs Typically higher Lower
Execution Speed Fast Can be slower

Forward contracts
An agreement to buy or sell an asset at a certain future time for a certain price.
Payoffs from forward contracts
(a) long position, (b) short position.
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Market Size
Both the over-the-
counter and the
exchange-traded
market for
derivatives are huge.
Although the
statistics that are
collected for the two
markets are not
exactly comparable,
it is clear that the
over-the-counter market is much larger than the exchange-traded market.
Forward Price and Spot Price
Forward price refers to a predetermined future delivery price for an
underlying commodity, currency, or financial asset agreed upon by the buyer
and seller of a forward futures contract.
Spot price refers to the asset’s current market price.
FUTURES CONTRACTS
A futures contract is an agreement between two parties to buy or sell an asset
at a certain time in the future for a certain price. Unlike forward contracts,
futures contracts are normally traded on an exchange.
OPTIONS
Options are traded both on exchanges and in the over-the-counter market.
There are two types of option.
A call option gives the holder the right to buy the underlying asset by a certain
date for a certain price.
A put option gives the holder the right to sell the underlying asset by a certain
date for a certain price.
Four types of participants in options markets:
1. Buyers of calls 2. Sellers of calls
3. Buyers of puts 4. Sellers of puts.
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Hedgers
Hedgers are primary participants in the futures markets. A hedger is any
individual or firm that buys or sells the actual physical commodity.
Hedging Using Forward Contracts
Hedging with forward contracts is a common strategy used by companies and
investors to manage risk, particularly when dealing with foreign exchange or
commodity price fluctuations. A forward contract is an agreement between
two parties to buy or sell an asset at a specific price on a future date, allowing
the buyer to lock in the price today to avoid uncertainties in the future.
Hedging Using Options
Hedging using options is another popular risk management strategy that
provides protection against adverse price movements while still allowing for
potential gains. Options are financial derivatives that give the holder the right,
but not the obligation, to buy or sell an asset at a predetermined price (strike
price) before or at a certain expiration date.
A Comparison

There is a fundamental
difference between the
use of forward contracts
and options for hedging.
Forward contracts are
designed to neutralize
risk by fixing the price
that the hedger will pay
or receive for the
underlying asset.
Option contracts, by contrast, provide insurance. They offer a way for
investors to protect themselves against adverse price movements in the
future while still allowing them to benefit from favorable price movements.
Unlike forwards, options involve the payment of an up-front fee.
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Difference Between Forward and Future Contract

Forward contract Future contract
Contract type Tailor made contract Organized stock
exchange
Traded on Over the counter Organized stock
exchange
Settlement happens On the maturity date Daily
Risk High Low
The size of the contract Depends on the fixed
contract terms
Maturity Based on the terms of Predetermined
the private contract
Liquidity Low High

SPECULATORS
Speculators are market participants who engage in financial trading with the
goal of profiting from price movements.
Speculation using futures involves trading in the futures market with the
intention of making a profit from price movements, rather than hedging to
reduce risk. Futures are standardized contracts where two parties agree to
buy or sell an asset (such as commodities, currencies, or financial instruments)
at a predetermined price on a specified future date.
Sheet-2
SPECIFICATION OF A FUTURES CONTRACT
The Asset: The asset is the commodity, financial instrument, or index that
underlies the futures contract. It can be a physical asset or a financial asset.
When the asset is specified, it is therefore important that the exchange
stipulate the grade or grades of the commodity that are acceptable.
Contract Size: The contract size refers to the specific quantity of the underlying
asset that each futures contract represents. It is standardized for each type of
futures contract, making it easier for participants to trade in the market.
Delivery Arrangements: It specify how the underlying asset will be delivered
or settled when the contract reaches its expiration date.