MBA II Sem.

Notes for MS 207 Management Science (Unit I to V)

UNIT I
Operations Research

Meaning of Operations Research

In any organization, managers have to take decisions while, planning the activities. Generally
decisions were taken based on past experiences, the style of working of the manager and
judgement. However, decisions taken in this manner had the risk of making wrong decisions
which would affect the cost of the project. To overcome this difficulty managers have started
using scientific methods to evaluate the various alternatives so that proper decisions can be
taken. With the increased complexities of life, the business has grown tremendously in different
directions and hence there is necessity to modify the organisations relevant to business. Decision
making is a requirement in business and as any problem becomes complicated with large input
data, the analysis becomes difficult and hence an effective use of systematic approach is needed.
This has created the necessity of scientific methods for decision making in business.

These methods are called Quantitative methods, Operations Research, Decision Science, System
Analysis etc. Hence, Operations Research can be understood as a scientific tool evolved as a
supporting help for the decision making process. This is extensively used in business, also in
government and defense organisations for solving complicated problems.

• Operations research is the research of operations. An operation may be called a set of acts
required for the achievement of a desired outcome.

• Such complex, inter-related acts can be performed by four types of systems :

• Man

• Machine

• Man-machine

• Men, machine, man-machine

Definition of Operations Research
1. “Operations Research” is the application of scientific methods, techniques and tools to
problems involving the operations of systems so as to provide those in control of operations with
optimum solution to the problems - CHURCHMAN
2. OR is a scientific method of providing executive departments with a quantitative basis for
decisions under their control. - P.M. MORSE & G.E. KIMBAIL
3. OR is the art of winning wars without actually fighting them. - AUTHER CLARK
4. OR is the systematic application of quantitative methods, techniques and tools to the analysis
of problems involving the operation of systems. - DAELLENBACK & GEORGE
Thus, we can conclude by saying OR arrives at optimal or nearoptimal solutions to complex
decision making problems.

History of OR
Many experts consider the start of OR in the III century B.C, during the II Punie War, with
analysis and solution that Archimedes named for the defense of the city of Syracuse, besieged by
the Romans.

In 1503, Leonardo Da Vinci a took part in the war against Prisa because he knew the techniques
to accomplish bombardments, to construct ships, armored vehicles, cannons, catapults, and
another warlike machines.

In 1885 Ferderick W. Taylor emphasised the application of scientific analysis to methods of

production.

In 1917, A. K. Erlang, a Danish mathematician, published his work on the problem of congestion
of telephone traffic.

In 1930, H.C. Levinson, an American astronomer, applied scientific analysis to the problem of
merchandising.

However, the development of OR started during the Second World War. The name was also
derived from its use for research on Military Operations during the war. Since strategic and
tactical decisions during the war are very complicated with time horizon for such decisions being
comparatively small, the necessity for group analysis and use of mathematical, economic and
statistical theories along with engineering, behavioural and Physical Sciences was felt and
utilized. American and British groups worked on various research projects. Success and
usefulness of these projects led to the development of various techniques for decision making
and later the results prompted their uses in business applications and civilian problems.

Hence, when the war ended, an effort was made to apply the OR techniques to other areas of
business and industry.

Nature of OR
The job of OR is to examine, formulate, analyse, treat, solve the problems of management in a
scientific way. OR study is always rooted in mathematical analysis.

OR is also an interdisciplinary mathematical sciences. Employing techniques from other

mathematical sciences - such as mathematical modeling, statistical analysis and mathematical
optimization - OR arrives at optimal or near-optimal solutions to complex decision making
problem.

OR has overlap with other disciplines, notably industrial engineering, management science,
psychology and economics.

Some of the tools used in OR are statistics, optimization, probability theory, queuing theory,
game theory, decision analysis, mathematical modeling and simulation. Because of the
computational nature of these fields, OR has also strong ties to computer science and analytics.

Characteristics of Operations Research

• Its system (or executive) orientation

• The use of interdisciplinary teams

• Application of scientific method

• Uncovering of new problems

• Improvement in the quality of decisions

• Use of computer

• Quantitative solutions

• Human factors

Scientific method in Operations Research

• The scientific method in operations research consists of the following three phases :

• The judgment phase

• The research phase

• The action phase

The Judgement phase

• Determination of the operation

• Determination of objectives and values associated with the operation

• Determination of effectiveness measures

• Formulation of the problem relative to the objectives

The Research phase

• Observation and data collection for better understanding of the problem

• Formulation of relevant hypotheses and models

• Analysis of available information and verification of hypotheses

• Prediction and generalization of results and consideration of alternative methods

The Action phase

• Complexity

• Scattered responsibility and authority

• Uncertainty

• Knowledge explosion

Scope of Operations Research

• Industry

• Defence

• Planning

• Agriculture

• Public utilities
Scope of Operations research in Management
• Allocation and distribution

• Production and facility planning

• Procurement

• Marketing

• Finance

• Personnnel

• Research and development

Allocation and distribution

• Optimal allocation of limited resources such as men, machines, materials, time and
money

• Location and size of warehouses, distribution centres, retail depots etc

• Distribution policy

Production and facility planning

• Selection, location and design of production plants, distribution centres and retail outlets

• Project scheduling and allocation of resources

• Preparation of forecasts for the various inventory items and computing economic order
quantities and reorder levels

• Determination of the number and size of the items to be produced

• Maintenance policy and preventive maintenance

• Scheduling and sequencing of production runs by proper allocation of machines

Procurement
 • What, how and when to purchase at the minimum procurement cost

• Bidding and replacement policies

• Transportation planning and vendor analysis

Marketing

• Product selection, timing and competitive actions

• Selection of advertising media

• Demand forecasts and stock levels

• Customer’s preference for size, colour and packaging of various products

• Best time to launch a new product

Finance

• Capital requirements, cash-flow analysis

• Credit policies, credit risks etc

• Profit plan for the company

• Determination of optimum replacement policies

• Financial planning, dividend policies, investment and portfolio management, auditing etc

Personnel

• Selection of personnel, determination of retirement age and skills

• Recruitment policies and assignment of jobs

• Wage/ salary administration

Research and development

• Determination of areas for research and development
 • Reliability and control of development projects

• Selection of projects and preparation of their budgets

Applications of various OR techniques

• Linear programming – has been used to solve problems involving assignment of jobs to
machines, blending, product mix, advertising media selection, least cost diet, distribution,
transportation, investment portfolio selection and many others.

• Dynamic programming – has been applied to capital budgeting, selection of advertising

media, employment smoothening, cargo loading and optimal routing problems.

• Inventory control – models have been used to determine economic order quantities,
safety stocks, reorder levels, minimum and maximum stock levels.

• Queuing theory – has been helpful to solve problems of traffic congestion, repair and
maintenance of broken – down machines, number of service facilities, scheduling and
control of air traffic, hospital operations, counters in banks and railway booking agencies.

• Decision theory – has been helpful in controlling hurricanes, water pollution, medicine,
space exploration, research and development projects

• Network techniques of PERT and CPM – have been used in planning, scheduling and
controlling construction of dams, bridges, roads, highways and development and
production of aircrafts, ships, computers etc.

• Simulation – has been helpful in a wide variety of probabilistic marketing simulations. It

has been, for example, used to find NPV (Net Present Value) distribution for the venture
of market introduction of a new product

• Replacement theory – has been extensively employed to determine the optimum

replacement interval for three types of replacement problems :

• Replacement of items that deteriorate with time

• Replacement of items that do not deteriorate with time but fail suddenly

• Staff replacement and recruitment

Phases of OR or Methodology of OR
 • Formulating the problem

• Constructing a model to represent the system under study

• Deriving a solution from the model

• Testing the model and the solution derived from it

• Establishing controls over the solution

• Putting the solution to work i.e. implementation

Formulating the problem

• In formulating a problem for OR study, analysis must be made of the four major
components :

a) The environment

b) The decision maker

c) The objectives

d) Alternative courses of action and constraints

Constructing a model to represent the system under study

• A mathematical model consists of a set of equations which describe the system or
problem. These equations represent :

• (i) the effectiveness function

• (ii) constraints

The effectiveness function, usually called the objective function is the operation.

Constraints or restrictions are mathematical expressions of the limitations on the fulfilment of the
objectives.

Deriving a solution from the model

 • A solution may be extracted from a model either by conducting experiments on it i.e. by
simulation or by mathematical analysis. Some cases may require the use of a combination
of simulation and mathematical analysis. This depends upon the nature and complexity of
the system under study.

Testing the model and the solution derived from it

• The usefulness of a model is tested by determining how well it predicts the effect of these
changes. Such an analysis is usually called sensitivity analysis. The utility or validity of
the solution can be checked by comparing the results obtained without applying the
solution with the results obtained when it is used.

Establishing controls over the solution

• A solution derived from a model remains a solution only so long as the uncontrolled
(uncontrollable) variables retain their values and the relationship between the variables
does not change.

Putting the solution to work i.e. implementation

• The success of an OR study depends upon the cooperation received from the
management at the implementation stage. One way of getting this cooperation is to make
management an active participant in all phases of OR study. The importance of this phase
cannot be overemphasized since it is from this phase that the benefits of an OR study will
be realized.

Linear programming

Origin of L.P.
It was in 1947 that George Dantzig and his associates found out that a technique for solving
military planning problems while they were working on a project for U.S. Air Force. This
technique consisted of representing the various activities of an organization as a linear
programming (L.P.) model and arriving at the optimal programme by minimizing a linear
objective function.
Requirements for a L.P. problem
• There must be a well defined objective function (profit, cost or quantities produced)
which is either maximized or minimized and which can be expressed as a linear function
of decision variables.

• There must be constraints on the amount or extent of attainment of the objective and
these constraints must be capable of being expressed as linear equations or inequalities in
terms of variables

• There must be alternative courses of action. For example, a given product may be
processed by two different machines and problem may be as to how much of the product
to allocate to which machine.

• Another necessary requirement is that decision variables should be interrelated and non-
negative.

• The resources must be in limited supply.

Assumptions in L.P. model

• Proportionality – A basic assumption of linear programming is that proportionality
exists in the objective function and the constraints. This assumption implies that if a
product yields profit of Rs. 10, the profit earned from the sale of 12 products will be 120.

• Additivity – It means that if we use t hours on machine A and s hours to make product 2,
the total time required to make products 1 and 2 on machine A is t + s hours.

• Continuity – The decision variables are continuous i.e. they are permitted to take any
non-negative values that satisfy the constraints.

• Certainty – The R.H.S. coefficients of the constraints and resource values in the
constraints are certainly and precisely known and that their values do not change with
time.
LINEAR PROGRAMMING MODEL –
GRAPHICAL METHOD
Introduction
The World War II introduced mathematics and statistics to business management which since
then have been two best friends of business managers. Linear programming came into business
management along with other Operations Research models from the knowledge bank of World
War II in the decade of 1950s. Linear programming is a mathematical model used extensively in
decision making, a process of allocating available resources to maximize profits or minimize
costs in business operations.

History of linear programming dates back to 1700s the time of Jean Baptiste Joseph Fourier in
France. Modern linear programming model was developed by Leonid Kantorovich, a Russian
mathematician, in 1939. Linear programming model consists of a set of algebraic inequalities
and or equations of linear nature (first degree or first order) in which the business problem is
expressed. These inequalities are analyzed in a series of steps to develop the solution. It was used
during World War II to plan operations to reduce costs to the army and increase losses to the
enemy. Postwar, many industries found its use in their daily planning. Linear Programming
model can deal with business problems with maximization objective and minimization
objective. The problems can also differ from each other in terms of business constraints. These
details are discussed subsequently in this analysis. In business management parameters like
profit are maximized and parameters like cost are minimized. For solving business problems,
Linear Programming Model follows a methodology. In this chapter focus will be on graphical
method of Linear Programming Model for solving business problems.

Graphical method being visual by nature enables understanding of various related concepts quite
easily. Inherent weakness of this method is its inability to evaluate more than two variables while
developing a decision. But this method laid the foundation to the development of a more
versatile method called simplex method which will be discussed later. The discussion will begin
with a business problem of maximization nature. A business case (Case1)will be taken through
all steps of the methodology so that the methodology and its application can be studied hand in
hand.
Anatomy of Graphical method of Linear Programming Model Structure or anatomy of the
graphical method is discussed below in a standardized form. The methodology of using graphical
method is broadly the same for maximization and minimization but may differ in specifics.
These specifics are clear when cases of maximization and minimization are discussed separately.
Case1 which is a maximization problem isanalyzed and structured accordingly to facilitate
development of the solution.

Maximization of Case (problem)

1. Study of the business problem: Now a profit maximization case is being considered. A
business problem calls for a decision by the concerned manager.Such a decision should lead the
business towards prosperity or profitability. Careful study of the case reveals:
a. Nature of business objective in the case which is profit maximization
b. Identification of decision variables.

c. Expected profits or costs per unit of the product in monetary terms

d. Availability of resources in physical quantities and other constraints like demand for the
products in physical quantities in the market.

The linear programming model is expected to give an optimal solution for maximizing profit to
meet the needs of business management.
A problem may have a large number of feasible solutions which fit within the constraints but
optimal solution is only one, or in some cases may have some alternate ones. It can be said that
an optimal solution is always feasible, but every feasible solution is not optimal. These concepts
are revisited while discussing the specific case.

2. Formulation of the business problem: Formulation is presenting the business problem in the
language of mathematics. Formulation starts with defining decision variables, identifying and
writing objective function,business constraints and non-negativity constraint.

a) Decision variables: these are unknown quantities which are to be decided. They generally
represent the amount of outputs produced by the production system
b) Objective function: Business objective is always to maximize profit which is a result of
minimization of consumption of resources. But in practice minimization of consumption of
resources cannot take place unchecked as there is always a minimum requirement of resources
by a unit of each product. Profit maximization has a limit posed by the availability of resources
for production. Hence business objective is always optimality and not unlimited cost
minimization or profit maximization. The business objective can be either cost minimization or
profit maximization in a particular case under various constraints in business. The objective
function is presented as a mathematical relationship in the form of an equation, consisting of
variables and coefficients. The variables are unknown quantities of production volumes and
coefficients are per unit profit or cost contributions of individual products. Development of
objective function is dependent on some important assumptionsnamely additivity,
proportionality, divisibility and non-negativity. Additivity states that the profits earned by
individual products, when produced in quantities suggested by the optimal solution, are addable
to determine total profit. It is an assumption because the respective quantities suggested by the
optimal solution may not get sold in reality. It is a well-known fact that one product steals the
market of the other. Principle of proportionality (also known as linearity) states that the total
profit is proportional to the total quantity of the product sold. This is not a reality as the price is
affected by quantity discount. The assumption of divisibility states that the decision variables
may be expressed as divisions of units and not necessarily as full integers. Assumption of non-
negativity is that the optimal solution gives non negative values for decision variables. In
graphical representation, the decision variables are in the first quadrant of the graph. While
formulating the objective function, these principles are applied. Without these principles, Linear
Programming Model cannot be structured. In a business problem there may be infinite number
of objective functions as mathematical relationships as explained earlier. But the business
objective is to find a single objective function which maximizes the profit.
c) Constraints: Constraints refer to the availability of resources, level of demand for products in
market, minimum per unit resource requirements of individual products and non-negativity
restriction on variables. For the feasibility of the solution the variables are required to be positive
or zero.
i) The resource constraints are written for individual resources as relationships of linear
inequality. On the left hand side (LHS) of the relationship the required quantity of resource to
produce unknown quantities of products is expressed. The coefficients of variables in the
constraint relationships are called technology constraints.The right hand side (RHS) should
reveal the availability or any other type of limit on the resource. The sign of inequality or
equality between LHS & RHS completes the expression of constraint. There will be as many
constraints as number of resources. There can also be other constraints like demand constraints
for individual products. Decision or output of the model (which is the values of the decision
variables) should be within the framework of constraints. The nature of the constraints in a
maximization problem is generally “at most” type. The sign between LHS and RHS is less than
type. But there are times when mixed constraints or constraints with different signs occur.
ii) Constraints on decision variables (non-negativity constraints): The decision variables are
restricted to non-negative values in optimal solution. In graphical representation, the decision
variables are limited to first quadrant of the graph.

3. The graphical construction: The inequalities between LHS & RHS in constraints are treated
as equalities and constraints are written as equations of first order and drawn on graph paper as
straight lines. The representation on paper brings visibility to the case. The graphical method
includes two basic steps.

a. Determination of what is known as Feasibility Region (FR) or Solution Space which is a

common feasibility area based on all constraints.
b. Solution space is formed by a set of constraints which is called a “convex set”. A set of
constraints forming a common area form a “convex set”, when a straight line joining any two
points picked at random in such an area lies completely within the area.
c. Identification of optimality and optimal solution from the above solution space.

a. Determination of Feasibility Region (FR) or solution space:

i. The first quadrant formed by the intersection of X axis and Y axis is the area in which the
construction is performed. Only the first quadrant satisfies the non-negativity constraint.
ii. All constraints now considered as linear equations must be drawn as straight lines.
iii. The area in which feasible solutions lie with respect to each constraint drawn as straight line
is marked as per the inequality sign between LHS and RHS of the constraint.
iv. The area in which each solution is feasible with respect to all constraints is Feasibility Region
(FR) or solution space.

To draw constraint equations as straight lines:

Two points on the straight line are required to be fixed. These points on the straight line are two
feasible solutions to the equation. Values of the decision variables of each feasible solution serve
as coordinates of the two points on the straight line. Let one of the decision variables in the
equation be equal to zero. Now the equation yields the value for other decision variable. These
two values are the coordinates of a point lying on the straight line. Similarly, when other decision
variable is put equal to zero, the equation yields the value for the other variable. These two
coordinates fix another point on the straight line. Now the full straight can be drawn on the graph
paper by joining these two points. Applying the same procedure as many constraints as exist in
the formulation can be drawn as straight lines. To identify feasibility region:
Once the straight lines are drawn on graph paper, the nature of the constraint is made visible on
the graph paper. In the constraint if the LHS is more than RHS, then area of graph paper on the
upper side of the straight line (away from origin) is feasible. If LHS is less than RHS, the area on
lower side of the straight line (towards origin) is feasible. The feasible areas for individual
constraints are marked on the graph paper. When all feasible areas are represented, the common
area feasible for all constraints in first quadrant is called feasibility region or solution space.

b. Optimal solution to Maximization problems:

Profit-slope method: As discussed above, FR is identified as the common area satisfying all
existing constraints. The objective function is assigned an arbitrary positive value. A value easily
divisible by coefficients of decision variables (unit contributions) in the objective function is
selected. Based on the assigned value, two points lying on this straight line are fixed. When these
two points are joined by a dotted line, a straight line is created which is parallel to itself which is
called iso profit line.If the iso profit line drawn as above is within the feasibility region, move
this straight line out of the FR away from the origin without changing its slope.

For this purpose set squares may be used. The last point of contact with the FR before exiting the
FR is the optimal point. If the iso profit line drawn as above is outside the FR, move this straight
line towards the FR without changing its slope. For this purpose set squares may be used. The
first point of contact with the FR is the optimal point.The coordinates of this contact point give
optimal solution. Corner-points method (vertices method): once the feasibility region or FR is
identified, the optimal solution from a number of feasible solutions within the FR is to be
separated. The corner points or vertices (extreme points) of the FR are denoted with convenient
notations and coordinates of every corner point (extreme point) are decided by solving
simultaneous equations. The corner points (extreme points) or vertices represent feasible
solutions at the high points of the FR as the objective function is maximization type. The
solution values of the feasible solutions at corner points are put in the objective function written
earlier. Whichever feasible solution gives the best value (highest value) of the objective function
is the optimal solution.

Following is a business case taken up for step by step discussion

Case1.A firm produces products, A & B, each of which requires two resources, namely raw
materials and labour. Each unit of product A requires 2 & 4 units and each unit of product B
requires 3 & 3 units respectively of raw materials and labour. Everyday 60 units of raw materials
and 96 units of labour are available. If the unit profit contribution of product A is Rs.40/-,
product B is Rs.35/- determine the number of units of each of the products that should be made
each day to maximize the total profit contribution.

1. Study of the business problem: Case1 is analyzed as per above guidelines and following
facts are established:
a. This is a case of profit maximization. An optimal solution maximizing profits is contemplated.
b. Company is considering producing products A & B.
c. Expected profit contribution by a unit of A is Rs 40/- and by a unit of B is Rs 35/-
d. Availability of raw materials is 60 units per day and availability of labour is only 96 units.

2. Formulation of the business problem:

a) The decision variables: Let an unknown quantity X1 units of A and an unknown quantity X2
units of B be produced per day. X1&X2 are the decision variables.
b) The objective function for Case1 is written as below.
The model will finally give the values of X1 and X2 for maximum profit at optimum level.
Contribution per unit for A & B are Rs 40/- and Rs 35/-. Then the objective is expressed in
mathematical form as:
40X1 + 35X2 = Z (Z is the total profit per day) which is to be maximized

c) Constraints for Case1 are written below:

The study of the case earlier has already revealed the required factors for writing constraints. The
constraint relationships are expressed below:

i) Resource constraints:
2X1 + 3X2  60………..(1) Raw Materials Constraint
4X1 + 3X2  96………..(2) Labour Constraint

ii) Constraint on decision variables:

X1, X2 ≥ 0 Non negativity constraint

3. Graphical construction of constraints in problem in Case1:

Constraint relationships are expressed below as equations:
2X1 + 3X2 = 60………(1) Raw Materials Constraint
4X1 + 3X2 = 96……. (2) Labour Constraint

In constraint (1):
Put X1=0, then X2=20, now point A (0, 20) gives a feasible solution.
When X2=0, then X1=30, now point B (30, 0) gives another feasible solution.
Points A& B are fixed on the 1st quadrant of graph paper, and joined by a straight line

In constraint (2):
Put X1=0, then X2=32, now point C (0, 32) gives a feasible solution.
When X2=0, then X1=24 now point D, (24, 0) gives another feasible solution.
Points C & D are fixed on the 1st quadrant of graph paper, and joined by a straight line

Feasibility Region (Solution Space): In the figure dotted area is feasibility region marked by
the high points O, A, E, D
Optimal solution for the problem in Case1 as per profit slope method
Optimal solution for maximization problem in Case1 as per corner point method is shown in
table below. Optimal solution is X1 = 18, X2= 8, maximum profit is Rs1000/-
HIGH POINT ON FR
X1 X2 40X1 + 35X2 = Z

Areas of application
• Industrial applications –

– Product mix problems

– Blending problems

– Production scheduling problems

– Trim loss problem

– Assembly line balancing

– Make or buy problems

• Management applications

– Media selection problems

– Portfolio selection problems

– Profit planning problems

– Transportation problems

– Assignment problems

– Manpower scheduling problems

• Miscellaneous

– Diet problems

– Agriculture problem

– Flight scheduling problems

– Environment protection

– Facilities location
Solution of L.P. problem
• Step 1 – Key decision – products 1,2, 3

• Step 2 – Assign variables to the products x1, x2, x3

• Step 3 – feasible alternatives x1,x2,x3 > 0

• Step 4 – Objective – Minimize or maximize

• Step 5 – Influencing factors

MAX PROFIT (OPTIMAL SOLUTION)

Maximization case (problem) with mixed constraints which form a closed common area
Maximization problems with mixed constraints occur when the nature of one or some of the
constraints (not all) is more than type. Such problems are solved by following the same
methodology. Case1a below is a maximization case (problem) with mixed constraints. Detailed
explanation of each step is not attempted while solving this case.

Important point to note is that a common closed area satisfying all constraints is required.

Following is a business case taken up for step by step discussion

Case1a.A firm produces products, A & B, each of which requires two resources, namely raw
materials and labour. Each unit of product A requires 2 & 4 units and each unit of product B
requires 3 & 3 units respectively of raw materials and labour. Every day at least 60 units of raw
materials and at most 96 units of labour must be used.If the unit profit contribution of product A
is Rs.40/-, product B is Rs.35/- determine the number of units of each of the products that should
be made each day to maximize the total profit contribution.

Objective function: 40X1 + 35X2 = Z (Z is the total profit per day) which is to be maximized

Constraints for Case1a are written below:

The study of the case reveals the required factors for writing constraints. The constraint
relationships are expressed below:
2X1 + 3X2 ≥ 60………..(1) Raw Materials Constraint
4X1 + 3X2  96………..(2) Labour Constraint
X1 , X2 ≥ 0 Non negativity constraint

Above constraints are treated as equations to plot on graph paper.

Taking up constraints one by one,

In constraint (1):
Put X1=0, then X2=20, now point A (0, 20) gives a feasible solution.
When X2=0, then X1=30, now point B (30, 0) gives another feasible solution.
Points A& B are fixed on the 1st quadrant of graph paper, and joined by a straight line.

In constraint (2):
Put X1=0, then X2=32, now point C (0, 32) gives a feasible solution.
When X2=0, then X1=24 now point D, (24, 0) gives another feasible solution.

Points C & D are fixed on the 1st quadrant of graph paper, and joined by a straight line
Graphical construction is done and optimal solution in the feasibility region is shown as per
profit slope method. Optimal solution is X1 = 0, X2= 32, maximum profit is Rs1120/-. Solution
by Corner point method can be worked out as per methodology followed earlier.

Minimization Case (problem)

To understand analysis of minimization problem, Case2 is considered below. As discussed
earlier, all the steps leading to the identification of FR are similar. FR is identified as the
common area satisfying all existing constraints. The nature of the constraints in a minimization
problem is generally “at least” type. The sign between LHS and RHS is more than type. But
there are times when mixed constraints or constraints with different signs occur.

Optimal solution to Minimization problems:

Cost-slope method
A straight line parallel to the objective function is setup which is called iso cost line.If the iso
cost line drawn as above is within the feasibility region, move this straight line out of the FR
towards the origin without changing its slope. For this purpose set squares may be used. The last
point of contact with the FR before exiting the FR is the optimal point.

If the iso cost line drawn as above is outside the FR, move this straight line towards the FR
without changing its slope. For this purpose set squares may be used. The first point of contact
with the FR is the optimal point. The coordinates of this contact point give optimal solution.

Corner-points (vertices) method

The corner points or vertices (extreme points) of the FR are denoted with convenient notations
and coordinates of every corner point (extreme point) are decided by solving simultaneous
equations. Each corner point is a feasible solution at low points of FR. Value of the objective
function for each solution is calculated and tabulated. The lowest value of the objective function
indicates optimal solution.

Following is a business case taken up for step by step discussion

Case2.A firm produces products, A & B, each of which requires two resources, namely raw
materials and labour. Each unit of product A requires 2 & 4 units and each unit of product B
requires 3 & 3 units respectively of raw materials and labour. Every day at least 60 units of raw
materials and at least 96 units of labour are to be used. If unit production cost of product A is
Rs.40/- and product B is Rs.35/- determine the number of units of each of the products that
should be made each day to minimize the total cost of production.
The objectives function for Case2 is written as below.
Let an unknown quantity X1 units of A and an unknown quantity X2 units of B be produced. The
model will finally give the values of X1 and X2 for minimum cost at optimum level. X1 and X2 are
the decision variables.

Cost contribution per unit for A & B are Rs 40/- and Rs 35/-. Then the objective is expressed in
mathematical form as:

40X1 + 35X2 = G (G is the total cost per day) which is to be minimized

Graphical construction of constraints in problem in Case2:

Constraint relationships are expressed below:

2X1 + 3X2 ≥ 60………(1) Raw Materials Constraint
4X1 + 3X2 ≥ 96……. (2) Labour Constraint
The inequalities between LHS & RHS in constraints are treated as equalities and constraints are
written as equations of first order and drawn on graph paper as straight lines.

In constraint (1):
Put X1=0, then X2=20, now point A (0, 20) gives a feasible solution.
When X2=0, then X1=30, now point B (30, 0) gives another feasible solution.
Points A& B are fixed on the 1st quadrant of graph paper, and joined by a straight line.

In constraint (2):
Put X1=0, then X2=32, now point C (0, 32) gives a feasible solution.
When X2=0, then X1=24 now point D, (24, 0) gives another feasible solution.

Points C & D are fixed on the 1st quadrant of graph paper, and joined by a straight line.

Feasibility Region (Solution Space): In the above dotted area is feasibility region marked by
the low points C,E,B

Optimal solution for cost minimization problem in Case2 as per cost slope method is shown.
Optimal solution is X1 = 18, X2= 8, minimum cost is Rs1000/-

Optimal solution for minimization problem in Case2 as per corner points or vertices method.

HIGH POINT ON FR
X1 X2 40X1 + 35X2 = Z

Minimization case (problem) with mixed constraints

Minimization problems with mixed constraints occur when the nature of one or some of the
constraints (not all) is less than type. Such problems are solved by following the same
methodology. Case1b below is a minimization case (problem) with mixed constraints. Detailed
explanation of each step is not attempted while solving this case.
Case2a.A firm produces products, A & B, each of which requires two resources, namely raw
materials and labour. Each unit of product A requires 2 & 4 units and each unit of product B
requires 3 & 3 units respectively of raw materials and labour. Everyday at least 60 units of raw
materials and at most 96 units of labour are to be used. If unit production cost of product A is
Rs.40/- and product B is Rs.35/- determine the number of units of each of the products that
should be made each day to minimize the total cost of production.

The objectives function for Case2b is written as below.

Let an unknown quantity X1 units of A and an unknown quantity X2 units of B be produced. The
model will finally give the values of X1 and X2 for minimum cost at optimum level. X1 and X2 are
the decision variables.
Cost contribution per unit for A & B are Rs 40/- and Rs 35/-. Then the objective is expressed in
mathematical form as:

40X1 + 35X2 = G (G is the total cost per day) which is to be minimized

Graphical construction of constraints

Constraint relationships are expressed below:
2X1 + 3X2 ≥ 60………(1) Raw Materials Constraint (at least constraint)
4X1 + 3X2 ≤ 96……. (2) Labour Constraint (at most constraint)
The inequalities between LHS & RHS in constraints are treated as equalities and constraints are
written as equations of first order and drawn on graph paper as straight lines.

In constraint (1):
Put X1=0, then X2=20, now point A (0, 20) gives a feasible solution.
When X2=0, then X1=30, now point B (30, 0) gives another feasible solution.

Points A& B are fixed on the 1st quadrant of graph paper, and joined by a straight line.

In constraint (2):
Put X1=0, then X2=32, now point C (0, 32) gives a feasible solution.
When X2=0, then X1=24 now point D, (24, 0) gives another feasible solution.
Points C & D are fixed on the 1st quadrant of graph paper, and joined by a straight line.

Graphical construction is done and optimal solution in the feasibility region is shown below as
per cost slope method. Optimal solution is X1 = 0, X2= 20, minimum cost is Rs700/-. Solution by
Corner point method can be worked out as per methodology followed earlier.
LINEAR PROGRAMMING MODEL – SIMPLEX
METHOD
Introduction
In the previous Section the learner is already introduced to linear programming as a
mathematical model for finding solutions to business problems. Graphical method studied earlier
is limited to business problems with only two decision variables. Simplex algorithm overcomes
this problem by offering a more versatile method to solve business problems. Prof George
Danzig, Prof von Newman and Prof Kantorovich are said to be the three founders of simplex
algorithm. Their researches in the area of mathematics during World War II largely contributed
to the development of simplex algorithm or method. This algorithm is one of the most popular
ones used in finding solutions to business problems. Simplex algorithm can deal with
maximization and minimization problems under constraints of resources and demand. The
assumptions of additivity, proportionality, divisibility and non-negativity hold good for
developing an optimal solution using simplex method.
The methodology follows the same route as graphical method for structuring a business problem
in mathematical form.

Anatomy of the Simplex Method

Structure or anatomy of the simplex method is discussed below in a standardized form. The
methodology of using simplex method is broadly the same for maximization and minimization
but may differ in specifics. These specifics are clear when cases of maximization and
minimization are discussed separately. A specific business case which is a maximization
problem is analyzed and structured accordingly to facilitate development of the solution.

MAXIMIZATION CASE (PROBLEM) WITH ALL “AT-MOST” TYPE OF

CONSTRAINTS
The linear programming model is expected to give an optimal solution for maximizing profit to
meet the needs of business management.

A problem may have a large number of feasible solutions which fit within the constraints but
optimal solution is only one, or in some cases may have some alternate ones. It can be said that
an optimal solution is always feasible, but every feasible solution is not optimal. These concepts
are revisited while discussing a specific business case later. A business case with similar
constraints which are of less than or equal to type ( ) is considered here. This type of
constraints is also known as “at-most” type.
Problems with mixed constraints (“at-most”, “at-least” & “equal to”) are discussed later. When
the availability of a resource is limited to a quantity and it is not available beyond that quantity,
the resource constraint is “atmost” type.

1.Study of the business case: it is same way as it was done in graphical method. Following
specific characteristics of the business case are identified.
a. Nature of business objective in the business problem now being considered is profit
maximization.
b. Identification of decision variables. Decision variables are unknown quantities to be decided
for maximization of profits
c. Expected profits per unit of the product in monetary terms
d. Availability of resources in physical quantities and other constraints like demand for the
products in physical quantities in the market.

2.Formulation: as it was done in graphical method. The details are not discussed once again
since this is already covered in previous chapter. Problem is expressed as a set of mathematical
equations. The set of equations formulated in terms of decision variables identified earlier consist
of
 objective function
 resource constraints
 non-negativity constraint

3. Standard form: This is a special requirement of simplex method. After formulation the step
is called standard form where the inequalities in the constraints are converted to equalities. When
the LHS is smaller than RHS, as in an at-most constraint, a slack variable is added to the LHS
to establish equality between LHS and RHS. Value of the slack variable is unknown so long as
the values of decision variables are unknown. Initially such cases where LHS is less than RHS
are considered. The constraint equations are rewritten in standard form, so also the objective
function. The non-negativity constraint will include all the variables in the objective function. It
may be noted that in each equation all variables are required to be represented. If a variable is
absent it should have zero as coefficient.

4. Starting solution: Simplex method needs a feasible starting solution which is improved in a
series of steps called iterations to reach optimality.
A feasible starting solution is found by equating all non-slack variables to zero in constraint
equations. This is same as not starting production activity in the work place. Then the slack
variables assume the values of balance resources in the receiving stores. These values of slack
variables, when all other variables are zero form the starting solution. The starting solution is put
in the first simplex table.

5. Structuring of Simplex table

Simplex table has a standardized structure which is given below.
1. Number of columns = number of variables in the standard form.
2. Number of rows = number of constraints in the formulation.
3. Each column has a variable as header. The variables as headers should appear in the same
sequence as they appear in the objective function in the standard form.
4. Above each variable its contribution is written.
5. Each row represents a constraint in the formulation.
6. In the first row, coefficients of the variables in first constraint, in the same order as they
appear in the objective function are entered. This is repeated for all rows representing
constraints.
7. From the above table where all coefficient values are filled in, a special formation is detected
which is known as "identity matrix". This matrix is formed by some variables located as
headers of the columns of the simplex tables. In this matrix, if a variable has 1 as coefficient in
row, in other rows its coefficient is zero. Similarly, another variable has 1 as coefficient in
another row and zero in others. The variables forming the identity matrix are identified as "basic
variables". Basic variables form the basis in the simplex table. These variables are headers of
the rows.
The variable which has 1 as coefficient in first row is the header of first row and so on. In the
column adjacent to the one where basic variables are written, the respective contributions of
basic variables are written. The contributions and the respective basic variables form the basis in
the simplex table. The basic variables form the output of the simplex model.
Their values known as solution values are listed in a column called solution values column
which is next to the column headed by the last variable in the objective function. The first
simplex table consists of the starting solution found earlier. It can be seen that basic variables are
the ones which give starting solution.
Write the values of the basic variables in the starting solution in solution values column.

Every solution offered by simplex must be tested for optimality.

6. Calculation of Z row values: the Z values are written for every column in the simplex table
in the Z row which is just below the row of the last basic variable. These values are the
contributions of individual variables in a particular solution. This is calculated as sum of the
products of the coefficient of individual variable in a particular row and the contribution of basic
variable of that particular row. This may be understood by looking at the analysis of Case1
below.

7. Optimality test: The index row is written below the Z row and (Cj-Zj) values are entered in
the index row. When the index row (Net Evaluation Row or NER) values, which are
calculated as (Cj-Zj), are non-positive the solution is optimal.

If solution is optimal, the process stops and solution offered by the simplex table which can be
read in bi column is put to use. If the solution is not optimal, the simplex method improves the
solution as described below.

8. Simplex Iterations: Each step of improvement is called an iteration of simplex method. Each
of the iterations is represented in a simplex table.

The iterations continue until optimality is reached.

a. Identify most positive NER value and mark the column in which this value is present as key
column. In the event of a tie, the NER value towards LHS (towards the basis) is selected. For
every basic variable write (bi/ai) ratio in a new column next to (bi) column. The (ai) value is the
coefficient in the key column for every basic variable and the (bi) value is the solution value of
for every basic variable. These ratios are called replacement ratios or exit ratios.

The least non-negative ratio is selected and its row is called key row. The intersection of key
column and key row gives the key element.
b. Set up a new table as described earlier. Make the change in the basis of the table. Remove the
variable with least non negative minimum ratio and in its place bring in the variable indicated by
key column. Other variables in the basis remain unchanged.
c. The new values of the row in which basic variable is changed are written first. This is done by
dividing each value in the cells in the row by the key element.
d. the values in the cells of other rows are written by using the formula given below:
 New value for a cell in a particular row rj = value in the same cell in the previous table – value
in the intersection of key column and the particular row rj in previous table X value in the
corresponding cell in the row where basic variable has been changed in the new table.

MINIMIZATION CASE (PROBLEM) - “BIG M” METHOD

The methodology for solving minimization problems follows the same flow as in maximization
case but certain steps are different. Minimization problems deal with parameters like cost. The
objective function is minimization type with constraints of at-least or at-most type.
Minimization problems also come with mixed constraints. The formulation is done in the same
manner as in maximization. Hence these cases are not discussed separately. For minimization
type of problems, study of the business case and mathematical formulation are done in the same
way as in the case of a maximization problem. Construction of objective function in standard
form and application of optimality test are different as compared to maximization problems. This
chapter covers two methods for solving minimization problem. The methods are “Big M”
method and “two phases” method. The Big M method is taken up first.

The concept of big M as a finite large quantity is already understood and applied while solving
maximization problem with mixed constraints.
“Two phases” method will be taken up later.
1. Study of the business case: done similarly as in the case of maximization
2. Formulation: done similarly as in the case of maximization. But nature of the objective
function is now minimization of cost.
3. Standard form:
a) Objective function: objective being minimization type in order to drive out the artificial
variable from the system, the artificial variable should be made very high. For this purpose
artificial variable is associated with a positive high value M.
b) Constraints: done similarly as in the case of maximization.
4. Starting solution: done similarly as in the case of maximization.
5. Structuring of Simplex table: done similarly as in the case of maximization.

6. Calculation of Z row values: done similarly as in the case of maximization.

7. Optimality test: when all the values in NER, index row or Δ row are non-negative (when
calculated as  = C – Z) the solution for a minimization problem is optimal. If solution is
optimal, the process stops and solution offered by the simplex table which can be read in bi
column is put to use. If the solution is not optimal, the simplex method improves the solution as
described below.
8. Simplex Iterations: iterations are carried out as in the case of maximization to improve the
solution until optimality is reached.

CONSTRUCTION OF DUAL FROM PRIMAL

The formulation of a business problem is called primal of the given LPP. Its dual is constructed
from the parameters of the primal itself. Before proceeding to carryout construction, a business
problem is taken up for discussion. The discussion reveals the basis for development of the dual.

Following is a business case taken up for step by step discussion

Case1. A firm produces products, A & B, each of which requires two resources, namely raw
materials and labour. Each unit of product A requires 2 & 4 units and each unit of product B
requires 3 & 3 units respectively of raw materials and labour. Everyday 60 units of raw materials
and 96 units of labour are available. If the unit profit contribution of product A is Rs.40/-,
product B is Rs.35/- determine the number of units of each of the products that should be made
each day to maximize the total profit contribution.

1. Study of the business problem: Case1 is analyzed as per above guidelines and following
facts are established:

This is a case of profit maximization. An optimal solution maximizing profits is contemplated.

Company is considering producing products A & B. Expected profit contribution by a unit of A
is Rs 40/- and by a unit of B is Rs 35/- Availability of raw materials is 60 units per day and
availability of labour is only 96 units.

2. Formulation of the business problem:

The decision variables: Let an unknown quantity X1 units of A and an unknown quantity X2
units of B be produced per day. X1 & X2 are the decision variables.

The objectives function for Case1 is written as below.

The model will finally give the values of X1 and X2 for maximum profit at optimum level.
Contribution per unit for A & B are Rs 40/- and Rs 35/-. Then the objective is expressed in
mathematical form as:

40X1 + 35X2 = Z (Z is the total profit per day) which is to be maximized

Constraints for Case1 are written below:

The study of the case earlier has already revealed the required factors for writing constraints. The
constraint relationships are expressed below:

i) Resource constraints:
2X1 + 3X2  60……….. (1) Raw Materials Constraint
4X1 + 3X2  96……….. (2) Labour Constraint

ii) Constraint on decision variables:

X1 , X2 ≥ 0 Non negativity constraint
Let the above formulation be called the primal of the LPP.

Products A&B are produced in quantities X1 & X2. Each unit of A generates profit of Rs40/- and
B generates a profit of Rs35/-. While running this process, 60 units of Raw Materials and 96
units of labour are consumed.

Now, the manager has an option of renting out all the resources to the market. If this option is
exercised, the production process cannot be run and respective profits are not generated. Hence it
is either produce or rent out.

Let the unknown per unit rent values be Y1 & Y2 for resources Raw materials and Labour in the
market. The manager can intelligently exercise his option if he knows the actual rent values. If
the total minimum rent which can be earned by renting out all available resources is equal to the
total maximum profit which can be earned by running the production process the Manager can
decide to rent the resources out. Hence to exercise this option the manager has to find out values
of Y1 & Y2 which minimize the total rent. Now, the original LPP is restructured to obtain the
values of Y1 & Y2.

The objectives function can be written as

60Y1 + 96Y2 = G (G is the total rent) which is to be minimized

If product A requires 2 units of raw materials and 4 units of labour and earns Rs40/- as profit
then the rent earned by 2 units of raw materials and 4 units of labour must be at least Rs40/-.
Similarly if each unit of product B requires 3 units each of raw materials and labour then the rent
earned by 3 units of raw materials and 3 units of labour must be at least Rs35/-.

Based on the above logic,

Constraint relations may be written as below.
2Y1 + 4Y2 ≥ 40……… (1) Product A unit profit Constraint
3Y1 + 3Y2 ≥ 35…….. (2) Product B unit profit Constraint
Y1 , Y2 ≥ 0 Non negativity constraint

Scrutiny of the two models (formulations and optimal solutions)

highlights the following facts:
1. If the primal is a maximization problem, the dual is a minimization problem.
2. The number of variables in the dual is equal to the number of constraints in the primal and
number of constraints in the dual is equal to number of variables in the primal.
3. Right hand side constants of the primal constraints become the coefficients of objective
function in dual
4. Coefficients in the objective function in the primal become RHS constants of the dual
constraints.
5. If the primal has all constraints of ≤ type as in a maximization problem, all constraints in the
dual become ≥ type. Sign of inequality between primal and dual are reversed.
UNIT II

TRANSPORTATION PROBLEM

INTRODUCTION
One important application of linear programming is in the area of physical distribution
(transportation) of goods and services from several supply centres to several demand centres. It
is easy to express a transportation problem mathematically in terms of an LP model, which can
be solved by the simplex method. But because it involves a large number of variables and
constraints, it takes a long time to solve it. However, transportation algorithms, namely the
Stepping Stone Method and the MODI (modified distribution) Method, have been developed for
his purpose. The structure of transportation problem involves a large number of shipping routes
from several supply origins to several demand destinations. The objective is to determine the
number of units of an item (commodity or product) which should be shipped from an origin to a
destination in order to satisfy the required quantity of goods or services at each destination
centre, within the limited quantity of goods or services available at each supply centre, at the
minimum transportation cost and / or time.
The transportation algorithm discussed in this chapter is applied to minimize the total cost of
transporting a homogeneous commodity (product) from supply centres to demand centres.
However, it can also be applied to the maximization of some total value of utility, for example,
financial resources are distributed in such a way that the profitable return is maximized.
There are various types of transportation models and the simplest of them was first presented by
F L Hitchcock (1941). It was further developed by T. C. Koopmans (1949) and G B Dantzig
(1951). Several extensions of transportation model and methods have been subsequently
developed.

MATHEMATICAL MODEL OF TRANSPORTATION

PROBLEM
Let us consider Example 6.1 to illustrate the mathematical model
formulation of transportation problem of transporting single commodity
from three sources of supply to four demand destinations. The sources of
supply are production facilities, warehouses, or supply points,
characterized by available capacities. The destinations are consumption
facilities, warehouses or demand points, characterized by required levels
of demand.

THE TRANSPORTATION ALGORITHM

The algorithm for solving to a transportation problem may be summarized into the following
steps :

Step 1 Formulate the Problem and Arrange the data in the Matrix Form :
The formulation of the transportation problem is similer to the LP problem formulation. Here the
objective function is the total transportation cost and the constraints are the supply and demand
available at each source and destination, respectively.

Step 2 Obtain an Initial Basic Feasible Solution :

In this chapter, following three different methods are discussed to obtain an initial solution :
 North-West Corner Method.
 Least Cost Method, and
 Vogel’s Approximation (or Penalty) Method.
The initial solution obtained by any of the three methods must satisfy the following conditions :

i) The solution must be feasible, i.e. it must satisfy all the supply and demand constraints (also
called rim conditions).
ii) The number of positive allocations must be equal to m + n - 1, when m is the number of rows
and n is the number of columns.

Any solution that satisfies the above conditions is called nondegenerate basic feasible solution,
otherwise, degenerate solution.

Step 3 Test the Initial Solution for Optimality :

The modified Distribution (MODI) method is discussed to test the optimality of the solution
obtained in Step 2. If the current solution is optimal then stop. Otherwise, determine a new
improved solution.

Step 4 Updating the Solution :

Repeat Step 3 until an optimal solution is reached.

STEPS OF MODI METHOD (TRANSPORTATION ALGORITHM)

The steps to evaluate unoccupied cells are as follows :

Step 1 For an initial basic feasible solution with m + n -1 occupied cells, calculate ui and vj for
rows and columns. The initial solution can be obtained by any of the three methods discussed
earlier.

To start with, any one of uj’s or vj’s is assigned the value zero. It is better to assign zero for a
particular ui or vj where there are maximum number of allocation in a row or column
respectively, as it will reduce arithmetic work considerably. Then complete the calculation of ui’s
and vj’s for other rows and columns by using the relation

cij = ui + vj for all occupied cells (i, j).

Step 2 For unoccupied cells, calculate opportunity cost (the difference that indicates the per unit
cost reduction that can be achieved by an allocation in the unoccupied cell) by using the
relationship
dij = cij - (ui + vj) for all i and j.

Step 3 Examine sign of each dij

i) If dij > 0, then current basic feasible solution is optimal.
ii) If dij = 0, then current basic feasible solution will remain unaffected but an alternative solution
exists.
iii)If one or more dij < 0, then an improved solution can be obtained by entering unoccupied cell
(i, j) in the basis. An occupied cell having the largest negative value of dij is chosen for entering
into the solution mix (new transportation schedule).

Step 4 Construct a closed-path (or loop) for the unoccupied cell with largest negative
opportunity cost. Start the closed path with the selected unoccupied cell and mark a plus sign (+)
in this cell, trace a path along the rows (or column) to an occupied cell, mark the corner with
minus sign (-) and continue down the column (or row) to an occupied cell and mark the corner
with plus (+) sign and minus sign (-) alternatively. Close the path back to the selected
unoccupied cell.

Step 5 Select the smallest quantity amongst the cell marked with minus sign on the corners of
closed loop. Allocate this value to the selected unoccupied cell and add it to other occupied cells
marked with plus sign and subtract it from the occupied cells marked with minus sign.

Step 6 Obtain a new improved solution by allocating units to the unoccupied cell according to
Step 5 and calculate the new total transportation cost.

Step 7 Test the revised solution further for optimality. The procedure terminates when all dij
0 , for unoccupied cells.

DEGENERACY AND ITS RESOLUTION

A basic feasible solution for the general transportation problem must consist of exactly m + n -1
(number of rows + number of columns –
1) positive allocations in independent positions in the transportation table. A solution will be
called degenerate when the number of occupied cells is less than the required number, m + n - 1.
In such cases, the current solution cannot be improved because it is not possible to draw a closed
path for every occupied cell. Also, the values of dual variables ui and vj which are used to test the
optimality cannot be computed. Thus, we need to remove the degeneracy to improve the given
solution. The degeneracy in the transportation problems may occur at two stages :

a) When obtaining an initial basic feasible solution we may have less than m + n - 1 allocations.
b) At any stage while moving towards optimal solution. This happens when two or more
occupied cells with the same minimum allocation become unoccupied simultaneously.

Case 1 Degeneracy at the initial solution :

To resolve degeneracy at the initial solution, we proceed by allocating a very small quantity
close to zero to one or more (if needed) unoccupied cells so as to get m + n -1 number of
occupied cells. This amount is denoted by a Greek letter  (epsilon) or  (delta). This quantity
would not affect the total cost as well as supply and demand values. In a minimization
transportation problem it is better to allocate  to unoccupied cells that have lowest
transportation costs, whereas in maximization problems it should be allocated to a cell that has a
high payoff value. In some cases, must be added in one of those unoccupied cells which makes
possible the determination of ui and vj uniquely.

The quantity  is considered to be so small that if it is transferred to an occupied cell it does not
change the quantity of allocation. That is, 0;
It is also then obvious that  does not affect the total transportation cost of the allocation.
Hence, the quantity  is used to evaluate unoccupied cells and to reduce the number of
improvement cycles necessary to reach an optimal solution. Once purpose is over,  can be
removed from the transportation table.

Cost 2 Degeneracy at subsequent iterations :

To resolve degeneracy which occurs during optimality test, the quantity may be allocated to one
or more cells which have become unoccupied recently to have m + n - 1 number of occupied
cells in the new solution.

The variations in the Transportation Problem are :

1) The Maximisation Case : Before obtaining the initial basic feasible solution to the
Transportation problem, it is necessary that the objective function is to minimize. The
maximisation Problem can be converted to the Minimisation Problem by any one of the
following method.
i) Multiply all the elements of maximisation variable by - 1.
ii) Subtract all the elements of maximisation variable from the highest element.
2) The Unbalanced Problem : The Transportation Problem is a balanced problem when the row
total = column total. When it is an unbalanced Transportation Problem it is necessary to
introduce a dummy row or a dummy column according to the requirement of the problem.

ASSIGNMENT PROBLEM
INTRODUCTION
An assignment problem is a particular case of transportation problem where the objective is to
assign a number of resources to an equal number of activities so as to minimize total cost or
maximize total profit of allocation.

The problem of assignment arises because available resources such as men, machines, etc., have
varying degrees of efficiency for performing different activities. Therefore, cost, profit or time of
performing the different activities is different. Thus, the problem is : How should the
assignments be made so as to optimize the given objective. Some of the problems where the
assignment technique may be useful are : Assignment of workers to machines, salesmen to
different sales areas, clerks to various checkout counters, classes to rooms, vehicles to routes,
contracts to bidders, etc.
MATHEMATICAL MODEL OF AN ASSIGNMENT
PROBLEM
Given n resources (or facilities) and n activities (or jobs), and effectiveness (in terms of cost,
profit, time, etc.) of each resource (facility) for each activity (job), the problem lies in assigning
each resource to one and only one activity (job) so that the given measure of effectiveness is
optimized.

SOLUTION METHOD OF ASSIGNMENT PROBLEM

Hungarian Assignment Method (HAM) :
It may be observed that none of the three working methods discussed earlier to solve an
assignment is efficient. A method, designed specially to handle the assignment problems in an
efficient way, called the Hungarian Assignment Method, is available, which is based on the
concept of opportunity cost. It is shown in Table 7.1 and is discussed here. For a typical balanced
assignment problem involving a certain number of persons and an equal number of jobs, and
with an objective function of the minimization type, the method is applied as listed in the
following steps :

Step 1 Locate the smallest cost element in each row of the cost table. Now subtract this smallest
element from each element in that row. As a result, there shall be at least one zero in each row of
this new table, called the Reduced Cost Table.

Step 2 In the Reduced Cost Table obtained, consider each column and locate the smallest
element in it. Subtract the smallest value from every other entry in the column. As a consequence
of this action, there would be at least one zero in each of the rows and columns of the second
reduced cost table.

Step 3 Draw the minimum number of horizontal and vertical lines (not the diagonal ones) that
are required to cover all the ‘zero’ elements. If the number of lines drawn is equal to n (the
number of rows/columns) the solution is optimal and proceed to step 6. If the number of lines
drawn is smaller than n, go to step 4.

Step 4 Select the smallest uncovered (by the lines) cost element. Subtract this element from all
uncovered elements including itself and add this element to each value located at the intersection
of any two lines. The cost elements through which only one line passes remain unaltered.

Step 5 Repeat steps 3 and 4 until an optimal solution is obtained.

Step 6 Given the optimal solution, make the job assignments as indicated by the ‘zero’ elements.
This is done as follows :
a) Locate a row which contains only one ‘zero’ element. Assign the job corresponding to this
element to its corresponding person. Cross out the zero’s, if any, in the column corresponding to
the element, which is indicative of the fact that the particular job and person are no more
available.
b) Repeat (a) for each of such rows which contain only one zero. Similarly, perform the same
operation in respect of each column containing only one ‘zero’ element, crossing out the zero(s),
if any, in the row in which the element lies.

c) If there is row or column with only a single ‘zero’ element left, then select a row/column
arbitrarily and choose one of the jobs (or persons) and make the assignment. Now cross the
remaining zeros in the column and row in respect of which the assignment is made.

d) Repeat steps (a) through (c) until all assignment are made.
e) Determine the total cost with reference to the original cost table.

UNIT III
GAME THEORY

Introduction to game theory

Game theory seeks to analyse competing situations which arise out of conflicts of interest.
Abraham Maslow’s hierarchical model of human needs lays emphasis on fulfilling the basic
needs such as food, water, clothes, shelter, air, safety and security. There is conflict of interest
between animals and plants in the consumption of natural resources. Animals compete among
themselves for securing food. Man competes with animals to earn his food. A man also competes
with another man. In the past, nations waged wars to expand the territory of their rule. In the
present day world, business organizations compete with each other in getting the market share.
The conflicts of interests of human beings are not confined to the basic needs alone. Again
considering Abraham Maslow’s model of human needs, one can realize that conflicts also arise
due to the higher levels of human needs such as love, affection, affiliation, recognition, status,
dominance, power, esteem, ego, self-respect, etc. Sometimes one witnesses clashes of ideas of
intellectuals also. Every intelligent and rational participant in a conflict wants to be a winner but
not all participants can be the winners at a time. The situations of conflict gave birth to Darwin’s
theory of the ‘survival of the fittest’. Nowadays the concepts of conciliation, co-existence, co-
operation, coalition and consensus are gaining ground. Game theory is another tool to examine
situations of conflict so as to identify the courses of action to be followed and to take appropriate
decisions in the long run. Thus this theory assumes importance from managerial perspectives.
The pioneering work on the theory of games was done by von Neumann and Morgenstern
through their publication entitled ‘The Theory of Games and Economic Behaviour’ and
subsequently the subject was developed by several experts. This theory can offer valuable
guidelines to a manager in ‘strategic management’ which can be used in the decision making
process for merger, take-over, joint venture, etc. The results obtained by the application of this
theory can serve as an early warning to the top level management in meeting the threats from the
competing business organizations and for the conversion of the internal weaknesses and external
threats into opportunities and strengths, thereby achieving the goal of maximization of profits.
While this theory does not describe any procedure to play a game, it will enable a participant to
select the appropriate strategies to be followed in the pursuit of his goals. The situation of failure
in a game would activate a participant in the analysis of the relevance of the existing strategies
and lead him to identify better, novel strategies for the future occasions.

Definitions of game theory

There are several definitions of game theory. A few standard definitions are presented below. In
the perception of Robert Mockler, “Game theory is a mathematical technique helpful in making
decisions in situations of conflicts, where the success of one part depends at the expense of
others, and where the individual decision maker is not in complete control of the factors
influencing the outcome”.

The definition given by William G. Nelson runs as follows: “Game theory, more properly the
theory of games of strategy, is a mathematical method of analyzing a conflict. The alternative is
not between this decision or that decision, but between this strategy or that strategy to be used
against the conflicting interest”.

In the opinion of Matrin Shubik, “Game theory is a method of the study of decision making in
situation of conflict. It deals with human processes in which the individual decision-unit is not in
complete control of other decision-units entering into the environment”.

According to von Neumann and Morgenstern, “The ‘Game’ is simply the totality of the rules
which describe it. Every particular instance at which the game is played – in a particular way –
from beginning to end is a ‘play’. The game consists of a sequence of moves, and the play of a
sequence of choices”.

Assumptions for a Competitive Game

Game theory helps in finding out the best course of action for a firm in view of the anticipated
countermoves from the competing organizations. A competitive situation is a competitive game
if the following properties hold:

1. The number of competitors is finite, say N.

2. A finite set of possible courses of action is available to each of the N competitors.
3. A play of the game results when each competitor selects a course of action from the set of
courses available to him. In game theory we make an important assumption that all the players
select their courses of action simultaneously. As a result, no competitor will be in a position to
know the choices of his competitors.
4. The outcome of a play consists of the particular courses of action chosen by the individual
players. Each outcome leads to a set of payments, one to each player, which may be either
positive, or negative, or zero.

Managerial Applications of the Theory of Games

The techniques of game theory can be effectively applied to various managerial problems as
detailed below:

1) Analysis of the market strategies of a business organization in the long run.

2) Evaluation of the responses of the consumers to a new product.
3) Resolving the conflict between two groups in a business organization.
4) Decision making on the techniques to increase market share.

5) Material procurement process.

6) Decision making for transportation problem.
7) Evaluation of the distribution system.
8) Evaluation of the location of the facilities.
9) Examination of new business ventures and
10) Competitive economic environment.

Key concepts in the Theory of Games

Several of the key concepts used in the theory of games are described below:

Players:
The competitors or decision makers in a game are called the players of the game.

Strategies:
The alternative courses of action available to a player are referred to as his strategies.

Pay off:
The outcome of playing a game is called the pay off to the concerned player.
Optimal Strategy:
A strategy by which a player can achieve the best pay off is called the optimal strategy for him.

Zero-sum game:
A game in which the total payoffs to all the players at the end of the game is zero is referred to as
a zero-sum game.

Non-zero sum game:

Games with “less than complete conflict of interest” are called non-zero sum games. The
problems faced by a large number of business organizations come under this category. In such
games, the gain of one player in terms of his success need not be completely at the expense of
the other player.

Payoff matrix:
The tabular display of the payoffs to players under various alternatives is called the payoff
matrix of the game.

Pure strategy:
If the game is such that each player can identify one and only one strategy as the optimal strategy
in each play of the game, then that strategy is referred to as the best strategy for that player and
the game is referred to as a game of pure strategy or a pure game.

Mixed strategy:
If there is no one specific strategy as the ‘best strategy’ for any player in a game, then the game
is referred to as a game of mixed strategy or a mixed game. In such a game, each player has to
choose different alternative courses of action from time to time.

N-person game:
A game in which N-players take part is called an N-person game.

Maximin-Minimax Principle :
The maximum of the minimum gains is called the maximin value of the game and the
corresponding strategy is called the maximin strategy. Similarly the minimum of the maximum
losses is called the minimax value of the game and the corresponding strategy is called the
minimax strategy. If both the values are equal, then that would guarantee the best of the worst
results.

Saddle point:
A saddle point of a game is that place in the payoff matrix where the maximum of the row
minima is equal to the minimum of the column maxima. The payoff at the saddle point is called
the value of the game and the corresponding strategies are called the pure strategies.

Dominance:
One of the strategies of either player may be inferior to at least one of the remaining ones. The
superior strategies are said to dominate the inferior ones.

Types of Games:
There are several classifications of a game. The classification may be based on various factors
such as the number of participants, the gain or loss to each participant, the number of strategies
available to each participant, etc. Some of the important types of games are enumerated below.

Two person games and n-person games:

In two person games, there are exactly two players and each competitor will have a finite number
of strategies. If the number of players in a game exceeds two, then we refer to the game as n-
person game.

Definition of two-person zero sum game

A game with only two players, say player A and player B, is called a two-person zero sum game
if the gain of the player A is equal to the loss of the player B, so that the total sum is zero.

Payoff matrix:
When players select their particular strategies, the payoffs (gains or losses) can be represented in
the form of a payoff matrix. Since the game is zero sum, the gain of one player is equal to the
loss of other and vice-versa. Suppose A has m strategies and B has n strategies. Consider the
following payoff matrix.

Assumptions for two-person zero sum game:

For building any model, certain reasonable assumptions are quite necessary. Some assumptions
for building a model of two-person zero sum game are listed below.
a) Each player has available to him a finite number of possible courses of action. Sometimes the
set of courses of action may be the same for each player. Or, certain courses of action may be
available to both players while each player may have certain specific courses of action which are
not available to the other player.
b) Player A attempts to maximize gains to himself. Player B tries to minimize losses to himself.
c) The decisions of both players are made individually prior to the play with no communication
between them.
d) The decisions are made and announced simultaneously so that neither player has an advantage
resulting from direct knowledge of the other player’s decision.
e) Both players know the possible payoffs of themselves and their opponents.

Minimax and Maximin Principles

The selection of an optimal strategy by each player without the knowledge of the competitor’s
strategy is the basic problem of playing games. The objective of game theory is to know how
these players must select their respective strategies, so that they may optimize their payoffs. Such
a criterion of decision making is referred to as minimax-maximin principle. This principle in
games of pure strategies leads to the best possible selection of a strategy for both players. For
example, if player A chooses his ith strategy, then he gains at least the payoff min ij a , which is
minimum of the ith row elements in the payoff matrix. Since his objective is to maximize his
payoff, he can choose strategy i so as to make his payoff as large as possible.

The amount of payoff, i.e., V at an equilibrium point is known as the value of the game.
The optimal strategies can be identified by the players in the long run.

Fair game:
The game is said to be fair if the value of the game V = 0.

GAMES WITH NO SADDLE POINT

2 x 2 zero-sum game

When each one of the first player A and the second player B has exactly two strategies, we have
a 2 x 2 game.

We see that max {row minima} and min {column maxima} are not equal. Hence the game has
no saddle point.

Method of solution of a 2x2 zero-sum game without saddle point

Suppose that a 2x2 game has no saddle point.
In this case, the game is called a mixed game. No strategy of Player A can be called the best
strategy for him. Therefore A has to use both of his strategies. Similarly no strategy of Player B
can be called the best strategy for him and he has to use both of his strategies.

THE PRINCIPLE OF DOMINANCE

The principle of dominance
In the previous lesson, we have discussed the method of solution of a game without a saddle
point. While solving a game without a saddle point, one comes across the phenomenon of the
dominance of a row over another row or a column over another column in the pay-off matrix of
the game.

If no pure strategy exist, the next step is to eliminate certain strategies (rows and/ or columns) by
dominance. Rows and / or columns of the payoff matrix that are inferior to at least one of the
remaining rows and/ or columns are deleted from further consideration. The resulting can be
solved for some mixed strategy.

The dominance rule for column is : Every value in the dominating column (s) must be less than
or equal to the corresponding value of the dominated column.

The dominance rule for rows is : Every value in the dominating row(s) must be greater than or
equal to the corresponding value of the dominated row.

Mixed strategy
Arithmetic method (odds method or short cut method) for finding optimum strategies and game
value

It provides an easy method for finding the optimum strategies for each player in a 2 X 2 game
without a saddle point. It consists of the following steps :

(i) subtract the two digits in column 1 and write the differences under column 2, ignoring sign

(ii) subtract the two digits in column 2 and write the difference under column 1, ignoring sign

(iii) similarly proceed for the two rows

These values are called oddments. They are the frequencies with which the players must use their
courses of action in their optimum strategies.
REPLACEMENT MODEL
Any capital item, which is continuously used for providing service or for producing the product
is subjected to wear and tear due to usage, and its efficiency goes on reducing. This reduction in
efficiency can be predicted by the increasing number of breakdowns or reduced productivity.
The worn out parts or components are to be replaced to bring the machine back to work. This
action is known as maintenance. A time is reached when the maintenance cost becomes very
high and the manager feels to replace the old machine by new one. This type of problems known
as replacement problems and can be solved by replacement models.

The problem of replacement arises when any one of the components of productive resources,
such as machinery, building and men deteriorates due to time or usage. The examples are: (a) A
machine, which is purchased and installed in a production system, due to usage some of its
components wear out and its efficiency is reduced. (b) A building in which production activities
are carried out, may leave cracks in walls, roof etc, and needs repair. (c) A worker, when he is
young, will work efficiently, as the time passes becomes old and his work efficiency falls down
and after some time he will become unable to work. In general, when any production facility is
new, it works with full operating efficiency and due to usage or of time, it may become old and
some of its components wear out and the operating efficiency of the facility falls down. To
regain the efficiency, a remedy by, namely maintenance is to be attended. The act of
maintenance consists of replacing the worn out part, or oiling or overhauling, or repair etc. In
modern industrial scene, the presence of highly sophisticated machinery in manufacturing system
will bother the manager, when any one of the facilities goes out of order or breakdown. Because
of the breakdown of one of the facility, the entire production system may be affected. This is
particularly true in batch manufacturing system and continuous manufacturing system. The loss
of production hours is more expensive factor for the manufacturing unit. Hence, the management
must take interest in maintaing the production facility properly, so that facility's available time
will be more than the down time. All the production facilities are subjected to deterioration due
to their use and exposure to the environmental conditions. The process of deterioration, if
unchecked or neglected, it culminates and makes the facility useless. Hence, the management has
to check the facilities periodically, and keep all the facilities in operating condition. Once the
maintenance is attended, the efficiency may not be regained to previous level but a bit less than
that of previous level. For example, if the operating efficiency is 95 percent and due to
deterioration, the efficiency reduces to 90 percent, after maintenance, it may regain to the level
of 93 percent. Once again due to usage the efficiency falls down and the maintenance is to be
attended. This is an ongoing business of the management. After some time, the efficiency
reduces to such a level, the maintenance cost will become very high and due to less efficiency
the unit production cost will be very high and this is the time the management has to think of
replacing the facility. This may be well explained by means of a figure. Referring to figure 7.1,
the operating efficiency at the beginning is 95%. When first maintenance is attended, it is
reduced to 93%. In the second maintenance it is reduced to 80 percent. Like this the facility
deteriorates, and finally the operating efficiency reduces to 50 percent, where the it is not
economical to use the facility for further production, as the maintenance cost will be very high,
and the unit production cost also increases, hence the replacement of the facility is due at this
stage. In this chapter, we will discuss the mathematical models used for finding the optimal
replacement time of facilities.

Thus the problem of replacement is experienced in systems where machines, individuals or

capital assets are the main production or job performing units. The characteristics of these units
is that their level of performance or efficiency decreases with time or usage and one has to
formulate some suitable replacement policy regarding these units to keep the system up to some
desired level of performance. We may have to take different type of decision such as:

(a) We may decide whether to wait for complete failure of the item (which may result in some
losses due to deterioration or to replace earlier at the expense of higher cost of the item,

(b) The expensive item may be considered individually to decide whether we should replace now
or, if not, when it should be reconsidered for replacement,

(c) Whether the item is to be replaced by similar type of item or by different type for example
item with latest technology The problem of replacement is encountered in the case of both men
and machines. Using probability, it is possible to estimate the chance of death or failure at
various ages. The main objective of replacement is to help the organization for maximizing its
profit or to minimize the cost.

The word failure has got a wider meaning in industrial maintenance than what it has in our daily
life. We can categorize the failure in two classes. They are

(i) Gradual failure and

(ii) Sudden failure.

Once again the sudden failure may be classified as:

(a) Progressive failure,

(b) Retrogressive failure and

(c) Random failure.

(i) Gradual failure: In this class as the life of the machine increases or due continuous usage, due
to wear and tear of components of the facility, its efficiency deteriorates due to which the
management can experience:

(a) Progressive Increase in maintenance expenditure or operating costs,

(b) Decreased productivity of the equipment and

(c) decrease in the value of the equipment i.e. resale value of the equipment/facility decreases.
Examples of this category are: Automobiles, Machine tools, etc.

(ii) Sudden failure: In this case, the items ultimately fail after a period of time. The life of the
equipment cannot be predicted and is some sort of random variable. The period between
installation and failure is not constant for any particular type of equipment but will follow some
frequency distribution, which may be:

(a) Progressive failure: In this case probability of failure increases with the increase in life of an
item. The best example is electrical bulbs and computer components. It can be shown as in figure
7.2 (a).

(b) Retrogressive failure: Some items will have higher probability of failure in the beginning of
their life, and as the time passes chances of failure becomes less. That is the ability of the item to
survive in the initial period of life increases its expected life. The examples are newly installed
machines in production systems, new vehicles, and infant baby (The probability of survival is
very less in infant age, but once the baby get accustomed to nature, the probability of failure
decreases). This can be shown as in figure 7.2 (b).

(c) Random failure: In this class, constant probability of failure is associated with items that fail
from random causes such as physical shocks, not related to age. In such cases all items fail
before aging has any effect. This can be shown as in figure 7.2. (c). Example is vacuum tubes.
UNIT IV

Job Sequencing

When a number of jobs are given to be done and they require processing on two or more
machines, the main concern of a manager is to find the order or sequence to perform these jobs.
We shall consider the sequencing problems in respect of the jobs to be performed in a factory
and study the method of their solution. Such sequencing problems can be broadly divided in two
groups. In the first one, there are n jobs to be done, each of which requires processing on some or
all of the k different machines. We can determine the effectiveness of each of the sequences that
the technologically feasible (that is to say, those satisfying the restrictions on the order in which
each job must be processed through the machines) and choose a sequence which optimizes the
effectiveness. To illustrate, the timings of processing of each of the n jobs on each of the k
machines, in a certain given order, may be given and the time for performing the jobs may be the
measure of effectiveness. We shall select the sequences for which the total time taken in
processing all the jobs on the machines would be the minimum.

In this unit we will look into solution of a sequencing problem. In this lesson the solutions of
following cases will be discussed:

a) n jobs and two machines A and B, all jobs processed in the order AB.
b) n jobs and three machines A, B and C all jobs processed in the order ABC
c) Problems with n jobs and m machines.

Basic Terminologies
In the following, we describe the basic terminologies which are commonly used in job
sequencing:

Number of machines
It refers to the number of service facilities through which a job must pass before it is assumed to
be completed.

Processing time
This is the time required by each job on each machine.
Processing order
This refers to the order (sequence) in which machines are required for completing the job.

Idle time on a machine

This is the time during which a machine does not have a job to process.

Total elapsed time

This is the time interval between starting the first job and completing the last job, including the
idle time (if any), in a particular order by the given set of machines.

No passing rule
This means that the passing is not allowed, i.e., the same order of jobs is maintained over each
machine.

If n jobs are to be processed through two machines A and B in the order AB, then this means that
each job will go to machine A first and then to B.

Principal Assumptions
General assumptions for sequencing problems are as follows:
• The processing time on each machine is known.
• The time required to complete a job is independent of the order of jobs in which they are to be
processed.
• No machine can process more than one job simultaneously.
• The time taken by each job in changing over from one machine to another is negligible.
• Each job, once started on a machine is to be performed up to completion on that machine.
• The order of completion of job has no significance, i.e., no job is to be given priority.

• A job starts on the machine as soon as the job and the machine both are idle.

Types of Job Sequencing Problem

Various types of job sequencing problem arise in the world. All sequencing problems cannot be
solved. Here, we consider the following four types of job sequencing problem:

I. n jobs are to be processed on 2 machines, say, machine A and machine B in the order AB.
This means that each job is to be processed first on machine A and then on machine B.

II. n jobs are to be processed on 3 machines A, B and C in the order ABC, i.e., first on machine
A, second on machine B and third on machine C.

III. n jobs are to be processed on m machines in the given order

IV.2 jobs are to be processed on m machines in the given order.

Processing of n jobs through two machines

The simplest possible sequencing problem is that of n job two machine sequencing problem in
which we want to determine the sequence in which n-job should be processed through two
machines so as to minimize the total elapsed time T. The problem can be described as:
a) Only two machines A and B are involved;
b) Each job is processed in the order AB.
c) The exact or expected processing times A1,A2,A3, --- , An ; B1,B2,B3, --- , Bn are known
and are provided in the following table

Job(s)
Machine
1 2 3 -- - i -- - n
A A1 A2 A3 -- - Ai -- - An
B B1 B2 B3 -- - Bi -- - Bn

The problem is to find the sequence (or order) of jobs so as to minimize the total elapsed time T.
The solution of the above problem is also known as Johnson�s procedure which involves the
following steps:
Step 1. Select the smallest processing time occurring in the list A1,A2,A3, --- , An ;
B1,B2,B3, --- , Bn if there is a tie, either of the smallest processing times can be
selected.
Step 2. If the least processing time is Ar , select the rth job first. If it is Bs, do the sth job
last as the given order is AB
Step 3. There are now (n-1) jobs left to be ordered. Repeat steps I and II for the remaining
set of processing times obtained by deleting the processing time for both the
machines corresponding to the job already assigned.
 Step 4. Continue in the same manner till the entire jobs have been ordered. The resulting
ordering will minimize the total elapsed time T and is called the optimal
sequence.
Step 5. After finding the optimal sequence as stated above find the total elapsed time and
idle times on machines A and B as under:

Total elapsed The time between starting the first job in the optimal sequence on machine A
time = and completing the last job in the optimal machine B.
Idle time on (Time when the last job in the optimal sequence on sequences is completed
machine A = on machine B)- (Time when the last job in the optimal sequences is
completed on machine A)
Idle time on (Time when the first job in the optimal sequences is completed on machine
machine B = A)+

The Johnson�s procedure can be illustrated by following examples:

Example 1

There are nine jobs, each of which must go through two machines P and Q in the order PQ, the
processing times (in hours) are given below:

Job(s)
Machine
A B C D E F G H I
P
2 5 4 9 6 8 7 5 4
Q
6 8 7 4 3 9 3 8 11

Find the sequence that minimizes the total elapsed time T. Also calculate the total idle time for
the machines in this period.

Solution
The minimum processing time on two machines is 2 which correspond to task A on machine P.
This shows that task A will be preceding first. After assigning task A, we are left with 8 tasks on
two machines

Machine
B C D E F G H I
P
5 4 9 6 8 7 5 4
Q
8 7 4 3 9 3 8 11

Minimum processing time in this reduced problem is 3 which correspond to jobs E and G (both
on machine Q). Now since the corresponding processing time of task E on machine P is less than
the corresponding processing time of task G on machine Q therefore task E will be processed in
the last and task G next to last. The situation will be dealt as

A G E

The problem now reduces to following 6 tasks on two machines with processing time as follows:
Machine B C D F H I
P 5 4 9 8 5 4
Q 8 7 4 9 8 11

Here since the minimum processing time is 4 which occurs for tasks C and I on machine P and
task D on machine Q. Therefore, the task C which has less processing time on P will be
processed first and then task I and task D will be placed at the last i.e., 7th sequence cell.

The sequence will appear as follows:

A C I D E G
The problem now reduces to the following 3 tasks on two machines

Machine B F H
P 5 8 5
Q 8 9 8

In this reduced table the minimum processing time is 5 which occurs for tasks B and H both on
machine P. Now since the corresponding time of tasks B and H on machine Q are same i.e. 8.
Tasks B or H may be placed arbitrarily in the 4th and 5th sequence cells. The remaining task F can
then be placed in the 6th sequence cell. Thus the optimal sequences are represented as

A I C B H F D E G

or
A 1 C H B F D E G

Further, it is also possible to calculate the minimum elapsed time corresponding to the optimal
sequencing A → I → C → B → H → F → D → E → G.

Job Machine A Machine B

Time In Time Out Time In Time Out

Sequence
A 0 2 2 8
I 2 6 8 19
C 6 10 19 26
B 10 15 26 34
H 15 20 34 42
F 20 28 42 51
 D 28 37 51 55
E 37 43 55 58
G 43 50 58 61

Hence the total elapsed time for this proposed sequence staring from job A to completion of job
G is 61 hours .During this time machine P remains idle for 11 hours (from 50 hours to 61
hours)and the machine Q remains idle for 2 hours only (from 0 hour to 2 hour ).

15.2 Processing of n Jobs through Three Machines

The type of sequencing problem can be described as follows:

a) Only three machines A, B and C are involved;
b) Each job is processed in the prescribed order ABC
c) No passing of jobs is permitted i.e. the same order over each machine is maintained.
d) The exact or expected processing times A1,A2,A3, --- , An ; B1,B2,B3, --- , Bn and
C1,C2,C3, --- , Cn are known and are denoted by the following table

Job(s)
Machine 1 2 3 -- - i - - n
-
A A1 A2 A3 -- - Ai -- - An
B B1 B2 B3 -- - Bi -- - Bn
C C1 C2 C3 Ci Cn

Our objective will be to find the optimal sequence of jobs which minimizes the total elapsed
time. No general procedure is available so far for obtaining an optimal sequence in such case.
However, the Johnsons procedure can be extended to cover the special cases where either one or
both of the following conditions hold:

a) The minimum processing time on machine A ≥ the maximum processing time on machine
B.
 b) The minimum processing time on machine C ≥ the maximum processing time on
machine B.

The method is to replace the problem by an equivalent problem involving n jobs and two
machines. These two fictitious machines are denoted by G and H and the corresponding time Gi
and Hi are defined by

Gi = Ai + Bi� and Bi + Ci

Now this problem with prescribed ordering GH is solved by the method with n jobs through two
machines, the resulting sequence will also be optimal for the original problem.

Network analysis

Network analysis is the general name given to certain specific techniques which can be used for
the planning, management and control of projects.

Typically all projects can be broken down into:

• separate activities (tasks/jobs) - where each activity has an associated duration or

completion time (i.e. the time from the start of the activity to its finish)
• precedence relationships - which govern the order in which we may perform the
activities, e.g. in a project concerned with building a house the activity "erect all four
walls" must be finished before the activity "put roof on" can start and the problem is to
bring all these activities together in a coherent fashion to complete the project.

Two different techniques for network analysis were developed independently in the late 1950's -
these were:

• PERT (for Program Evaluation and Review Technique); and

• CPM (for Critical Path Management).

RULES FOR DRAWING NETWORK ANALYSIS

Introduction
A fundamental ingredient in both PERT and CPM is the use of network systems as a means of
graphically depicting a project. When a network is being constructed, certain conventions are
followed to represent a project graphically, for it is essential that the relationship between
activities and events are correctly depicted. Drawing a network diagram is a relatively easy task,
and can be accomplished by listing each task on a piece of paper and representing the sequence
in which the tasks take place. Lines and arrows are drawn between the pieces of paper to show
which tasks follow on from others. The diagram aims to portray how the tasks relate to one
another i.e. which tasks have to be completed before others begin and which tasks can be
performed simultaneously. Creating the network is an iterative process and may involve a
number of revisions before an optimum solution is found.

Sequencing

The initial step in project scheduling process is the determination of all specific activities that
comprise the project and their interdependence relationships. In order to make a network
following points should be taken into consideration.

• What job or jobs precede it?

• What job or jobs run concurrently?
• What job or jobs follow it?
• What controls the start and finish of a job?

Since all further calculations are based on the network, it is necessary that a network be drawn
with full care. There are many ways to draw a network, in this lesson we will describe the
method which follows the precedence table. The following example of preparation of Paneer
(Cottage cheese) shows the basic steps required in drawing a network.

Guidelines for Drawing Network Diagram

There are number of rules in connection with the handling of events and activities of a project
network which are given below:

a) Each activity is represented by one and only one arrow in the network. This implies that
no single activity can be represented twice in the network. This is to be distinguished
 from the case where one activity is broken into segments. In such a case each segment
may be represented by a separate arrow.
b) No two activities can be identified by the same beginning and end event. In such cases,
a dummy activity is introduced to resolve the problem as shown in Fig. 19.2

c) In order to ensure the correct precedence relationship in arrow diagram following

question must be checked whenever any activity is added to a network.

What activity must be completed immediately before this activity can start?

What activities must follow this activity?

What activities must occur simultaneously with this activity?

d) Thus a network should be developed on the basis of logical or technical dependence.

e) The arrows depicting various activities are indicative of logical precedence only; hence length
and bearing of the arrows are of no significance.

f) The flow of the diagram should be from left to right.

g) Two events are numbered in such a way that the event of higher number can happen only after
the event of lower number is completed.
h) Arrows should be kept straight and not curved. Avoid arrow which cross each other.
i) Avoid mixing two directions vertical and standing arrows may be used if necessary.

j) Use dummy activity freely in rough graph but final network should have only reluctant
dummy.
k) The network has only one entry point called the start event and one point of emergence called
end event.

l) Angle between the arrows should be as large as possible.

Labeling of a Network Diagram

For network representation it is necessary that various nodes be properly labeled. For
convenience, labeling is done on a network diagram. A standard procedure called i-j rule
developed by D.R.F Fulkerson is most commonly used for this purpose.

Fulkersons i-j Rule

Step 1: First, a start event is one which has arrows emerging from it but not entering it. Find the
start event and label it as number1.

Step 2: Delete all arrows emerging from all numbered events. This will create at least one new
start event out of the preceding events.

Step 3: Number all new start events �2�, �3� and so on. No definite rule is necessary but
numbering from top to bottom may facilitate other users using the network when there are more
than one new start event.

Step 4: Go on repeating step no. 2 & 3 until the end reached.

Programme Evaluation and Review Technique and Critical Path Method

(PERT and CPM)

Programme Evaluation and Review Technique (PERT) and Critical Path Method (CPM) are two
techniques that are widely used in planning and scheduling the large projects. A project is a
combination of various activities. For example, Construction of a house can be considered as a
project. Similarly, conducting a public meeting may also be considered as a project. In the above
examples, construction of a house includes various activities such as searching for a suitable site,
arranging the finance, purchase of materials, digging the foundation, construction of
superstructure etc. Conducting a meeting includes, printing of invitation cards, distribution of
cards, arrangement of platform, chairs for audience etc. In planning and scheduling the activities
of large sized projects, the two network techniques — PERT and CPM — are used conveniently
to estimate and evaluate the project completion time and control the resources to see that the
project is completed within the stipulated time and at minimum possible cost. Many managers,
who use the PERT and CPM techniques, have claimed that these techniques drastically reduce
the project completion time. But it is wrong to think that network analysis is a solution to all bad
management problems. In the present chapter, let us discuss how PERT and CPM are used to
schedule the projects.
Initially, projects were represented by milestone chart and bar chart. But they had little use in
controlling the project activities. Bar chart simply represents each activity by bars of length
equal to the time taken on a common time scale as shown in figure 15. l. This chart does not
show interrelationship between activities. It is very difficult to show the progress of work in
these charts. An improvement in bar charts is milestone chart. In milestone chart, key events of
activities are identified and each activity is connected to its preceding and succeeding activities
to show the logical relationship between activities. Here each key event is represented by a node
(a circle) and arrows instead of bars represent activities, as shown in figure 15.2. The extension
of milestone chart is PERT and CPM network methods.

PERT AND CPM

In PERT and CPM the milestones are represented as events. Event or node is either starting of an
activity or ending of an activity. Activity is represented by means of an arrow, which is resource
consuming. Activity consumes resources like time, money and materials. Event will not consume
any resource, but it simply represents either starting or ending of an activity. Event can also be
represented by rectangles or triangles. When all activities and events in a project are connected
logically and sequentially, they form a network, which is the basic document in network-based
management. The basic steps for writing a network are:
(a) List out all the activities involved in a project. Say, for example, in building construction, the
activities are:
(i) Site selection,
(ii) Arrangement of Finance,
(iii) Preparation of building plan,
(iv) Approval of plan by municipal authorities,
(v) Purchase of materials,
(vi) Digging of foundation,
(vii) Filling up of foundation,
(viii) Building superstructure,
(ix) Fixing up of doorframes and window frames,
(x) Roofing,
(xi) Plastering,
(xii) Flooring,
(xiii) Electricity and water fittings,
(xiv) Finishing.

(b) Once the activities are listed, they are arranged in sequential manner and in logical order. For
example, foundation digging should come before foundation filling and so on.
(c) After arranging the activities in a logical sequence, their time is estimated and written against
each activity. For example: Foundation digging: 10 days, or 1½ weeks.

(d) Some of the activities do not have any logical relationship, in such cases; we can start those
activities simultaneously. For example, foundation digging and purchase of materials do not have
any logical relationship. Hence both of them can be started simultaneously. Suppose foundation
digging takes 10 days and purchase of materials takes 7 days, both of them can be finished in 10
days. And the successive activity, say foundation filling, which has logical relationship with both
of the above, can be started after 10 days. Otherwise, foundation digging and purchase of
materials are done one after the other; filling of foundation should be started after 17 days.

(e) Activities are added to the network, depending upon the logical relationship to complete the
project network. Some of the points to be remembered while drawing the network are

(a) There must be only one beginning and one end for the network
(b) Event number should be written inside the circle or node (or triangle/square/rectangle etc).
Activity name should be capital alphabetical letters and would be written above the arrow.
(c) While writing network, see that activities should not cross each other.
(d) While writing network, looping should be avoided. This is to say that the network arrows
should move in one direction, i.e. starting from the beginning should move towards the end.
(e) When two activities start at the same event and end at the same event, they should be shown
by means of a dummy activity.

Dummy activity is an activity, which simply shows the logical relationship and does not
consume any resource. It should be represented by a dotted line as shown.

(f) When the event is written at the tail end of an arrow, it is known as tail event. If event is
written on the head side of the arrow it is known as head event. A tail event may have any
number of arrows (activities) emerging from it. This is to say that an event may be a tail event to
any number of activities. Similarly, a head event may be a head event for any number of
activities. This is to say that many activities may conclude at one event.

There are three time estimates in PERT, they are:

(a) OPTIMISTIC TIME: Optimistic time is represented by tO. Here the estimator thinks that
everything goes on well and he will not come across any sort of uncertainties and estimates
lowest time as far as possible. He is optimistic in his thinking.

(b) PESSIMISTIC TIME: This is represented by tP. Here estimator thinks that everything goes
wrong and expects all sorts of uncertainties and estimates highest possible time. He is pessimistic
in his thinking.

(c) MOST LIKELY TIME: This is represented by tm. This time is in between optimistic and
pessimistic times. Here the estimator expects he may come across some sort of uncertainties and
many a time the things will go right. So while estimating the time for a PERT activity, the
estimator will give the three time estimates. When these three estimates are plotted on a graph,
the probability distribution that we get is closely associated with Beta Distribution curve.

(g) Numbering of events: Once the network is drawn the events are to be numbered. In PERT
network, as the activities are given in terms of events, we may not experience difficulty. Best in
case of CPM network, as the activities are specified by their name, is we have to number the
events. For numbering of events, we use D.R. Fulkerson’s rule.
As per this rule:
An initial event is an event, which has only outgoing arrows from it and no arrow enters it.
Number that event as 1. Delete all arrows coming from event 1. This will create at least one more
initial event. Number these initial events as 2, 3 etc. Delete all the outgoing arrows from the
numbered element and which will create some more initial events. Number these events as
discussed above. Continue this until you reach the last event, which has only incoming arrows
and no outgoing arrows. While numbering, one should not use negative numbers and the initial
event should not be assigned ‘zero’. When the project is considerably large, at the time of
execution of the project, the project manager may come to know that some of the activities have
been forgotten and they are to be shown in the current network. In such cases, if we use skip
numbering, it will be helpful. Skip numbering means, skipping of some numbers and these
numbers may be made use to represent the events forgotten. We can skip off numbers like 5, 10,
15 etc. or 10, 20 and 30 or 2, 12, 22 etc. Another way of numbering the network is to start with
10 and the second event is 20 and so on. This is a better way of numbering the events.

CRITICAL PATH METHOD (CPM) FOR CALCULATING

PROJECT COMPLETION TIME
In critical path method, the time duration of activity is deterministic in nature i.e. there will be a
single time, rather than three time estimates as in PERT networks. The network is activity
oriented. The three ways in which the CPM type of networks differ from PERT networks are:

CPM PERT
(a) Network is constructed on the basis of jobs (a) Network is constructed basing on the
or activities (activity oriented). events (event oriented)
(b) CPM does not take uncertainties involved (b) PERT network deals with uncertainties and
in the estimation of times. The time required is hence three time estimations are considered
deterministic and hence only one time is (Optimistic Time, Most Likely Time and
considered. Pessimistic Time)
(c) CPM times are related to cost. That is can (c) As there is no certainty of time, activity
be by decreasing the activity duration direct duration cannot be reduced. Hence cost cannot
costs increased (crashing of activity duration is be expressed correctly. We can say expected
possible) cost of completion of activity (crashing of
activity duration is not possible)

Writing the CPM Network

First, one has to establish the logical relationship between activities. That is predecessor and
successor relationship, which activity is to be started after a certain activity. By means of
problems let us see how to deal with CPM network and the calculations needed.

UNIT V
Inventory control

Definition
The function of directing the movement of goods through the entire manufacturing cycle from
the requisitioning of raw materials to the inventory of finishes goods orderly mannered to meet
the objectives of maximum customer-service with minimum investment and efficient (low-cost)
plant operation. What Is Inventory? In broad sense, inventory may be defined as the stock of
goods, commodities or other economic resources that are stored or reserved in order to ensure
smooth and efficient running of business affairs. The inventory or stock of goods may be kept in
any of the following forms:

i. Raw material inventory, i.e. raw materials which are kept in stock for using in the production
of\ goods.

ii. Work-in-process inventory, i.e. semi finished goods or goods in process, which are stored
during the production process.

iii. Finished goods inventory, i.e. finished goods awaiting shipment from the factory.

iv. Inventory also include: furniture, machinery, fixtures, etc. The term inventory may be
classified in two main categories.1- Direct Inventories The items which playa direct role in the
manufacture and become an integral part of finished goods are included in the category of direct
inventories. These may be further classified into four main groups:

a. Raw material inventories are provided:

i. for economical bulk purchasing,

ii. to enable production rate changes

iii. to provide production buffer against delays intransportation,

iv. for seasonal fluctuations.

b. Work-in-process inventories are provided:

i. to enable economical lot production,

ii. to cater to the variety of products

iii. for replacement of wastages,

iv. to maintain uniform production even if amount ofsales may vary.

c. Finished-goods inventories are provided:

i. for maintaining off-self delivery,

ii. to allow stabilization of the production level

iii. for sales promotion.

d. Spare parts. Indirect Inventories

Indirect inventories include those items, which are necessarily required for manufacturing but do
not become the component of finished production, like: oil, grease, lubricants, petrol, and office-
material maintenance material, ecotypes of Inventory Models Basically, there are five types of
inventory models:

i. Fluctuation Inventories. These have to be carried because sales and production times cannot be
predicted accurately. In real-life problems, there are fluctuations in the demand and lead-times
that affect the production of items. Such types of reserve stocks or safety stocks are called
fluctuation inventories.

ii. Anticipation Inventories.

These are built up in advance for the season of large sales, a promotion programme or a plant
shutdown period. In fact, anticipation inventories store the men and machine hours for future
requirements.

iii. Cycle lot-size) inventories. In practical situations, it seldom happens that the rate of
consumption is the same as threat of production or purchasing. So the items are procured in
larger quantities than they are required. This results in cycle (or lot-size) inventories.

iv. Transportation Inventories. Such inventories exist because the materials are required to move
from one place to another. When the transportation time is long, the items under transport cannot
be served to customers. These inventories exist solely because of transportation time.

v. Decoupling Inventories. Such inventories are needed for meeting out the demands during the
decoupling period of manufacturing or purchasing. Inventory Decisions The managers must take
two basic decisions in order to accomplish the functions of inventory. The decisions made
forever item in the inventory are:
i. How much amount of an item should be ordered when the inventory of that item is to be
replenished?

ii. When to replenish the inventory of that item? Inventory decisions may be classified as
follows:

Deterministic model

Essentially, a deterministic model is one where inventory control is structured on the basis that
all variables associated with inventory are known, predictable and can be predicted with a fair
amount of certainty. Because of this, inventory is counted, tracked, stocked and ordered
according to a stable set of assumptions that largely remain the same. So, with a deterministic
model, it is presumed that factors such as lead time will remain stagnant.

In practice, a deterministic approach to inventory may see business owners or inventory

managers blindly ordering inventory without considering variables that are subject to change.
This may lead to, for example, over ordering a certain item in inventory on the basis that it has
been popular over the past few months, without considering whether the trend may have passed
(or may be about to pass).

In this situation, the company may end up with inventory gathering dust on shelves which is
nearly impossible to sell, resulting in reduced profitability.

Probabilistic model

On the other end of the spectrum is the probabilistic model, which says that there is generally
some degree of uncertainty associated with inventory variables, the demand pattern in particular.
With this model, everything inventory control related is predicated on the assumption that
demand may fluctuate and may not always be predictable.

In practice, a probabilistic approach would be informed by the assumption that not everything is
certain, especially relating to inventory. A probabilistic approach allows for fluctuations in
demand and considers this when it comes to managing inventory.

Because of this, a probabilistic model may be the preferred approach for many business owners
and inventory managers. By identifying changes in demand, inventory can be managed
appropriately so that supply is neither excessive nor inadequate. When it comes to ordering
inventory, historic sales trends won’t be the only factor taken into account but will be one of the
various factors that will influence the final order.

How to Develop an Inventory Model?

As explained earlier, inventory models are concerned with two main decisions: how much to
order at a time and when to orders as to minimize the total cost?
The sequence of basic steps required for developing an inventory model may be organized as
follows:
Step 1. First take the physical stock of all the inventory items in an organization.
Step2. Then, classify the stock of items into various categories. Although several methods are
available to classify the inventories; but the selected method must serve the objectives of
inventory management. For example, inventory items may be classified as raw materials, work-
in process. Purchased components, consumable stores and maintenance spares, and finished
goods, etc.
Step 3. Each of above classifications may be further divided into several groups. For example,
consumable stores and maintenance spares can be further divided into the following groups:
(i) building materials.
(ii) hardware items,
(iii) lubricants andoils,
(iv) textiles and fibres,
(v) electric spares,
(vi) mechanical spares,
(vii) stationary items, etc.
Step 4. After classification of inventories, each item should be assigned a suitable code. Coding
system’ should be flexible so that new items may also be permitted for inclusion.
Step 5. Since the number of items in an organization is very large, separate inventory
management model should be developed for each category of items.
Step 6. Use A-B-C or V-E-D classification which provide a basis for a selective control of
inventories through formulation of suitable inventory policies for each category.
Step 7. Now decide about the inventory model to be developed. For example, fixed-order-
quantity system may be developed for ’A’ class and high valued ‘B’ class items, whereas
periodic review system may be developed for low valued ‘B’ class and ‘C’ class items.
Step 8. For this, collect data relevant to determine ordering cost, shortage cost, inventory
carrying cost, etc.
Step 9. Then, make an estimate of annual demand for each inventory item and their prevailing
market price.
Step 10. Estimate lead-time safety stock and reorder level, if supply is not instantaneous. Also,
decide about the service-level to be provided to the customers.
Step 11. Now develop the inventory mode.
Step 12. Finally, review the position and make suitable alterations, if required, due to current
situations or constraints. Before we proceed to discuss inventory models, it is very desirable to
consider briefly the costs involved in the inventory decisions.

Inventory Costs
1.Holding Cost (C] or Ch)’ The cost associated with carrying or holding the goods in stock is
known as holding or carrying cost which is usually denoted by C. or Ch per unit of goods for a
unit of time. Holding cost is assumed to vary directly with the size of inventory as well as the
time for which the item is held in stock.

The following components constitute the holding cost:,

i. Invested Capital Cost. This is the interest charge over the capital investment. Since this is the
most important component, a careful investigation is required to determine its rate.
ii. Record Keeping and Administrative Cost. This signifies the need of keeping funds for
maintaining the records and necessary administration.
iii. Handling Costs. These include all costs associated with movement of stock such as: cost of
labour over head cranes, gantries and other machinery required for this purpose.
iv. Storage Costs. These involve the rent of storage space or depreciation and interest even if the
own space is used.
v. Depreciation, Deterioration and Obsolescence Costs. Such costs arise due to the items in stock
being out of fashion or the items undergoing chemical changes during storage (e.g. rusting in
steel).
vi. Taxes and Insurance Costs. All these costs require careful study and generally amounts to I%
to 2% of the invested capital.
vii. Purchase Price or Production Costs. Purchase price per-unit item is affected by the quantity
purchased due to quantity discounts or price-breaks. Production cost per unit item depends upon
the length of production runs. For long smooth production runs this cost in lower due to more
efficiency of men and machines. So the order quantity must be suitably modified to take the
advantage of these price discounts. If P is the purchase price of an item and I is the stock holding
cost per unit item expressed as a fraction of stock value (in rupees), then the holding cost C. =IP.

viii. Salvage Costs or Selling Price. When the demand for an item is affected by its quantity in
stock, the decision model of the problem depends upon the profit maximization criterion and
includes the revenue (sales tax etc.) from the sale of the item. Generally, salvage costs are
combined with the storage costs and not considered independently.2.Shortage Costs or Stock-out
Costs (C2 or C,). The penalty costs that are incurred as a result of running out of stock (i.e.,
shortage) are known as shortage or stock-out costs. These are denoted by C2 or Cs per unit of
goods (or specified period. These costs arise due to shortage of goods, sales may be lost, and
good will may be lost either by a delay in meeting the demand or being quite unable to meet the
demand atoll. In the case where the unfilled demand for the goods can be satisfied at a later date
(backlog case), these costs are usually assumed to vary directly with the shortage quantity and
the delaying time both. On the other hand, if the unfilled demand is lost (no backlog case),
shortage costs become proportional to shortage quantity only.3.Set-up Costs (C3 or Co), these
include the fixed cost associated with obtaining goods through placing of an order or purchasing
or manufacturing or setting up a machinery before starting production. So they include costs of
purchase, requisition, follow-up, receiving the goods, quality controlled. These are also called
order costs or replenishment costs, usually denoted by C3 or Co per production run (cycle).They
are assumed to be independent of the quantity ordered or produced. Why Inventory is
maintained? As we are aware of the fact that the inventory is maintained for efficient and smooth
running of business affairs. If a manufacturer has no stock of goods at all, on receiving a sale-
order he has to place an order for purchase of raw materials, wait frothier receipt and then start
his production. Thus, the customers will have to wait for a long time for the delivery of the
godsend may turn to other suppliers. This results in a heavy loss of business. So it becomes
necessary to maintain an inventory because of the following reasons:

i. Inventory helps in smooth and efficient running of business.

ii. Inventory provides service to the customers immediately or at a short notice.

iii. Due to absence of stock, the company may have to pay high prices because of piece-wise
purchasing. Maintaining of inventory may earn price discount because of bulk-purchasing.

iv. Inventory also acts as a buffer stock when raw materials are received late and so many sale-
orders are likely to be rejected.

v. Inventory also reduces product costs because there is an additional advantage of batching and
long smooth running production runs.

vi. Inventory helps in maintaining the economy by absorbing some of the fluctuations when the
demand for an item fluctuates or is seasonal.

i. Firstly, demand for the item is at a constant rate and is known to the decision maker in
advance.

ii. Secondly, the lead-time (which is the elapsed time between the placement of the order and its
receipt into inventory) or the time required for acquiring an item is also known. Although above
two assumptions are rarely valid for inventory problems in the business world, they do allow us
to develop a simple model into which more realistic, complicating factors can be introduced.

Concept of Economic Ordering Quantity (EOQ)

The concept of economic ordering quantity was first developed by F. Harris in 1916. The
concept is that management is confronted with a set of opposing costs-as the lot size (q)
increases; the carrying charges (C) will increase while the ordering costs (C3) will decrease. On
the other hand, as the lot size (q) decreases, the carrying cost (C) will decrease but the ordering
costs will increase (assuming that only minor deviations from these trends may occur). Thus,
economic ordering quantity (EOQ) is that size of order which minimizes total annual (or other
time period as determined by individual firms) cost of carrying inventory and cost of ordering
under the assumed conditions of certainty and that annual demands are known. The concept of
EOQ applies to items, which are replenished periodically into inventory inlets covering several
periods’ need. The EOQ concept is applicable under the following conditions:

a. The item is replenished in lots or batches, either by purchasing or by manufacturing.

b. Consumption of items (or sales or usage rate) is uniform and continuous.EOQ is that order
quantity or optimal order size which minimises the total cost. The model is described under the
following situations:

i. Planning period is one year.

ii. Demand is deterministic and indicated by parameter D units per year.

iii. Cost of purchases, or of one unit is C.

iv. Cost of ordering (or procurement cost of replenishment cost) is C3or Co ‘For manufacturing
goods, it is known as set-up cost.

v. Cost of holding stock (also known as inventory carrying cost) is C1or Ch per unit per year
expressed either in items of cost per unit per period or in terms of percentage charge of the
purchase price.

vi. Shortage cost (mostly it is back order cost) is C2or Cs per unit per year.

vii. Lead time is L, expressed in unit of time.

viii. Cycle period in replenishment is t.

ix. Order size is Q.

Determination of EOQ by Trial and Error Method (or Tabular Method) This method involves the
following steps:

Step 1. Select a number of possible lot sizes to purchase.

Step 2. Determine total cost for each lot size chosen.

Step 3. Finally, select the ordering quantity, which minimizes total cost
Deterministic model in the context of inventory management
A deterministic model is a method based on the assumption that all parameters and variables
associated with an inventory stock are known and that there is no uncertainty associated with
demand and replenishment of inventory stock.

On the contrary, the probabilistic models recognise the fact that there is always some degree of
uncertainty associated with the demand pattern and lead times for inventory stock.

Deterministic models of inventory control are used to determine the optimal inventory of a single
item when demand is mostly largely obscure. Under this model, inventory is built up at a
constant rate to meet a determined or accepted demand.

For example, a business has received an order in January for 100 model trains for delivery to be
completed by November for the holiday season. Due to the deadline being 10 months away, the
trains can be produced at a rate of ten per month.

The most common deterministic models used in inventory control today are:

• Economic Ordering Quantity (EOQ) Model

• ABC Analysis
• Inventory Turnover Ratio

Economic Ordering Quantity (EOQ) Model

One of the important decisions to be made in inventory management is how much inventory
stock to actually buy. The EOQ is a company’s optimal order quantity that minimises its total
costs related to ordering, receiving and holding the inventory.

Because of this model’s assumptions that demand, ordering, and holding costs remain constant
over time — it is best to use this model in similar circumstances. EOQ also gives solutions to
other problems like, at what frequency, when and helping determine reserve stock quantities.

ABC Analysis

Also known as selective inventory control, the ABC analysis suggests that inventory values are
not equal, and so divides your inventory stock into three categories A, B and C. The inventory
stock with the highest value are classified as ‘A’ inventory. The items with relatively low value
as ‘B’ inventory and the items which are the least valuable are classified as ‘C’ inventory. The
ABC Analysis allows different inventory management techniques to be applied to different
segments of the inventory in order to increase revenue and decrease costs.

Inventory Turnover Ratio

This inventory ratio establishes the relationship between the average inventory and the cost of
inventory sold during a particular period. This is calculated using the following formula:

Inventory Turnover Ratio = Cost of Goods Sold /Average Inventory

Average inventory is used instead of ending inventory because many businesses merchandise
fluctuates greatly throughout the year. When comparing the current year’s inventory ratio with
those of previous years, it will reveal the following points relating to inventories:

• Fast-Moving Items: High inventory ratio as this has high demand

• Slow-Moving Items: Low turnover ratio, as they have a lower demand they should be
maintained at minimum quantity levels
• Dormant or obsolete Items: Zero demand. These should be liquidated or disposed of as
early as possible to curb further losses