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Markov Model

1) A Markov process is a series of experiments performed at regular intervals that always have the same set of possible outcomes called states. 2) The example analyzes a brand switching problem between cereal company K and the competition using a Markov chain model. 3) The transition matrix represents the probability of customers switching between states of buying K's cereal or the competition's cereal each year. 4) Calculations show K's market share increases from an initial 25% to 33.25% after 2 years and 39.2725% after 3 years, demonstrating the Markov chain model's ability to predict changes over time.

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113 views22 pages

Markov Model

1) A Markov process is a series of experiments performed at regular intervals that always have the same set of possible outcomes called states. 2) The example analyzes a brand switching problem between cereal company K and the competition using a Markov chain model. 3) The transition matrix represents the probability of customers switching between states of buying K's cereal or the competition's cereal each year. 4) Calculations show K's market share increases from an initial 25% to 33.25% after 2 years and 39.2725% after 3 years, demonstrating the Markov chain model's ability to predict changes over time.

Uploaded by

katasani likhith
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Markov Model

Matrix Multiplication
• Matrices can b multiplied only if the number of columns in
the first matrix equals the number of rows in the second
matrix.
•
Markov Process
• Markov process is a series of experiments which are performed at
regular time intervals and which always have the same set of
outcomes. These outcomes are called states and the outcome of the
current experiment is called the current state.
• Markov processes
• Consider the following problem: company K, the
manufacturer of a breakfast cereal, currently has some
25% of the market. Data from the previous year indicates

Market
that 88% of K's customers remained loyal that year, but
12% switched to the competition. In addition, 85% of the
competition's customers remained loyal to the
competition but 15% of the competition's customers
switched to K. Assuming these trends continue determine

Share
K's share of the market:
• in 2 years; and
• in the long-run.

Analysis
• This problem is an example of a brand switching problem
that often arises in the sale of consumer goods.
• To solve this problem, we make use of Markov
chains or Markov processes (which are a special type
of stochastic process). The procedure is given below.
Solution
• Observe that, each year, a customer can either be buying K's cereal or
the competition's. Hence we can construct a diagram as shown below
where the two circles represent the two states a customer can be in
and the arcs represent the probability that a customer makes
a transition each year between states. Note the circular arcs
indicating a "transition" from one state to the same state. This
diagram is known as the state-transition diagram (and note that all
the arcs in that diagram are directed arcs).
DIAGRAM
• Given that diagram we can construct the transition matrix (usually
denoted by the symbol P) which tells us the probability of making a
transition from one state to another state. Letting:
• state 1 = customer buying K's cereal and
• state 2 = customer buying competition's cereal
• we have the transition matrix P for this problem given by
Note here that the sum of the elements in each row of the transition matrix is one.
Note also that the transition matrix is such that the rows are "From" and the columns
are "To" in terms of the state transitions.
• Now we know that currently K has some 25% of the market. Hence
we have the row matrix representing the initial state of the system
given by:
• We usually denote this row matrix by s1 indicating the state of the
system in the first period (years in this example). Now Markov theory
tells us that, in period (year) t, the state of the system is given by the
row matrix st where:
• We have to be careful here as we are doing matrix multiplication and
the order of calculation is important (i.e. st-1(P) is not equal to (P)st-1 in
general). To find st we could attempt to raise P to the power t-1
directly but, in practice, it is far easier to calculate the state of the
system in each successive year 1,2,3,...,t.
• We already know the state of the system in year 1 (s1) so the state of
the system in year two (s2) is given by:
• Note that this result makes intuitive sense, e.g. of the 25% currently
buying K's cereal 88% continue to do so, whilst of the 75% buying the
competitor's cereal 15% change to buy K's cereal - giving a (fractional)
total of (0.25)(0.88) + (0.75)(0.15) = 0.3325 buying K's cereal.
• Hence in year two 33.25% of the people are in state 1 - that is buying
K's cereal. Note here that, as a numerical check, the elements of
st should always sum to one.
• In year three the state of the system is given by:
Hence in year three 39.2725% of the people are buying K's cereal.

Now it is plainly nonsense to suggest that we can predict to four decimal places K's market share in two years time -
but the calculation has enabled us to get some insight into the change in K's share of the market over time that
we otherwise might not have had.

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