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Lecture 2-Optimization and Short Term Decisin Making

This document discusses optimization and short-term decision making. It defines optimization as a process where a firm intends to maximize profits subject to resource constraints. It identifies the four factors of production and explains the concept of limiting factors. Several examples are provided to illustrate how to identify limiting factors and allocate scarce resources to determine the optimal production mix that maximizes profits. The examples demonstrate how to calculate contribution per unit and contribution per limiting factor to rank products and determine the production plan.

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14 views18 pages

Lecture 2-Optimization and Short Term Decisin Making

This document discusses optimization and short-term decision making. It defines optimization as a process where a firm intends to maximize profits subject to resource constraints. It identifies the four factors of production and explains the concept of limiting factors. Several examples are provided to illustrate how to identify limiting factors and allocate scarce resources to determine the optimal production mix that maximizes profits. The examples demonstrate how to calculate contribution per unit and contribution per limiting factor to rank products and determine the production plan.

Uploaded by

admiremukure
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Optimization and short term decision

making
Objectives of the lecture
Apply limiting factor analysis to determine the
optimum production mix
Definition of optimization
Refers to the process where by a firm intends to
maximize profits subject to resource constrains
The four factor of production are
1land
2 labour
3 capital
4 entrepreneurship
In accordance with theory of constrains, resources are
scarce meaning they are not enough to give us the
desired profit.
Constrains are those limiting factors that are stopping
the firm from achieving the desired goals
Marginal cost
Only variable cost are considered as part of product
cost.
Total cost under marginal cost is given by
Direct material +direct labour +direct expenses
Example 1
The following is a profit and loss of GEE Ltd
Sales $1200
Direct materials $350
Direct wages $200
Fixed production cost $200
Variable production cost $50
Selling and distribution(fixed) $120
Production in units 1200
Determine the total marginal cost
Calculate marginal cost per unit
Contribution
Cal contribution per unit
Identification of Limiting factors
A firm is producing two products P and Q.The
following information relates to the two products
 P Q
Labour hours per unit 1 1.5
Machine hours 2.5 1.8
Raw material per unit 2kg 2 kg
Market demand(units) 15000 10000
Labours hours available is 28000 and machine hours
available is 50000.60 000kgs of raw materials are
available

Required
Identify the limiting factors
ALLOCATION OF SCARCE
RESOURCES
Sometimes called limiting factor analysis.

management is faced with scarcity of a factor of production

(termed a limiting or key factor), it must ensure that the affected


factor of production is used in such a way that profits per unit of
the factor automatically secure maximum profit.
In order to maximise profit, contribution should be maximised. In

order to maximise contribution, products should be produced in


the order of their contribution per limiting factor.
Decision making given 1 limiting factor
A firm is producing two products x and y. The following
information relates to the two products
 X Y
Direct labour s($6 per hour) 1.5hrs 1.8hrs
Raw material ($2 per kg) 2kg 2 kg
Variable cost unit $21 $29.4
Market demand(units) 3000 4500
Selling price per unit $42 $55

12 000kg of raw materials are available


Required
Determine the production plan which maximizes the
profit
Identify limiting factor
Contribution per unit
Contribution per limiting factor
Rank the products
Production plan
Calculate contribution per unit
 X Y
Selling price 42 55
Less marginal cost
Direct labor 9 10.8
Direct material 4 4
Variable cost 21 29.4
Contribution 8 10.8
Decision making given 2 limiting factors
not conflicting
A firm is producing two products x and y .The
following information relates to the two products
 X Y
Direct labour ($2.5 per hour) 2hrs 1.5hrs
Raw material ($1.5 per kg) 2.5kg 2kg
Variable cost unit $9 $7
Market demand(units) 10000 12000
Selling price $30 $25
48000 kgs of raw materials are available
36000 of labour hours are available
Required
Determine the production plan
which maximizes the profit
Identify limiting factor
Contribution per unit
Contribution per limiting factor
Rank the products
Production plan
Decision making given 2 limiting factors
conflicting
A firm is producing two products x and y.The following
information relates to the two products
 X Y
Direct labour ($3 per hour) 1.8hrs 1.3hrs
Raw material ($2 per kg) 2kgs 2 kg
Variable cost unit $9 $7
Market demand (units) 20000 22000
Selling price $40 $42
Machine hours per unit 2 3
60000 kgs of raw materials are available
 80000 of machine hours are available
Required
Determine the production plan which
maximizes the profit
The end

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