Programming and

Economic Analysis
BY
STEPHEN L. KIRAMA (PHD)
EC 228. 2017
Why this Topic?
LEARNING OBJECTIVES
 1. Understand basic assumptions and properties of
linear programming (LP).
 2. Understand formulation of LP Model
 3. Understand different solution procedures for LP
problems
 4. Understand the Duality Problem
 5. Understand special situations such as redundancy,
infeasibility, unboundedness, and alternate
optimal solutions in LP problems.
Topic Coverage
Introduction to Linear Programming
Formulation of LP Model
Estimation Approaches for the LP
Model: Solution to LP Problems
Duality Problems
Uses of LP in Economics
Main Reading Sources
 Chiang, A.C (1984) Fundamental Methods of
Mathematical Economics, 3rd Edition, McGraw-Hill
 Loomba, N.P (1978) Linear Programming: An
Introductory Analysis, McGraw-Hill
 Sydsaster, K. and P. Hamond (1994), Mathematics for
Economists, Academic Book, North Holland, Amsterdam
 Search Engines such as www.google.com
Topic Coverage
Introduction
Formulation of LP Model
Estimation Approaches for the LP
Model
Duality Problems
Uses of LP in Economics
 INTRODUCTION
 Economic Decision (both managerial and financial) in
many organizations involve trying to make most effective
use of resources (machinery, labor, money, time,
warehouse space, and raw materials). WHY?
 Produce products - such as computers, automobiles, or clothing or
 Provide services - such as package delivery, health services, or investment
decisions.

 To solve problems of resource allocation one may use

mathematical programming.
 Introduction
 Mathematical programming is used to find the best or
optimal solution to a problem that requires a decision or set
of decisions about how best to use a set of limited
resources to achieve a state goal of objectives.

 Steps involved in mathematical programming

 Conversion of stated problem into a mathematical model that
abstracts all the essential elements of the problem.

 Exploration of different solutions of the problem.

 Finding out the most suitable or optimum solution.

 Linear programming requires that all the mathematical

functions in the model be linear functions.
What is Linear Programming?
 LINEAR PROGRAMMING
Linear programming (LP) is the most common type of
mathematical programming.
LP seeks to maximize or minimize a linear objective
function subject to a set of linear constraints
LP assumes all relevant input data and parameters are
known with certainty (deterministic models).
Computers play an important role in the solution of LP
problems
© 2002 Prentice-Hall, Inc 10 Ch 2-10
LINEAR PROGRAMMING

 Linear programming is an aid to decision making in

business, industry and government.
 It includes the determination of facility or machine
scheduling, distribution of commodities, determination of
optimum product mix and allocation of labor and other
resources
 Linear programming is a method of determining an
optimum program of interdependent activities in view of
available resources
 Linearity implies that all relationships involved in the
particular problem which can be solved by this method
are linear
11
WHEN DOES LINEAR
PROBLEM ARISES?
LINEAR PROGRAMMING

 A linear programming problem arises whenever two

or more candidates or activities are competing for
limited resources and when it can be assumed that all
relationships with the problem are linear
 A linear equation is a relationship between quantities in
which, when reduced to its simplest form, the sum of
the exponents of the variables in anyone term adds
up to 1.
 For example Y = 4 + 2X is a linear equation relating the
variables X and Y.
 When we say the relationship between Y and X is linear
we mean that the additions of the same magnitude to
the one have a constant effect on the other
 WHAT ARE THE
REQUIREMENTS FOR LP?
 REQUIREMENTS OF A LINEAR
PROGRAMMING PROBLEM
 All LP problems have FOUR properties in common:

1. LP problems seek to maximize or minimize some

quantity (usually profit or cost).

 We refer to this property as the objective function of an LP

problem.
 The major objective of a typical firm is to maximize dollar profits in
the long run.
 In the case of a trucking or airline distribution system, the
objective might be to minimize shipping costs.
REQUIREMENTS OF A LINEAR PROGRAMMING
PROBLEM

2. The presence of restrictions, or constraints, limits the

degree to which we can pursue our objective.

 For example, deciding how many units of each product in a

firm’s product line to manufacture is restricted by available labor and
machinery.

 We want, therefore, to maximize or minimize a quantity (the

objective function) subject to limited resources (the constraints).
REQUIREMENTS OF A LINEAR PROGRAMMING
PROBLEM

3. There must be alternative courses of action to choose

from.
 For example, if a company produces three different
products, management may use LP to decide how to
allocate among them its limited production resources (of
labor, machinery, and so on).
 If there were no alternatives to select from, we would not
need LP
 Why?
REQUIREMENTS OF A LINEAR PROGRAMMING
PROBLEM

4. The objective and constraints in linear programming

problems must be expressed in terms of linear equations
or inequalities.
minimize z = 3x1 + 8x2
subject to
x1 + x2 ≥ 8
2x1 −3x2 ≤ 0
x2 ≥ 9
x1, x2 ≥ 0
Topic Coverage
Introduction
Formulation of LP Model
Estimation Approaches for the LP
Model
Duality Problems
Uses of LP in Economics
Formulation of LP Model

FORMULATING LINEAR
PROGRAMMING PROBLEMS
FORMULATING LINEAR PROGRAMMING
PROBLEMS

 One of the most common linear programming applications

is the product-mix problem.
 Two or more products are usually produced using limited
resources.
 The company would like to determine how many units
of each product it should produce to maximize overall
profit given its limited resources.
 Let’s look at an example from Sony Electronics
Company.
 The Sony Electronics Company

 The Sony Electronics Company produces two products:

 (1) the Sony Walkman, a portable CD/DVD player, and
 (2) the Sony Watch-TV, a wristwatch-size internet-connected color
television.
 The production process for each product is similar in that
both require a certain number of hours of electronic work
and a certain number of labor-hours in the assembly
department.
 Each Walkman takes 4 hours of electronic work and 2
hours in the assembly shop. Each Watch-TV requires 3
hours in electronics and 1 hour in assembly.
 The Sony Electronics Company

 During the current production period, 240 hours of

electronic time are available, and 100 hours of
assembly department time are available.
 Each Walkman sold yields a profit of $7; each Watch-TV
produced may be sold for a $5 profit.
 Sony’s problem is to determine the best possible
combination of Walkmans and Watch-TVs to
manufacture to reach the maximum profit.
 This product-mix situation can be formulated as a linear
programming problem.
PLEASE PROCEED TO
FORMULATE THE LP PROBLEM
 The Sony Electronics Company

 create the LP objective function in terms of X1 and X2:

 Maximize profit = $7X1 + $5X2
 next step is to develop mathematical relationships to
describe the two constraints in this problem. One general
relationship is that the amount of a resource used is to
be less than or equal to (≤) the amount of resource
available
 First constraint:
 Electronic time used is ≤ Electronic time available.
 4X1 + 3X2 ≤ 240 (hours of electronic time)
 Second constraint:
 Assembly time used is ≤ Assembly time available.
 2X1 + 1X2 ≤ 100 (hours of assembly time)
 The Sony Electronics Company

 Both these constraints represent production capacity

restrictions and, of course, affect the total profit.
 For example, Sony Electronics cannot produce 70
Walkmans during the production period because if X1 = 70,
both constraints will be violated.
 It also cannot make X1 = 50 Walkmans and X2 = 10 Watch-
TVs.
 This constraint brings out another important aspect of linear
programming; that is, certain interactions will exist between
variables.
 The more units of one product that a firm produces, the
fewer it can make of other products.
 The Sony Electronics Company
 X1 = number of Walkman to be produced
 X2 = number of Watch-TVs to be produced

Hours Required for 1 Unit

Department Walkman (X1) Watch-TV (X2) Available

Weekly Hours

Electronic 4 3 240

Assembly 2 1 100

Profit per Unit 7 5

in US $
Required

Required:
a) Use graphical Solution Method to find the profit
maximization output for the Sony Electronics
b) Use Corner Point Solution Method to find the profit
maximization output for the Sony Electronics
LP MODEL COMPONENTS AND
FORMULATION
 LP MODEL COMPONENTS AND
FORMULATION
 Decision variables - mathematical symbols representing
levels of activity of a firm mathematical symbols
representing levels of activity of a firm.
 Objective function - a linear mathematical relationship
describing an objective of the firm, in terms of decision
variables, that is to be maximized or minimized
 Constraints - restrictions placed on the firm by the
operating environment stated in linear relationships of
the decision variables.
 Parameters - numerical coefficients and constants used
in the objective function and constraint equations.
DEVELOPMENT OF A LP MODEL
 LP applied extensively to problems areas -
 medical, transportation, operations,
 financial, marketing, accounting,
 human resources, and agriculture.

 Development and solution of all LP models can be

examined in a four step process:
(1) identification of the problem as solvable by LP
(2) formulation of the mathematical model.
(3) solution.
(4) interpretation.
BASIC STEPS OF DEVELOPING A LP
MODEL
Formulation
 Process of translating problem scenario into simple LP model
framework with a set of mathematical relationships.
Solution
 Mathematical relationships resulting from formulation process are
solved to identify optimal solution.
Interpretation and What-if Analysis
 Problem solver or analyst works with the manager to
o interpret results and implications of problem solution.
o investigate changes in input parameters and model variables and impact on problem
solution results.
LINEAR EQUATIONS AND
INEQUALITIES
This is a linear equation:
2A + 5B = 10
This equation is not linear:
2A2 + 5B3 + 3AB = 10
LP uses, in many cases, inequalities like:
A+BC or A+BC
 BASIC ASSUMPTIONS OF A LP MODEL

1. Conditions of certainty exist.

2. Proportionality in objective function and constraints (1
unit – 3 hours, 3 units- 9 hours).
3. Additivity (total of all activities equals sum of individual
activities).
4. Divisibility assumption that solutions need not necessarily
be in whole numbers (integers); ie.decision variables can
take on any fractional value.
 FORMULATING A LP PROBLEM
A common LP application is product mix problem.
 Two or more products are usually produced using limited resources - such
as personnel, machines, raw materials, and so on.

Profit firm seeks to maximize is based on profit

contribution per unit of each product.
 Firm would like to determine -
 How many units of each product it should produce in order to maximize
overall profit given its limited resources.
 The Linear Programming Model (1)
Let: X1, X2, X3, ………, Xn = decision variables
Z = Objective function or linear function

Requirement: Maximization of the linear function Z.

Z = c1X1 + c2X2 + c3X3 + ………+ cnXn …..Eq (1)
subject to the following constraints:

…..Eq (2)

where aij, bi, and cj are given constants.

 The Linear Programming Model (2)
 The linear programming model can be written in more
efficient notation as:

…..Eq (3)

The decision variables, xI, x2, ..., xn, represent levels of n

competing activities.
 Examples of LP Problems (1)
1. A Product Mix Problem

 A manufacturer has fixed amounts of different resources

such as raw material, labor, and equipment.

 These resources can be combined to produce any one of

several different products.

 The quantity of the ith resource required to produce one unit

of the jth product is known.

 The decision maker wishes to produce the combination of

products that will maximize total income.
 Examples of LP Problems (2)
2. A Blending Problem

 Blending problems refer to situations in which a number of

components (or commodities) are mixed together to yield
one or more products.

 Typically, different commodities are to be purchased. Each

commodity has known characteristics and costs.

 The problem is to determine how much of each commodity

should be purchased and blended with the rest so that the
characteristics of the mixture lie within specified bounds
and the total cost is minimized.
 Examples of LP Problems (3)
3. A Production Scheduling Problem

 A manufacturer knows that he must supply a given number

of items of a certain product each month for the next n
months.
 They can be produced either in regular time, subject to a
maximum each month, or in overtime. The cost of
producing an item during overtime is greater than during
regular time. A storage cost is associated with each item
not sold at the end of the month.
 The problem is to determine the production schedule that
minimizes the sum of production and storage costs.
 Examples of LP Problems (4)
4. A Transportation Problem

 A product is to be shipped in the amounts al, a2, ..., am from

m shipping origins and received in amounts bl, b2, ..., bn at
each of n shipping destinations.

 The cost of shipping a unit from the ith origin to the jth
destination is known for all combinations of origins and
destinations.

 The problem is to determine the amount to be shipped from

each origin to each destination such that the total cost of
transportation is a minimum.
 Examples of LP Problems (5)
5. A Flow Capacity Problem

 One or more commodities (e.g., traffic, water, information,

cash, etc.) are flowing from one point to another through a
network whose branches have various constraints and flow
capacities.

 The direction of flow in each branch and the capacity of

each branch are known.

 The problem is to determine the maximum flow, or capacity

of the network.
 Developing LP Model (1)
 The variety of situations to which linear programming has
been applied ranges from agriculture to zinc smelting.

 Steps Involved:

 Determine the objective of the problem and describe it by a

criterion function in terms of the decision variables.
 Find out the constraints.
 Do the analysis which should lead to the selection of values
for the decision variables that optimize the criterion function
while satisfying all the constraints imposed on the problem.
 Developing LP Model (2)
Example: Product Mix Problem
The Ngareni Company produces two products: I and II. The raw material
requirements, space needed for storage, production rates, and selling
prices for these products are given in Table 1.

The total amount of raw material available per day for both products is
15751b. The total storage space for all products is 1500 ft2, and a
maximum of 7 hours per day can be used for production.
 Developing LP Model (3)
Example Problem
All products manufactured are shipped out of the storage area at the end
of the day. Therefore, the two products must share the total raw material,
storage space, and production time. The company wants to determine
how many units of each product to produce per day to maximize its
total income.

Solution
• The company has decided that it wants to maximize its sale income,
which depends on the number of units of product I and II that it
produces.
• Therefore, the decision variables, x1 and x2 can be the number of units
of products I and II, respectively, produced per day.
 Developing LP Model (4)
• The object is to maximize the equation:
Z = 13x1 + 11x2
subject to the constraints on storage space, raw materials, and
production time.

• Each unit of product I requires 4 ft2 of storage space and each unit of
product II requires 5 ft2. Thus a total of 4x1 + 5x2 ft2 of storage space is
needed each day. This space must be less than or equal to the
available storage space, which is 1500 ft2. Therefore,
4X1 + 5X2  1500
• Similarly, each unit of product I and II produced requires 5 and 3 1bs,
respectively, of raw material. Hence a total of 5xl + 3x2 Ib of raw
material is used.
 Developing LP Model (5)
• This must be less than or equal to the total amount of raw material
available, which is 1575 Ib. Therefore,
5x1 + 3x2  1575
• Prouct I can be produced at the rate of 60 units per hour. Therefore, it
must take I minute or 1/60 of an hour to produce I unit. Similarly, it
requires 1/30 of an hour to produce 1 unit of product II. Hence a total of
x1/60 + x2/30 hours is required for the daily production. This quantity
must be less than or equal to the total production time available each
day. Therefore,
x1 / 60 + x2 / 30  7
or x1 + 2x2  420
• Finally, the company cannot produce a negative quantity of any
product, therefore x1 and x2 must each be greater than or equal to zero.
 Developing LP Model (6)
• The linear programming model for this example can be summarized as:

…..Eq (4)
Questions/Queries?