Balotcopo, Arabella A.

BSMA – 2101

LESSON 1: Introduction to Management Science

Management Science

- Is the application of a scientific approach to

solving management problems in order to help
managers make better decisions.
- Is a recognized and established discipline in
business. The applications of management
science techniques are widespread, and they
have been frequently credited with increasing
the efficiency and productivity of business firms.
- The objective of management science is to solve Figure 1.1
the decision-making problems that confront and
confound managers in both the public and the
private sector by developing mathematical
models of those problems. These models have Management Science Process/Method
traditionally been solved with various 1. Observation
mathematical techniques, all of which lend
themselves to specific types of problems. - the first step in the management
- It is common referred to as operations science process is the identification of a problem
research, quantitative methods, quantitative that exists in the system (organization). The
analysis, decision sciences, and business system must be continuously and closely
analytics which is part of the fundamental observed so that problems can be identified as
curriculum of most programs in business. soon as they occur or are anticipated.
- Management science techniques can be applied
to solve problems in different types of - a management scientist, a person
organizations, including services, government, skilled in the techniques of management science
military, business and industry, and health care. and trained to identify problems, who has been
hired specifically to solve problems using
management science techniques.
As you proceed through the various management science - What is the situation all about?
models and techniques contained in this text, you should
remember several things. 2. Definition of the Problem
- once it has been determined that a
1. First, most of the examples presented in this text problem exists, the problem must be clearly and
are for business organizations because concisely defined. Improperly defining a problem
businesses represent the main users of can easily result in no solution or an
management science. inappropriate solution.
2. Second, in this text all of the modeling - Therefore, the limits of the problem
techniques and solution methods are and the degree to which it pervades other units
mathematically based. of the organization must be included in the
3. Finally, as the various management science problem definition. Because the existence of a
techniques are presented, keep in mind that problem implies that the objectives of the firm
management science is more than just a are not being met in some way, the goals (or
collection of techniques. Management science objectives) of the organization must also be
also involves the philosophy of approaching a clearly defined. A stated objective helps to focus
problem in a logical manner (i.e., a scientific attention on what the problem actually is.
approach). - What is the problem?
- What do we want to achieve?

The Management Science Approach to Problem 3. Model Contruction

Solving - A management science model is an
abstract representation of an existing problem
• Management Science encompasses a logical,
solution.
systematic approach to problem solving, which
closely parallels what is known as the scientific - It can be in the form of a graph or
method for attacking problems. chart, but most frequently a management science
• This approach, as shown in Figure 1.1 follows a model consists of a set of mathematical relationships.
generally recognized and ordered series of These mathematical relationships are made up
steps: of numbers and symbols.
1. Observation
2. Definition of the Problem As an example, consider a business firm that sells a
3. Model Construction product. The product costs $5 to produce and sells for $20.
4. Model Solution A model that computes the total profit that will accrue from
5. Implementation of Solution Results. the items sold is:

z= $20x-$5x
• Variable Break-even Analysis

- is used because no set numeric value - is a modeling technique to determine the number
has been specified for these items. of units to sell or produce that will result in zero
profit.
- the symbol x and z are variables. - also called profit analysis.
- The purpose of break-even analysis is to
- The number of units sold, x, and the
determine the number of units of a product (i.e.,
profit, z, can be any amount (within limits); they
the volume) to sell or produce that will equate
can vary.
total revenue with total cost. The point where
- Z is a dependent variable because total revenue equals total cost is called the
its value is dependent on the number of units break-even point, and at this point profit is zero.
sold; X is an independent variable because the - The break- even point gives a manager a point
number of units sold is not dependent on of reference in determining how many units will
anything else. be needed to ensure a profit.

• Parameters

- are constant values that are generally Components of Break-Even Analysis

coefficients of the variables (symbols) in an The three components of break-even analysis are:
equation.
1. Volume
- usually remain constant durin the
process of solving a specific problem. - is the level of sales or production by
a company. It can be expressed as the number
• The equation as a whole is known as functional of units (i.e., quantity) produced and sold, as the
relationship (also called function and dollar volume of sales, or as a percentage of
relationship). The terms is derived form the fact total capacity available.
that profit, Z, is a function of the number of units
sold, x, and the equation relates profit to units 2. Cost
sold.
- Two types of cost are typically
4. Model Solution incurred in the production of a product: fixed
costs and vari- able costs.
- Once models have been constructed
in management science, they are solved using • Fixed costs
the man- agement science techniques - are generally independent of the
presented in this text. volume of units produced and sold.
- That is, fixed costs remain constant,
- A management science solution regardless of how many units of product are
technique usually applies to a specific type of produced within a given range.
model. Thus, the model type and solution - can include such items as rent on
method are both part of the management plant and equipment, taxes, staff and
science technique. We are able to say that a management salaries, insurance, advertising,
model is solved because the model represents a depreciation, heat and light, and plant
problem. When we refer to model solution, we maintenance. Taken together, these items result
also mean problem solution. in total fixed costs.

5. Implementation
• Variable costs
- is the actual use of the model once
- are determined on a per-unit basis.
it has been developed or the solution to the
Thus, total variable costs depend on the number
problem the model was developed to solve. This
of units produced. Variable costs include such
is a critical but often overlooked step in the
items as raw materials and resources, direct
process. It is not always a given that once a
labor, packaging, material handling, and freight.
model is developed or a solution found, it is
- Total variable costs are a function of
automatically used.
the volume and the variable cost per unit.
- Frequently the person responsible for
putting the model or solution to use is not the
• Total Cost
same person who developed the model, and
thus the user may not fully understand how the - The total cost of an operation is
model works or exactly what it is supposed to do. computed by summing total fixed cost and total
Individuals are also sometimes hesitant to variable cost.
change the normal way they do things or to try
new things. 3. Profit
- In this situation, the model and solu- - is the difference between total
tion may get pushed to the side or ignored revenue and total cost.
altogether if they are not carefully explained and
their benefit fully demonstrated. If the
management science model and solution are not
implemented, then the effort and resources used
in their development have been wasted.
Break-even Point

- is the volume (v) that equates total revenue with

total cost where profit is zero.

- In Figure 1.2, the fixed cost, of, has a constant

value of $10,000, regardless of the volume. The
total cost line, TC, represents the sum of variable
cost and fixed cost. The total cost line increases
because variable cost increases as the volume
increases. The total revenue line also increases
as volume increases, but at a faster rate than
total cost. The point where these two lines
intersect indicates that total revenue equals total
cost. The volume, v, that corresponds to this
point is the break-even volume. The break-even
volume in Figure 1.2 is 666.7 pairs of denim
jeans.

Graphical Solution

- It is possible to represent many of the LESSON 2: Decision Analysis

management science models in this text
graphically and use these graphical models to Decision Making Categories:
solve problems.
- Graphical models also have the advantage of 1. Decision Making Without Probabilities
provid- ing a “picture” of the model that can - uncertain about what will happen in
sometimes help us understand the modeling the future.
process better than mathematics alone can.
2. Decision Making With Probabilities

Computer Solution - certain in what will happen in the

future.
- Excel spreadsheets have become an
increasingly important management science tool
because of their ability to support numerous
software add-ins for various management Decision Making With Probabilities
science techniques, their ability to effectively
convey complex models to clients, their general 1. Maximax Criterion
availability on virtually every computer, their - the attitude of the decision-maker is
flexibility and ease of use, and the fact that they optimistic.
are inexpensive. - the decision maker selects the
- As a result, spreadsheets are used for the decision that will result in the maximum of the
application of management science techniques maximum payoffs.
to a wide variety of different problems across - The decision maker assumes that the
many diverse organizations. most favorable state of nature for each decision
alternative will occur. Thus, for example, using
this criterion, the investor would optimistically
assume that good economic conditions will pre-
Management Science Modeling Techniques vail in the future.

This text focuses primarily on two of the five 2. Maximin Criterion

steps of the management science process described in - the attitude of the decision-
Figure 1.1—model construction and solution. These are maker is pessimistic.
the two steps that use the manage- ment science - the decision maker selects the
techniques. In a textbook, it is difficult to show how an decision that will reflect the maximum of the
unstructured real-world problem is identified and defined minimum payoffs.
because the problem must be written out. However, once - For each decision alternative, the
a problem statement has been given, we can show how a decision maker assumes that the minimum
model is constructed and a solution is derived. The payoff will occur. Of these minimum payoffs, the
techniques presented in this text can be loosely classified maximum is selected.
into four categories, as shown in Figure 1.6.
 3. Minimax Regret Criterion Example of Decision Tree

- With this decision criterion, the

decision maker attempts to avoid regret by
selecting the decision alternative that
minimizes the maximum regret.

- Regret is the difference between the

payoff from the best decision and all other
decision payoffs.

4. Hurwicz

- criterion strikes a compromise

between the maximax and maximin
criteria.

- The principle underlying this

decision criterion is that the decision maker is
neither totally optimistic (as the maximax
criterion assumes) nor totally pessimistic (as the
maximin criterion assumes).
LESSON 3: Linear Programming
- With the Hurwicz criterion, the
Linear Programming
decision payoffs are weighted by a coefficient of
optimism, a measure of the decision maker’s - mathematical technique to use in solving
optimism. allocation of resources such as: time, labor,
energy, material.
- multiplies the best payoff by a,
- is a model that consists of linear relationships
the coefficient of optimism, and the worst payoff
representing a firm’s decision(s), given an
by 1 - a, for each decision, and the best result is
objective and resource constraints.
selected.
- The objectives of a business frequently are to
5. Equal Likelihood / Laplace Criterion maximize profit or minimize cost.

- weights each state of nature equally,

thus assuming that the states of nature are
Model Formulation
equally likely to occur.
A linear programming model consists of certain common
components and characteristics. The model components
Decision Making With Probabilities include decision variables, an objective function, and
model constraints.
1. Expected Value

- the decision maker must first

estimate the probability of occurrence of each 1. Decision Variables
state of nature. Once these estimates have been - are mathematical symbols that
made, the expected value for each decision represent levels of activity by the firm.
alternative can be computed.
2. Objective Function
- the expected value is computed by
multiplying each outcome (of a decision) by the - is a linear mathematical relationship
probability of its occurrence and then summing that describes the objective of the firm in terms
these products. of the decision variables. The objective function
always consists of either maximizing or
2. Expected Opportunity Loss minimizing some value (e.g., maximize the profit
- the expected value of regret for each or minimize the cost of producing radios).
decision.
- To use this criterion, we multiply the 3. Model Constraints
probabilities by the regret (i.e., opportunity loss)
- are also linear relationships of the
for each decision outcome rather than
decision variables; they represent the
multiplying the decision outcomes by the
restrictions placed on the firm by the operating
probabilities of their occurrence, as we did for
environment.
expected monetary value.
- The restrictions can be in the form of
limited resources or restrictive guidelines.
Expected Value of Perfect Information (EVPI)
- The actual numeric values in the
- has some maximum value that represents the objective function and the constraints are
limit of what the decision maker would be willing parameters.
to spend. This value of information can be
- Also includes non-negativity
computed as an expected value.
constraints which is the restriction to the
- is the maximum amount a decision maker would
decision variables to zero or positive values.
pay for additional information.
Feasible solution Two Types of Distribution Model

- does not violate any of the constraints given. 1. Transportation

2. Assignment

Infeasible solution or problem

- violates at least one of the constraints.

Optimal solution point

- is the last point the objective function touches as

it leaves the feasible solution area.

Two Ways of Computing the Maximization Model

1. Graphical Analysis
2. Computer Solution

LESSON 4: Transportation Problem

Transportation Problem

- In a transportation problem, items are allocated

from sources to destinations at a minimum cost.

Components

1. Sources – Supply
2. Destination – Demand

Transportation Model

- The transportation model is formulated for a

class of problems with the following unique
characteristics: (1) A product is transported from
a number of sources to a number of destinations
at the minimum possible cost; and (2) each
source is able to supply a fixed number of units
of the product, and each destination has a fixed
demand for the product.
- Although the general transportation model can
be applied to a wide variety of problems, it is this
particular application to the transportation of
goods that is most familiar and from which the
problem draws its name.

Balanced transportation model

- supply equals demand, all constraints are

equalities.

Unbalanced transportation model

- supply is greater than demand or demand is

greater than supply.

Initial Feasible Solution

1. Northwest Corner Method

2. Least Cost Method
3. Vogel’s Approximation Model