Optimization Techniques and New Management Tools

Optimization
Techniques
Prepared by Robert F. Brooker, Ph.D.
Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.
Slide 1
Tujuan perusahaan adalah:

memaksimumkan profit
memaksimumkan value of the
firm atau Meminimumkan cost
berdasarkan constraint yang
ada
Slide 2
The objective of a business firm is to

maximize profits or the value of the firm
or to minimize costs, subject to some
constraints.
Techniques or methods for maximizing
or minimizing the objective function of
the firm are very important to be
described.
Economic relationships can be
expressed in the form of equations,
tables or graphs.
Slide 3
Economic Optimization
Process
Optimal Decisions
Best decision helps achieve objectives
most efficiently.
Maximizing the Value of the Firm

Value maximization requires serving
customers efficiently.
What do customers want?
How can customers best be served?
Steps in Optimization
Define an objective mathematically as a
function of one or more choice variables
Define one or more constraints on the
values of the objective function and/or
the choice variables
Determine the values of the choice
variables that maximize or minimize the
objective function while satisfying all of
the constraints
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.
Slide 5
Optimization Techniques
Methods for maximizing or minimizing
an objective function
Examples
Consumers maximize utility by purchasing
an optimal combination of goods
Firms maximize profit by producing and
selling an optimal quantity of goods
Firms minimize their cost of production by
using an optimal combination of inputs
Slide 6
Maximizing the Value of the Firm

The value of the firm is impacted by
Total Revenue.... which is a function of marketing
strategies, pricing and distribution policies,
nature of competition....
Total Cost .... which is a function of the price and
availability of inputs, alternative production
methods...
Review of Basic Microeconomics

What is the objective of the firm?
PROFIT MAXIMIZATION
Profit = Total Revenue Total Cost
To understand profit, you need to understand
both revenue and cost. Understanding total
revenue begins with the Law of Demand.
Understanding total cost begins with the Law of
Diminishing Returns.
Review of Basic Microeconomics
The Law of Diminishing Returns As a variable input

increases, holding all else constant, the rate of increase in
output will eventually diminish.
OR..... As a firm increases its employment of labor, holding
capital and all other factors constant, the productivity of
each worker hired will eventually diminish.
WHY? Each additional worker has less and less capital to
work with.
The Law of Diminishing Returns is the foundation from
which we build the relationship between output and total
cost, marginal cost, and average cost.
Expressing Economic
Relationships
Equations:
Tables:
TR = 100Q - 10Q2
Q
TR
0
0
1
90
2
3
4
5
6
160 210 240 250 240
TR
300
250
Graphs:
200
150
100
50
0
0
7
Q
Slide 10
Total, Average, and Marginal

Revenue
TR = PQ
AR = TR/Q
MR = TR/Q
Slide 11
Slide 12
Total Revenue
Average and
Marginal Revenue
Slide 13
Total, Average, and

Marginal Cost
AC = TC/Q
MC = TC/Q
Q
0
1
2
3
4
5
TC AC MC
20 140 140 120
160 80 20
180 60 20
240 60 60
480 96 240
Slide 14
Slide 15
Profit Maximization
Q
0
1
2
3
4
5
TR
0
90
160
210
240
250
TC Profit
20
-20
140
-50
160
0
180
30
240
0
480 -230
Slide 16
Profit Maximization
($) 300
TC
The firm maximizes total
profit at Q=3, where thhe
positive difference between
TR and TC is greatest,
MR=MC, and the
function is at its highest
point
240
TR
180
MC
120
60
MR
0
60
30
0
-30
Profit
-60
Slide 17
Geometric Relationships
The slope of a tangent to a total curve
at a point is equal to the marginal value
at that point
The slope of a ray from the origin to a
point on a total curve is equal to the
average value at that point
Slide 18
Geometric Relationships
A marginal value is positive, zero, and
negative, respectively, when a total
curve slopes upward, is horizontal, and
slopes downward
A marginal value is above, equal to, and
below an average value, respectively,
when the slope of the average curve is
positive, zero, and negative
Slide 19
Optimization analysis can be conducted much more

efficiently and precisely with differential calculus,
with relies on concept derivative.
Concept of the Derivative

The concept of derivative is closely related to the concept
of the margin. For example when output increase from 2
to 3 unit and TR increases from $160 t0 $210 then MR =
$50/1 = $ 50
The derivative of Y with respect to X is equal to the

limit of the ratio Y/X as X approaches zero.
dY
Y
lim
dX X 0 X
Slide 20
Rules of Differentiation
Constant Function Rule: The derivative
of a constant, Y = f(X) = a, is zero for all
values of a (the constant).
Y f (X ) a
dY
0
dX
If Y = 2, dX/dY =0
Slide 21
Power Function Rule: The derivative of
a power function, where a and b are
constants, is defined as follows.
Y f (X ) aX b
dY
b a X b 1
dX
Y=4X, dY/dX = 8X
Slide 22
Sum-and-Differences Rule: The derivative
of the sum or difference of two functions
U and V, is defined as follows.
U g( X )
V h( X )
dY dU dV
dX dX dX
Y U V
Y = 2X + X, dY/dX = 2 + 2X
Slide 23
Product Rule: The derivative of the
product of two functions U and V, is
defined as follows.
U g( X )
V h( X )
dY
dV
dU
U
V
dX
dX
dX
Y U V
Y=2X(3-2X), U=2X, V=3-2X
dY/dX=2x(dV/dX)+(3-2X)(dU/dX)
=2X(-2)+(3-2X)(4x)
=-4X+12X-8X = 12X-12X
Slide 24
Quotient Rule: The derivative of the
ratio of two functions U and V, is
defined as follows.
U g( X )
dY
dX
V dU
V h( X )
dX
U dV
dX
U
Y
V
Y=(3-2X)/2X, U=3-2X, V=2X
dY/dX=(4X-12X)/(2X)= (4X12X)/4X(X) = 4X(x-3)/4X(X)
dY/dX= (X-3)/X
Slide 25
Chain Rule: The derivative of a function
that is a function of X is defined as follows.
Y f (U )
dY dY dU
dX dU dX
U g(X )
Y=(3X+10), U=3X+10, Y =U
dY/dU = 3U and dU/dX = 6X
dY/dX = 3(3X+10)(6X)
=3(9X4+60X+100)(6X)
Slide 26
Slide 27
Optimization With Calculus

Optimization often requires finding the maximum or the
minimum value of the function.
Find X such that dY/dX = 0

Second derivative rules:
If d2Y/dX2 > 0, then X is a minimum.
If d2Y/dX2 < 0, then X is a maximum.
Slide 28
Example 1
Given the following total revenue (TR)
function, determine the quantity of
output (Q) that will maximize total
revenue:
TR = 100Q 10Q2
dTR/dQ = 100 20Q = 0
Q* = 5 and d2TR/dQ2 = -20 < 0
Slide 29
Example 2
Given the following total revenue (TR)
function, determine the quantity of
output (Q) that will maximize total
revenue:
TR = 45Q 0.5Q2
dTR/dQ = 45 Q = 0
Q* = 45 and d2TR/dQ2 = -1 < 0
Slide 30
For example, for total-revenue function:

TR = 100Q 10Q
d(TR)/dQ = 100 20 Q, setting
d(TR)/dQ = 0
100 20 Q = 0 20 Q = 100, Q = 5
d(TR)/d(Q) = - 20, d(TR)/d(Q) < 0 ,
maka TR mencapai maximum pada Q=5
**Another example: TR = 45Q -0.5Q,
d(TR)/d(Q)= 45 Q, d(TR)/dQ = - 1
TR mencapai maximum
pada Q = 45
Example 3
Given the following marginal cost
function (MC), determine the quantity of
output that will minimize MC:
MC = 3Q2 16Q + 57
dMC/dQ = 6Q - 16 = 0
Q*= 2.67 and d2MC/dQ2 = 6 > 0
Slide 32
****TR = 45Q - 0.5Q

TC = Q - 8Q + 57Q + 2
= TR TC
45 Q 0.5 Q - (Q - 8Q + 57Q + 2) = - Q + 7.5Q - 12Q 2
d/dQ = - 3Q + 15 Q 12 = 0, (- 3Q + 3)(Q 4) = 0, Q1 = 1, Q2 =
4
d/dQ = - 6 Q + 15
at Q =1 d/dQ = 9, at Q = 4 d/dQ = - 9,
jadi pada Q = 4
= - (4) + 7.5 (4) - 12(4) 2 = $ 6
****TR = 45Q - 0.5Q
TC = Q - 8Q + 57Q + 2
Max Profit MR=MC
MR = - Q + 45
MC = 3Q2 16 Q + 57
MR=MC -Q+45 = 3Q 2-16Q+57

-3Q2 + 15 Q 12 = 0
(-3Q + 3) (Q - 4) = 0 Q1 = 1, Q2 = 4
d2 profit/d2 Q = -6 Q + 15
at Q=1 d2profit/d2Q = 9 minimum
at Q =4 d2profit/d2Q = - 9
Profit => TR TC = 45Q 0.5Q2 (Q3 8Q2 + 57Q + 2)
= - Q3 + 7.5Q2 12Q -2
=6
Slide 34
Demonstration Problem (1)

An engineering firm recently conducted a study to determine
its profit and cost structure. The results of the study are as
follows:
TR = 300Q 6Q and TC = 4Q
so that MR = 300 -12Q and MC = 8Q , The manager has been
asked to determine that maximum level of net profits and the level
of Q that will yield that result.
Answer: Equating MR and MC yield 300 -12Q = 8Q
Solving this equation for Q reveals that the optimal level of Q is Q = 15
Plugging Q = 15 into the net profit relation yields the maximum level of
net profits:
= 300 (15) (6)(15) - 4 (15)

= $ 2,250
Demonstration Problem (2)

Suppose TR = 10 Q 2 Q and TC = 2 + Q
What value of the managerial control variable, Q, maximize net
profit?
Answer: Net profits are
= TR TC = 10Q 2Q - 2 - Q
taking the derivative of with respect to Q and setting it equal to
zero gives d/dQ = 10 -4Q - 2Q = 0 and Q = 10/6
to verify that this indeed a maximum, we must check that

the second derivative of is negative:
d/dQ = - 4 2 = - 6 < 0
therefore, Q = 10/6 is indeed a maximum
Multivariate Optimization
Objective function Y = f(X1, X2, ...,Xk)
Find all Xi such that Y/Xi = 0
Partial derivative:
Y/Xi = dY/dXi while all Xj (where j i) are
held constant
Slide 37
Multivariate Optimization
- the process of determining the maximum and minimum point of a
function of two or more variables.
Partial Derivatives
Suppose that the total profit () function of the the firm depend on sales of
commodities X and Y as follows:
= f(X,Y) = 80X 2X - XY 3Y + 100Y
to find the partial derivative of with respect to X, d/dX, we hold

Y constant
d/dX = 80 4X Y and to find derivative of
with respect to Y
d/dY = - X - 6Y + 100,
Multiply the first equation by 6, rearranged - 480 + 24 X 6Y = 0
100 X - 6Y = 0 adding
- 380 + 23 X
=0
X = 380/23 = 16.52 Y = 80 4 (16.52) = 13.92
= 80(16.52) 2 (16.52) - (16.52)(13.92) 3(13.92) + 100(13.92)

= $1,356.52
Constrained Optimization
Substitution Method
Substitute constraints into the objective
function and then maximize the objective
function
Lagrangian Method
Form the Lagrangian function by adding the
Lagrangian variables and constraints to the
objective function and then maximize the
Lagrangian function
Slide 39
Constrained Optimization
Most of the time, managers face constraints in their optimization decisions.
For example, a firm may face a limitation on its production capacity or on the
availability of skilled personnel and raw material constraint optimization
problem.
Example: the firm seeks to max. function = 80X - 2X -XY - 3Y + 100Y
but faces the constraint that the output of commodity X plus the output
commodity Y must be 12, X + Y = 12
solving the constraint for X, then X = 12 Y, substituting into
= 80 (12-Y) 2(12-Y) - (12-Y) Y 3Y + 100Y

= 960 80Y- 2(144-24Y + Y) 12Y + Y - 3Y + 100Y
= - 4Y + 56Y + 672,
d/dY = - 8Y + 56 = 0 therefore Y = 7, X = 12 -7 = 5 and
with constraint = 80 (5) 2(5) - (5)(7) -3(7) = 100(7) = $ 868
without constraint = $ 1356.52
Langrangian Multiplier Method

Set the constraint function (X + Y = 12) equal to zero X + Y 12 = 0
then this Constraint function multiply by and add to function:
L = 80X 2X - XY 3Y + 100Y + (X + Y 12)
with three unknown variables: X, Y and
to maximize L, we set the partial derivative of L with respect to X, Y and equal to zero,
1.
2.
3.
dL/dX = 80 4X Y + = 0
dL/dY = - X 6Y + 100 + = 0
dL/d = X + Y 12 = 0
to find the value of X , Y and that maximizes L
80 4X Y + = 0
100 - X - 6Y + = 0 substract - 20 -3X + 5Y = 0 (4)
and
,we simultaneously
Multiplying equation (3) dL/d = X + Y 12 = 0 by 3 3X + 3Y 36 = 0

adding to equation (4) we obtain: 3X + 3Y 36 = 0
-3X + 5Y 20 = 0
8Y - 56 = 0
Y = 7, X = 5
substituting into equation (2) -5 42 + 100 = -
= - 53
= - 53
the value of has an important economic interpretation. It is a
marginal effect on the objective-function solution associated
with a 1-unit change in the constraint. In the above problem, this
means that a decrease in the output capacity constraint from 12
to 11 unit or an increase to 13 units will reduce or increase,
respectively, the total profit of the firm ( ) by about $ 53.
Interpretation of the
Lagrangian Multiplier,
Lambda, , is the derivative of the

optimal value of the objective function
with respect to the constraint
In Example , = -53, so a one-unit
increase in the value of the constraint (from
-12 to -11) will cause profit to decrease by
approximately 53 units
Slide 43
New Management Tools for Optimization

Selama 2 dekade terakhir ini banyak management tools baru
diperkenalkan yang merubah the way firms are managed.
Management tools yang baru ini al:
a. Benchmarking
refers to the finding out how other firms may be doing something better
(cheaper) so that your firm can copy and possibly improve on its
technique, usually accomplished by field trip.
b.Total Quality Management

refers to constantly improving the quality of products and the firms
processes so as to consistently deliver value to customers. TQM

constantly asks, How can we do this cheaper, faster, or better?
This involves maximizing quality and minimizing costs.
c. Reengineering
Its asks If this were an entirely new firm,
how would you organize it? Or if you were able
to start all over again, how would you do it?
Reengineering involves the radical redesign of
all the firms processes to achieve major gains
in speed, quality, service and profitability.
There are 2 major reasons to reengineer:
1. Fear that competitors may come up with new
products, services, or ways of doing business
that might destroy your firm
2. Desire if you believe that by reengineering, your
company can erase competition.
Reengineering is extremely difficult to carry it out in
the real world, and not all firms are capable or
need to reengineer.
d. The Leaning Organization

is one that value continuing learning, both individual and
collective, and believes that competitive advantage derives
requires continuous learning.
A learning organization is based on five basic ingredient:
from and
1. to develop a new mental model putting aside old ways of

thinking and being willing to change.
2. to achieve personal mastery- by learning to be open with
others and listen to them rather than telling them what
to do.
3. to develop system thinking an understanding of how the
firm really works.
4. to develop a shared vision - a strategy for the firm that all its
employee share
5. to strive/make an effort for team learning seeing how all the
firms employees can be made to work and learn
together to realize the shared vision and carry out the
strategy of the firm.
Problems
1. Given the following total revenue and total cost functions
of a firm:
TR = 22 Q 0.5Q
TC = 1/3 Q - 8.5 Q + 50 Q + 90
determine (a) the level of output at which the firm
maximizes its total profit; (b) the maximum profit the firm
could earn.
2. for the following total profit function of a firm:
= 144X 3X - XY 2Y + 120Y 35
determine (a) the level of output of each commodity at which the
firm maximize it total profit; (b) the value of maximum amount of the total
profit of the firm.

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Optimization

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Tujuan perusahaan adalah:

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

The objective of a business firm is to

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Maximizing the Value of the Firm

Maximizing the Value of the Firm

Review of Basic Microeconomics

Review of Basic Microeconomics

The Law of Diminishing Returns As a variable input

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Total, Average, and Marginal

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Total, Average, and

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Optimization analysis can be conducted much more

Concept of the Derivative

The derivative of Y with respect to X is equal to the

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

Optimization With Calculus

Find X such that dY/dX = 0

Prepared by Robert F. Brooker, Ph.D.

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

For example, for total-revenue function:

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

****TR = 45Q - 0.5Q

****TR = 45Q - 0.5Q

Max Profit MR=MC

MR=MC -Q+45 = 3Q 2-16Q+57

Copyright 2004 by South-Western, a division of Thomson Learning. All rights reserved.

Demonstration Problem (1)

= 300 (15) (6)(15) - 4 (15)

Demonstration Problem (2)

to verify that this indeed a maximum, we must check that

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.

to find the partial derivative of with respect to X, d/dX, we hold

= 80(16.52) 2 (16.52) - (16.52)(13.92) 3(13.92) + 100(13.92)

= 80 (12-Y) 2(12-Y) - (12-Y) Y 3Y + 100Y

Langrangian Multiplier Method

Multiplying equation (3) dL/d = X + Y 12 = 0 by 3 3X + 3Y 36 = 0

substituting into equation (2) -5 42 + 100 = -

Lambda, , is the derivative of the

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D.