11/6/2019

Decision Making Under Risk

and Uncertainty-II

Prof. Pankaj Dutta

SJM School of Management
IIT Bombay

Decision Models in Management

SOM 608

Contents
 Introduction
 Types of decision-making environments
 Decision making under uncertainty
 Decision making under risk
 Decision tree analysis
 Posterior probabilities and Bayesian analysis
 Decision making with utilities
 MC Simulation
 @Risk
 Game Theory
 Waiting Line Analysis

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Decision making with utilities

 In the preceding presentation (DMURU-I), the expected value criterion
has been applied in situations where the payoff is a real money. There
are cases where the utility rather than the real value should be used
in the analysis.
 The term, utility is the measure of preference for various alternatives in
terms of relative value for money.

 Utility Theory
 Measuring Utility and Constructing a Utility Curve
 Utility as a Decision-Making Criterion

Multi-attribute Utility Model Aids in Disposal of Nuclear Weapons

When the Cold War between the United States and the USSR ended, the two countries agreed to dismantle a
large number of nuclear weapons. The exact number of weapons is not known, but the total number has been
estimated to be over 40,000. The plutonium recovered from the dismantled weapons presented several concerns.
The National Academy of Sciences characterized the possibility that the plutonium could fall into the hands of
terrorists as a very real danger. Also, plutonium is very toxic to the environment, so a safe and secure disposal
process was critical. Deciding what disposal process would be used was no easy task.
Due to the long relationship between the United States and the USSR during the Cold War, it was necessary that
the plutonium disposal process for each country occur at approximately the same time. Whichever method was
selected by one country would have to be approved by the other country. The U.S. Department of Energy (DOE)
formed the Office of Fissile Materials Disposition (OFMD) to oversee the process of selecting the approach to
use for disposal of the plutonium. Recognizing that the decision could be controversial, the OFMD used a team
of operations research analysts associated with the Amarillo National Research Center. This OR group used a
multiattribute utility (MAU) model to combine several performance measures into one single measure.
A total of 37 performance measures were used in evaluating 13 different possible alternatives. The MAU model
combined these measures and helped to rank the alternatives as well as identify the deficiencies of some
alternatives. The OFMD recommended 2 of the alternatives with the highest rankings, and development was
begun on both of them. This parallel development permitted the United States to react quickly when the USSR’s
plan was developed. The USSR used an analysis based on this same MAU approach. The United States and the
USSR chose to convert the plutonium from nuclear weapons into mixed oxide fuel, which is used in nuclear
reactors to make electricity. Once the plutonium is converted to this form, it cannot be used in nuclear weapons.
The MAU model helped the United States and the USSR deal with a very sensitive and potentially hazardous
issue in a way that considered economic, nonproliferation, and ecology issues. The framework is now being
used by Russia to evaluate other policies related to nuclear energy.
Source: “The United States and Russia Evaluate Plutonium Disposition Options with Multiattribute Utility
Theory,” Interfaces 35, 1 (January–February 2005).

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Utility Theory
 So far, problems were analyzed with probabilistic states of nature, where
the selection of an optimal course of action was based on the criterion of
expected profit (or loss) expressed in monetary terms.
 However, in many situations, such criterion that involves expected
monetary payoff may not be appropriate.
 Different individuals attach different utility to money, under different conditions.
 The term, utility is the measure of preference for various alternatives in
terms of relative value for money.
 The utility of a given alternative is unique to the individual decision-
makers and unlike a simple monetary amount, can incorporate intangible
factors or subjective standards from their own value systems.
 Examples… Kaun Banega Crorepati.

Example: Why, in situations, one need Utility

over EMV in making decisions?
 Suppose, there is a 50-50 chance that a $20,000 investment will produce a profit of
$40,000 or be lost completely.
 The associated expected profit is 40,000x0.5-20,000x0.5 = $10,000.
Although, there is a net expected profit, different individuals may vary in
interpreting the result. An investor who is willing to accept the risk may undertake
the investment for a 50% chance to make a $40,000 profit. Conversely, a
conservative investor may not be willing to take risk of losing $20,000. From this
standpoint, we say that different individuals exhibit different attitudes towards risk,
meaning that individuals exhibit different utility regarding risk.

The determination of the utility is completely subjective. It depends on our attitude

towards accepting risk.

Example: Consider KBC. If you are not 100% sure about the next question, then
will you quit with assured return (say, 10 lacs) or take the risk for next amount (say,
20 lacs or zero)??

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Utility Theory : Illustration through Example

 Suppose that you are the lucky holder of a lottery ticket. Five minutes from
now a fair coin could be flipped, and if it comes up tails, you would win $5
million. If it comes up heads, you would win nothing. Just a moment ago a
wealthy person offered you $2 million for your ticket. Let’s assume that you
have no doubts about the validity of the offer. The person will give you a
certified cheque for the full amount, and you are absolutely sure the cheque
would be good.

Utility Theory : Illustration through Example

 The EMV for rejecting the offer indicates that you should hold on to your
ticket, but what would you do?
 Just think, $2 million for sure instead of a 50% chance at nothing.
 Suppose you were greedy enough to hold on to the ticket, and then lost.
How would you explain that to your friends?
 Wouldn’t $2 million be enough to be comfortable for a while?
 Most people would choose to sell the ticket for $2 million. Most of us, in
fact, would probably be willing to settle for a lot less. Just how low we
would go is, of course, a matter of personal preference. People have
different feelings about seeking or avoiding risk. Using the EMV alone is
not always a good way to make these types of decisions.
 One way to incorporate your own attitudes toward risk is through utility
theory.

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Measuring Utility and Constructing a Utility Curve

 It is convenient to begin utility assessment by assigning the worst outcome a
utility of 0 and the best outcome a utility of 1.

 Expected utility of alternative 2 = Expected utility of alternative 1

 Utility of other outcome = (p) (utility of best outcome, which is 1) + (1-p) (utility
of the worst outcome, which is 0)
 Utility of other outcome = (p)(1)+(1-p)(0)= p
 Determine the value of the probability (p) that makes you indifferent
between alternatives 1 and 2

Measuring Utility and Constructing a Utility Curve

 In setting the probability, you should be aware that utility assessment is
completely subjective. It’s a value set by the decision maker that can’t be
measured on an objective scale.
 Example:
 Jane Dickson would like to construct a utility curve revealing her preference for
money between $0 and $10,000. A utility curve is a graph that plots utility value
versus monetary value. She can either invest her money in a bank savings account
or she can invest the same money in a real estate deal.
 If the money is invested in the bank, in three years Jane would have $5,000. If she
invested in the real estate, after three years she could either have nothing or
$10,000. Jane, however, is very conservative. Unless there is an 80% chance of
getting $10,000 from the real estate deal, Jane would prefer to have her money in
the bank, where it is safe. What Jane has done here is to assess her utility for
$5,000. When there is an 80% chance (this means that p is 0.8) of getting $10,000,
Jane is indifferent between putting her money in real estate or putting it in the
bank. Jane’s utility for $5,000 is thus equal to 0.8, which is the same as the value
for p.

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Measuring Utility and Constructing a Utility Curve

 Utility assessment for the example

Measuring Utility and Constructing a Utility Curve

 Other utility values can be assessed in the same way. For example, what
is Jane’s utility for $7,000? What value of p would make Jane indifferent
between $7,000 and the gamble that would result in either $10,000 or $0?
For Jane, there must be a 90% chance of getting the $10,000. Otherwise,
she would prefer the $7,000 for sure. Thus, her utility for $7,000 is 0.90.
 Jane’s utility for $3,000 can be determined in the same way. If there were
a 50% chance of obtaining the $10,000, Jane would be indifferent
between having $3,000 for sure and taking the gamble of either winning
the $10,000 or getting nothing. Thus, the utility of $3,000 for Jane is 0.5.
 Of course, this process can be continued until Jane has assessed her utility
for as many monetary values as she wants. These assessments, however,
are enough to get an idea of Jane’s feelings toward risk.
 In fact, we can plot these points in a utility curve, as is done in next
Figure.

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Measuring Utility and Constructing a Utility Curve

Utility curve for

Jane Dickson

 Jane’s utility curve is typical of a risk avoider. A risk avoider is a decision maker
who gets less utility or pleasure from a greater risk and tends to avoid situations in
which high losses might occur. As monetary value increases on her utility curve,
the utility increases at a slower rate.

Measuring Utility and Constructing a Utility Curve

 A person who is a risk seeker has an opposite-shaped utility curve. This decision
maker gets more utility from a greater risk and higher potential payoff. As monetary
value increases on his or her utility curve, the utility increases at an increasing rate.
 A person who is indifferent to risk has a utility curve that is a straight line.

 The shape of a person’s utility curve depends on the specific decision being
considered, the monetary values involved in the situation, the person’s psychological
frame of mind, and how the person feels about the future. It may well be that you
have one utility curve for some situations you face and completely different curves
for others.

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Utility as a Decision-Making Criterion

 After a utility curve has been determined, the utility values from the curve
are used in making decisions. Monetary outcomes or values are replaced
with the appropriate utility values and then decision analysis is performed
as usual. The expected utility for each alternative is computed instead of
the EMV.
 Example:
 Mark Simkin loves to gamble. He decides to play a game that involves
tossing thumbtacks in the air. If the point on the thumbtack is facing up
after it lands, Mark wins $10,000. If the point on the thumbtack is down,
Mark loses $10,000. Should Mark play the game (alternative 1) or should
he not play the game (alternative 2)?
 Alternative 1 is to play the game. Mark believes that there is a 45% chance
of winning $10,000 and a 55% chance of suffering the $10,000 loss.
Alternative 2 is not to gamble. What should Mark do?

Utility as a Decision-Making Criterion

 Decision Facing Mark Simkin

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Utility as a Decision-Making Criterion

 Utility Curve for Mark Simkin

 We see that Mark’s utility for –$10,000 is 0.05, his utility for not playing ($0)
is 0.15, and his utility for $10,000 is 0.30.

Utility as a Decision-Making Criterion

 Mark’s objective is to maximize his expected utility, which can be done as
follows:
 Step1: U(-$10,000)=0.05, U($0)=0.15, U($10,000)=0.30
 Step2: Replace monetary values with utility values.

 Here are the expected utilities for alternatives 1 and 2:

 E(alternative 1: play the game) = (0.45)(0.30) + (0.55)(0.05)=0.162
 E(alternative 2: don’t play the game) = 0.15

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Utility as a Decision-Making Criterion

Summary from Example:

 Therefore, alternative 1 is the best strategy using utility as the decision
criterion.
 If EMV had been used, alternative 2 would have been the best
strategy.
 The utility curve is a risk-seeker utility curve, and the choice of
playing the game certainly reflects this preference for risk.

Example

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Example

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Example

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Decision Making Under Risk: Single Period

Inventory Model

 Consider the Newsvendor Problem?

 Either Over Stock– Excess inventory/salvage value
 or Under Stock – Penalty cost/shortage cost/loss of goodwill

 Newsvendor’s Dilemma? How much to order (Q)?

 Solution 1: Expected Payoff/Profit
 Solution 2: NV’s Utility towards risk?
 Conclusions: A complete different solution.

Basic Simulation Study:

Monte Carlo Simulation

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Simulation Defined
Simulation is the process of designing a model of a real system and
conducting experiments with this model for the purpose of understanding
the behaviour (within the limits imposed by a criterion or set of criteria) for
the operation of the system.
— Shannon

Simulation is a numerical technique for conducting experiments on a digital

computer, which involves certain types of mathematical and logical
relationships necessary to describe the behaviour and structure of a
complex real-world system over extended periods of time.

— Naylor et al.

Allows us to:
 Model complex systems in a detailed way
 Describe the behavior of systems
 Construct theories or hypotheses that account for the observed
behavior
 Use the model to predict future behavior, that is, the effects that
will be produced by changes in the system
 Analyze proposed systems

What can be simulated?

Almost anything can
and
almost everything has...

Simulation’s greatest strength is its ability to answer “what

if” questions...

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Applications:
• MANUFACTURING: material handling systems, assembly lines, automated
production facilities, inventory control systems, plant layout, etc..
• COMPUTER SYSTEMS: hardware components, software systems, networks,
data base management, information processing, etc..
• FINANCE and BUSINESS: stock and commodity analysis, pricing policies,
marketing strategies, cash flow analysis, forecasting, etc..
• GOVERNMENT: military weapons and their use, military tactics, population
forecasting, land use, health care delivery, fire protection, criminal justice,
traffic control, etc..
 Telecommunications: almost all type of problems can be handled
 Applications at Disney World…

And the list goes on and on...

Simulation – What it is/not

It is not a technique which should be applied in all cases. However, table below
highlights what simulation is and what it is not.

It is
 a technique which uses
computers.
 an approach for reproducing the
processe by which events of
chance and change are created in
a computer.
 a procedure for testing and
experimenting on models to
answer what if ..., then so and so
... types of questions.
It is not
 an analytical technique which
provides exact solution.
 A programming language but it
could be programmed into a set of
commands which can form a
language to facilitate the
programming of simulation.

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Steps of Simulation Process

Identify the problem: The simulation process is used to solve any problem
only when the assumptions required for analytical models are not satisfied or
there is no appropriate model developed for a system under study. For
example, a queuing situation may be of interest but the arrival and/or service
pattern do not meet the assumptions required to use queuing theory.

Identify the decision variables and decide the performance criterion

(objective): In the context of an inventory control situation, the demand
(consumption rate), lead time and safety stock are identified as decision
variables. These variables shall be responsible to measure the performance of
the system in terms of total inventory cost under the decision rule – when to
order.

Construct a simulation model: For developing a simulation model, an

intimate understanding of the relationships among the elements of the
system being studied is required. For this purpose the influence diagram
(drawn in a variety of different ways) is useful because simulation models
for each of these diagrams may be formulated until one seems better or more
appropriate than the other. Even after one has been chosen, it may be
modified again and again before a final version is acceptable.

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Testing and validating the model: The validation process requires (i)
determine whether the model is internally correct in a logical and
programming sense called internal validity and (ii) determine whether it
represents the system under study called external validity. The first step
involves checking the equations and procedures in the model for accuracy,
both in terms of mistakes (or errors) and in terms of properly representing the
system under study. The verification of internal validity can be simplified if
the model is developed in modules and each module is tested as it is
developed.

After verifying internal validity the model is tested by substituting historical

values into the model and seeing if it replicates what happens in reality. If the
model passes this test, extreme values of the input variables are entered and
the model is checked for the expected output.

Designing of the experiment: Experimental design refers to controlling the

conditions of the study, such as the variables to include.

It requires to determine factors considered fixed and variable in the model

(ii) levels of the factors to use, (iii) what the resulting dependent measures
are going to be, (iv) how many times the model will be replicated, and
length of time of each replication, and so on. For example, in a queuing
simulation we may consider arrival and service rates constant but vary the
number of servers and the evaluate the customer waiting times. (dependent
variable).

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Identify the Problem

Run the simulation model: Run the
model on the computer to get the Identify Decision Variables,
Performance Criterion and
results in the form of operating Decision Rules
characteristics.
Construct Simulation Model
Evaluate the results: Examine the
Modify the
results of problem as well as their Validate the Model model by
changing the
reliability and correct-ness. If the input data, i.e.
simulation process is complete, Design Experiments (specify values of
values of decision variables decision
then select the best course of action to be tested) variables

(or alternative) otherwise make

desired changes in model decision
variables, parameters or design,
and return to Step 3.
Run or Conduct the Simulation
Is simulation process completed?
Examine the results and
Select the best course of action

Steps of Simulation Process

What is a Monte Carlo simulation?

• In a Monte Carlo simulation we attempt to follow the ‘time dependence’ of
a model for which change, or growth, does not proceed in some rigorously
predefined fashion but rather in a stochastic manner which depends on a
sequence of random numbers which is generated during the simulation.
• A large proportion of the applications of simulations are for probabilistic
models.
• The Monte Carlo technique is defined as a technique for selecting numbers
randomly from a probability distribution for use in a trial (computer run) of
a simulation model.
• The partitioned roulette wheel in Monte Carlo replicates the probability
distribution for demand if the values of demand occur in a random manner.

Copyright@sjmsomiitbombay2014

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Monte Carlo simulation:

Details of the Method
 Random Walk: Markov chain is a sequence of events with the condition
that the probability of each succeeding event is uninfluenced by prior
events.
 Choosing from Probability Distribution: Any random variable has a
probability distribution for its occurrence. We need to choose a random
variable which mimics that probability distribution.

 Random Numbers: Best way to relate random number to a random

variable is to use cumulative probability distribution and equating it to the
random number.
 Uniformly distributed numbers in [0,1]
 Most useful method for obtaining random numbers for computer use is a pseudo
random number generator
 How random are these pseudo random numbers?

Monte Carlo Simulation

In Brief,
The Monte Carlo simulation technique involved conducting repetitive experiments on
the model of the system under study with some known probability distribution to draw
random samples (observations) using random numbers. If a system cannot be described
by a standard probability distribution, an empirical probability distribution can be
constructed.

The Monte Carlo simulation technique consists of following steps:

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Steps of Monte Carlo Simulation

Setting up a probability distribution for variables to be analyzed.
Building a cumulative probability distribution for each random variable.
Establishing an interval of random numbers for each variable.
Generate random numbers and then assign an appropriate set of random
numbers to represent value or range (interval) of values for each random
variable.
Conduct the simulation experiment using random sampling.
Repeat Step 4 until the required number of simulation runs has been
generated.
Design and implement a course of action and maintain control.

Monte Carlo Simulation

1. Fixed time increment model

Here the observations are made at fixed increments of time.
2. Next Event/interval increment model
Here the observations are made whenever certain specified events
take place.
3. General Purpose Languages: Visual Basic, C, C+=, Java etc.
4. Special Purpose Simulation Languages: GPSS, SIMSCRIPT,
SIMUL8, ARENA, etc

5. Prewritten Simulation Languages: DYNAMO, VENSIM,

STELLA, etc.

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Deterministic case:

Let Y=Objective function =f(x) be a real-valued function

X= input variables  deterministic

Y= output variables  deterministic

X  [a,b] ; e.g.; [1, 5]

Here the occurrence of all the points between 1 and 5 are uniformly
distributed.

Random Number U [0,1)

Probabilistic case:

Let Y=Objective function = function(x) be a real-valued function

X= input variables  stochastic

Y= output variables  stochastic/deterministic

X 1 2 3 4

Prob. .2 .1 .4 .3

Calculate F(x)  Cumulative distribution function

X: f(x) F(x) Range of U(two digit random number)

1 .2 .2 00 - 19

2 .1 .3 20 - 29

3 .4 .7 30 - 69

4 .3 1 70 - 99

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Random number generation:

Monte Carlo simulation requires the generation of a sequence of random numbers.

This sequence of random numbers help in choosing random observations (samples)
from the probability distribution.

Example: the nth random number rn, consisting of k-th digits, generated by using
multiplicative congruential method is given by

rn ≡ p. rn-1 (modulo m)

where p and m are positive integers, p<m,

modulo m means that rn is the remainder when p.rn-1 is divided by m.

For illustration, let p=35, m=100 with initial r0 = 57

r1= p r0 (modulo m) = 35x57 (modulo 100) = 1995/100 = 95 (remainder)

r2= pr1 (modulo m) = 35x95 (modulo 100) = 3325/100 = 25 (remainder)

…..

Probabilistic case: Continuous distribution

For Exponential distribution

The random number generating scheme is

For Triangular distribution?

For Normal distribution?

For Uniform distribution?

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How to simulate values of a normal

random variable?
If you enter into any cell the formula NORMINV(rand(), mu , sigma), you
will generate a simulated value of a normal random variable having a mean
mu and standard deviation sigma. For example, let mu = 4000 (E1) and
sigma = 1000 (E2), then the simulated mean and sigma is illustrated as:

Harry’s Auto Shop Example

 Want to simulate monthly demand for tires

 Have data on past 60 months

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Random Number Intervals

for Harry’s Auto Shop

Harry’s Auto Shop: 10 months

simulation for demand for tires

Iteration Random Number Monthly Demand

1 36 360
2 67 380
3 12 320
4 50 360
5 3 300
6 32 340
7 21 340
8 8 320
9 97 400
10 70 380

Average Monthly Demnad 350

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Simulation of Queuing Problems

Example: A dentist schedules all his patients for 30-minute appointments. Some
of the patients take more or less than 30 minutes depending on the type of dental
work to be done. The following summary shows the various categories of work,
their probabilities and time actually needed to complete the work:

Category of Time Required Probability

Service (minutes) of Category
Filling 45 0.40
Crown 60 0.15
Cleaning 15 0.15
Extraction 45 0.10
Checkup 15 0.20

Simulate the dentist’s clinic for four hours and determine the average waiting time
for the patients as well as the idleness of the doctor. Assume that all the patients
show up at the clinic at exactly their scheduled arrival time starting at 8.00 a.m. Use
the following random numbers for handling the above problem:
40 82 11 34 25 66 17 79

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Solution: The cumulative probability distribution and random number

interval for service time are shown below:

Category Service Time Required Probability Cumulative Random Number

of Service (minutes) Probability Interval

Filling 45 0.40 0.40 00–39

Crown 60 0.15 0.55 40–54
Cleaning 15 0.15 0.70 55–69
Extraction 45 0.10 0.80 70–79
Checkup 15 0.20 1.00 80–99

The various parameters of a queuing system such as arrival pattern of

customers, service time, waiting time in the context of the given problem
are shown below:

Arrival Pattern and Nature of Service

Patient Scheduled Random Category of Service Time
Number Arrival Number Service (minutes)

1 8.00 40 Crown 60
2 8.30 82 Checkup 15
3 9.00 11 Filling 45
4 9.30 34 Filling 45
5 10.00 25 Filling 45
6 10.30 66 Cleaning 15
7 11.00 17 Filling 45
8 11.30 79 Extraction 45

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Computation of Arrivals, Departures and Waiting of Patients

Time Event Patient Number Waiting
(Patient Number) (Time to Exit) (Patient Number)
08.00 1 arrive 1 (60) –
08.30 2 arrive 1 (30) 2
09.00 1 departs; 3 arrive 2 (15) 3
09.15 2 depart 3 (45) –
09.30 4 arrive 3 (30) 4
10.00 3 depart; 5 arrive 4 (45) 5
10.30 6 arrive 4 (15) 5, 6
10.45 4 depart 5 (45) 6
11.00 7 arrive 5 (30) 6, 7
11.30 5 depart; 8 arrive 6 (15) 7, 8
11.45 6 depart 7 (45) 8
12.00 End 7 (30) 8

Average Waiting Time for Dentists

Patient Arrival Time Service Starts at Waiting Time
(minutes)
1 8.00 8.00 0
2 8.30 9.00 30
3 9.00 9.15 15
4 9.30 10.00 30
5 10.00 10.45 45
6 10.30 11.30 60
7 11.00 11.45 45
8 11.30 12.30 60
280
The average waiting time = 280/8 = 35 minutes.

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Simulation with Excel Spreadsheets

Simulation with Excel Spreadsheets

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Simulation with Excel Spreadsheets

Example: A Model for Profit on a

Special Sale Promotion
A large catalog merchandiser is planning to have a special furniture
promotion a year from now. To do this the company must place its order
for the furniture now. It plans to sign a contract with the manufacturer for
3000 chairs at a cost of $175 per unit, which the company plans to offer
initially for $250 per unit. The promotion will last for eight weeks, after
which all remaining units will be offered for sale at a half the initial price,
or $125 per unit. The company believes that 2000 units will be sold during
the first eight weeks.
Represent the profit from this sale.

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Example: A Model for Profit on a

Special Sale Promotion
P = profit
C = per unit price ($175)
R = initial price ($250)
S = units ordered (3000)
V = no of units sold during the first 8 weeks of the promotion (2000)

R-C = net profit per unit sold for first 8 weeks

R/2-C = net profit or loss per unit after 8 weeks.
S-V = no of units sold at the discounted price R/2.

Profit(P) = (R-C)V + (R/2-C)(S-V)

Thus the profit will be exactly $100,000.

A Model for Profit on a Special

Sale Promotion
 Demand in uncertain and follows Triangular distribution
 Sales price is also uncertain and follows Uniform distribution
 Simulation: Excel Spreadsheet Approach?
 Excel: furniture promotion

 Post Spreadsheet Analysis: Confidence interval for profit?

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Simulation Using Spreadsheets:

How should a greeting card company
determine how many cards to produce?
Here we can see, how Monte Carlo simulation can be used as a tool to help
businesses make better decisions. Suppose that the demand for a
Valentine’s Day card is governed by the following discrete random
variable:
Demand Probability
10,000 .10
20,000 .35
40,000 .3
60,000 .25

The greeting card sells for $4.00, and the variable cost of producing each
card is $1.50. Leftover cards must be disposed of at a cost of $0.20 per
card. How many cards should be printed?

Valentine’s Day card Problem

produced 40000
rand# 0.297628
demand 20000
unit prod cost    ($) 1.5
unit price     ($) 4
unit disposal cost   ($) 0.2

revenue 80000
total var cost 60000
total disposing cost 4000
profit 16000
Demand Distribution
0 10000
0.1 20000
0.45 40000
0.75 60000

Sim Profit 25000 46342.34 57327.33 46030.03

Sim sigma 0 11848.36 47745.86 72662.86
16000 10000 20000 40000 60000Optimal Quantity
1 25000 50000 100000 66000
2 25000 50000 100000 66000
3 25000 50000 100000 ‐18000
4 25000 50000 100000 ‐18000
5 25000 50000 16000 ‐18000
6 25000 50000 100000 66000
7 25000 50000 16000 ‐60000
8 25000 50000 100000 66000
9 25000 8000 ‐26000 150000
10 25000 50000 100000 ‐60000
11 25000 50000 100000 66000

31
 11/6/2019

Return to Harry’s Auto Shop

 Want to compute expected profit
 Revenue per tire varies with market
conditions
 Discrete uniform distribution $60 to $80
 Profit margin per tire also varies
 Continuous uniform distribution, 20% to 30%
 Fixed operating cost is $2000 per month

Flowchart for Harry’s Simulation

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