(1) Merton Truck Company (2) Sensitivity Analysis (3) Duality

Case Discussion
Case context

Case facts

Some specific questions we would like to address

Best product mix?

Which of the 3 options suggested is/ are better? (and why?) Other options?

Before we formulate
I know we are operating at capacity in some of our production lines.
Is this true? If so, which production line(s)?

 Decision Variables?

 What if there were no constraints?

Demand?
What is actually constraining production?

 As I see it, we are losing $1205 for each Model 101 truck we sell. ?? What is missing in the meeting?

 Objective function? Max contribution or max profit? Does it matter? What if economies of scale?

Contributions
Unit contribution for Model 101 trucks = selling price variable costs = selling price (direct material + direct labor + variable overhead) = $39,000 ($24,000 + $4,000 + $8,000) = $3,000. Similarly, contribution per unit of Model 102 truck = $38,000 ($20,000 + $4,500 + $8,500) = $5,000.

 Objective Function?

 Constraints?

max 3000 x + 5000 y

s.t. Capacity Constraints Non-negativity Constraints Integer Constraints

Solving the LP Relax

Graphical approach
Simplex and other algorithms. (Well not get into details) Excel Solver

Graphical approach

Corner points

Iso-contribution/ Iso-profit

 Start from O(0, 0) There are unused capacities Manufacture Model 101 trucks, i.e. increase x. By how much?

 Move to A (2500, 0). Corresponding contribution = 7.5 million. (Note: Same contribution at E(0, 1500) too). Model 101 assembly capacity is tight (binding). Other constraints are slack (have excess capacities). Manufacture model 102 trucks. Increase y by how much?

 We move to B (2500, 500). Contribution = 10 million. Now, each unit increase in y requires unit decrease in x. This tradeoff is worthwhile as this increases total contribution by $2000.

Move to C (2000, 1000). Contribution = 11 million.

 This is optimal. (Note that further one unit increase in y can be achieved only by decreasing x by 2).
Which of the constraints are binding and which slack? What are the respective slacks? Shadow-prices? (Well come back to this after looking at iso-contribution).

Iso-contribution line
Production mixes at all points on this line will yield the same contribution. Can there be many iso-contribution lines? Slope of iso-contribution lines in this case is -3/5, negative of ratio of coefficients in objective function. If infinitely many solutions, then?

 In this case, iso-contribution and iso-profit lines are the same. Iso-cost line in case of minimization problems

Sensitivity Analysis
Shadow prices and reduced costs Allowable Increase

Allowable Decrease
Ranging 100% rule

Shadow price of Engine Assembly Constraint

Consider the metal stamping constraint. It is tight. Merton must reduce one Model 101 truck in order to increase Model 102 truck by one unit. Engine assembly constraint is tight (binding) too. If we produce one less Model 101 truck and increase the engine assembly capacity by one hour, we can produce one more Model 102 truck. Net increase in contribution = $2000, which is the shadow price of the engine assembly constraint.

 Merton can increase the engine assembly capacity by 500, before running out of capacity in some other department (i.e. before some other constraint becomes tight). This is the allowable increase.

Engine Assembly Constraint (Allowable increase, allowable decrease and shadow price):
Capacity 4500 4000 3500 Optimal Value 12,000,000 11,000,000 10,000,000 (x, y) (1500, 1500) (2000, 1000) (2500, 500)

Metal Stamping Constraint (Allowable increase, allowable decrease and shadow price):
Capacity 6500 6000 5000 Optimal Value 11,250,000 11,000,000 10,500,000 (x, y) (2500, 750) (2000, 1000) (1000, 1500)

Graphical Approach to Sensitivity Analysis

What if we have an additional machine-hour of engine capacity? The line CD will move outward and the coordinates of C and D will change. New coordinates of C are (1999, 1001)

Increase in contribution = $2000 (the shadow price for the engine assembly constraint)

 Till when will this shadow price hold? What is the allowable increase?
Till C overlaps with D. Allowable increase = 500, as seen earlier. At this point, 3 constraints are binding. Further increase in engine assembly capacity will make the corresponding constraint slack (and Model 102 assembly constraint and metal stamping capacity constraint will be binding).

 Questions listed towards end of the case

Sourcing Out Engine Assembly

? Using shadow prices?

Shadow price of engine assembly constraint is $2000.

Allowable increase is 500 machine-hours. Therefore?

Model 103?
? Recall that the first two constraints are tight. Recall that the shadow prices for the 4 constraints are $2000, $500, 0, 0 respectively.

 Cost to company in lost contribution = sum of resource use for each constraint times the respective shadow price = $2000*(4000/5000)*2000 + $500*(6000/4000) + $0*1 + $0*0 = $2350 The additional contribution from the production and sale of one Model 103 truck is $2000. Therefore?

 We have just priced out Model 103 trucks and shown that the reduced cost is $350 Cross-check with corresponding LP formulation using Solver.

Add constraint z = 1, and observe the change in contribution.

Overtime production
? Reformulate by adding two more decision variables What are the decision variables? x_Overtime, y_Overtime

 Additional constraints? Engine assembly operations overtime. Mertons contribution increases by $0.7 million. Therefore?

Question 5
? Additional constraint Hence, ?

Complementary Slackness
If slack is non-zero, shadow price is zero. If slack is zero?

If optimal solution calls for nonzero values of decision variables, corresponding reduced costs are 0. When optimal value for a decision variable is zero?

Slack Engine Assembly Metal Stamping M101 Assembly M102 Assembly 0 0 1000 1500

Shadow 2000 500 0 0

Duality

Dual LP formulation for Merton Truck Company

Primal (P):
Slack Engine Assembly Metal Stamping M101 Assembly 0 0 1000 Shadow 2000 500 0

M102 Assembly

1500

Dual (D): Slack Shadow

Constraint 1 Constraint 2

0 0

2000 1000

Primal (P):
Slack Engine Assembly Metal Stamping M101 Assembly 0 0 1000 Shadow 2000 500 0 Dual DV 2000 500 0

M102 Assembly

1500

Dual (D): Slack Shadow Primal DV

Constraint 1 Constraint 2

0 0

2000 1000

2000 1000

Observations
Ref Duality_MertonTruck.xlsx for Primal and Dual LP formulations and solutions. The shadow price of a primal constraint is the value (at optimal) of the corresponding dual DV (Decision Variable). Allowable increase and allowable decrease alongside constraints are the allowable increase and allowable decrease of the capacities of the corresponding constraints (i.e. point up to which the same shadow price holds). Similarly for reduced costs.

Allowable increase and allowable decrease alongside decision variables are the allowable increase and allowable decrease of the coefficients of the corresponding variables up to which the same corner point remains optimum.
Sensitivity analyses sheets of (P) and (D).