MBA-H2040 Quantitative Techniques for Managers

UNIT II

1 TRANSPORTATION PROBLEM

LESSON STRUCTURE

1.5 Introduction
1.6 Transportation Algorithm
1.7 Basic Feasible Solution of a
Transportation Problem
1.8 Modified Distribution Method
1.9 Unbalanced Transportation Problem
1.10 Degenerate Transportation
Problem
1.11 Transshipment Problem
1.12 Transportation Problem
Maximization
1.13 Summary
1.14 Key Terms
1.15 Self Assessment Questions
1.16 Key Solutions
1.17 Further References Objectives
After Studying this lesson, you should be able
to:

Formulation of a Transportation Problem

Determine basic feasible solution using
various methods
Understand the MODI, Stepping Stone
Methods for cost minimization
Make unbalanced Transportation Problem
into balanced one using appropriate
method
Solve Degenerate Problem
Formulate and Solve Transshipment
Problem
Describe suitable method for maximizing
the objective function instead of
minimizing

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1.1 Introduction

A special class of linear programming problem is Transportation Problem, where the objective is to
minimize the cost of distributing a product from a number of sources (e.g. factories) to a number of
destinations (e.g. warehouses) while satisfying both the supply limits and the demand requirement.
Because of the special structure of the Transportation Problem the Simplex Method of solving is
unsuitable for the Transportation Problem. The model assumes that the distributing cost on a given rout
is directly proportional to the number of units distributed on that route. Generally, the transportation
model can be extended to areas other than the direct transportation of a commodity, including among
others, inventory control, employment scheduling, and personnel assignment.

The transportation problem special feature is illustrated here with the help of following Example 1.1.

Example 1.1:

Suppose a manufacturing company owns three factories (sources) and distribute his products to five
different retail agencies (destinations). The following table shows the capacities of the three factories,
the quantity of products required by the various retail agencies and the cost of shipping one unit of the
product from each of the three factories to each of the five retail agencies.

Retail Agency
Factories 1 2 3 4 5 Capacity
1 1 9 13 36 51 50
2 24 12 16 20 1 100
3 14 33 1 23 26 150

Requirement 100 60 50 50 40 300

Usually the above table is referred as Transportation Table, which provides the basic information
regarding the transportation problem. The quantities inside the table are known as transportation cost per
unit of product. The capacity of the factories 1, 2, 3 is 50, 100 and 150 respectively. The requirement of
the retail agency 1, 2, 3, 4, 5 is 100,60,50,50, and 40 respectively.

In this case, the transportation cost of one unit

from factory 1 to retail agency 1 is 1,
from factory 1 to retail agency 2 is 9,
from factory 1 to retail agency 3 is 13, and so on.

A transportation problem can be formulated as linear programming problem using variables with
two subscripts.
Let
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x11=Amount to be transported from factory 1 to retail agency 1
x12= Amount to be transported from factory 1 to retail agency 2
……..
……..
……..
……..
x35= Amount to be transported from factory 3 to retail agency 5.

Let the transportation cost per unit be represented by C11, C12, …..C35 that is C11=1, C12=9, and so on.
Let the capacities of the three factories be represented by a 1=50, a2=100, a3=150.
Let the requirement of the retail agencies are b1=100, b2=60, b3=50, b4=50, and b5=40.

Thus, the problem can be formulated as

Minimize
C11x11+C12x12+……………+C35x35

Subject to:
x11 + x12 + x13 + x14 + x15 = a1
x21 + x22 + x23 + x24 + x25 = a2
x31 + x32 + x33 + x34 + x35 = a3

x11 + x21 + x31 = b1

x12 + x22 + x32 = b2
x13 + x23 + x33 = b3
x14 + x24 + x34 = b4
x15 + x25 + x35 = b5

x11, x12, ……, x35

Thus, the problem has 8 constraints and 15 variables. So, it is not possible to solve such a
problem using simplex method. This is the reason for the need of special computational procedure to
solve transportation problem. There are varieties of procedures, which are described in the next section.
1.2 Transportation Algorithm

The steps of the transportation algorithm are exact parallels of the simplex algorithm, they are:
Step 1: Determine a starting basic feasible solution, using any one of the following three methods
1. North West Corner Method
2. Least Cost Method
3. Vogel Approximation Method

Step 2: Determine the optimal solution using the following method

1. MODI (Modified Distribution Method) or UV Method.

1.3 Basic Feasible Solution of a Transportation Problem

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The computation of an initial feasible solution is illustrated in this section with the help of the
example1.1 discussed in the previous section. The problem in the example 1.1 has 8 constraints and 15
variables we can eliminate one of the constraints since a1 + a2 + a3 = b1 + b2 + b3 + b4 +b5. Thus now the
problem contains 7 constraints and 15 variables. Note that any initial (basic) feasible solution has at
most 7 non-zero Xij. Generally, any basic feasible solution with m sources (such as factories) and n
destination (such as retail agency) has at most m + n -1 non-zero Xij.
The special structure of the transportation problem allows securing a non artificial basic feasible
solution using one the following three methods.

4. North West Corner Method

5. Least Cost Method
6. Vogel Approximation Method

The difference among these three methods is the quality of the initial basic feasible solution they
produce, in the sense that a better that a better initial solution yields a smaller objective value. Generally
the Vogel Approximation Method produces the best initial basic feasible solution, and the North West
Corner Method produces the worst, but the North West Corner Method involves least computations.

North West Corner Method:

The method starts at the North West (upper left) corner cell of the tableau (variable x 11).

Step -1: Allocate as much as possible to the selected cell, and adjust the associated amounts of capacity
(supply) and requirement (demand) by subtracting the allocated amount.

Step -2: Cross out the row (column) with zero supply or demand to indicate that no further assignments
can be made in that row (column). If both the row and column becomes zero simultaneously, cross out
one of them only, and leave a zero supply or demand in the uncrossed out row (column).

Step -3: If exactly one row (column) is left uncrossed out, then stop. Otherwise, move to the cell to the
right if a column has just been crossed or the one below if a row has been crossed out. Go to step -1.

Example 1.2:

Consider the problem discussed in Example 1.1 to illustrate the North West Corner Method of
determining basic feasible solution.
Retail Agency
Factories 1 2 3 4 5 Capacity
1 1 9 13 36 51 50
2 24 12 16 20 1 100
3 14 33 1 23 26 150

Requirement 100 60 50 50 40 300

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The allocation is shown in the following tableau:

Capacity
1 9 13 36 51 50
50
24 12 16 20 1 100 50
50 50
14 33 1 23 26
10 50 50 40 150 140 90 40

Requirement 100 60 50 50 40
50 10
The arrows show the order in which the allocated (bolded) amounts are generated. The starting
basic solution is given as
x11 = 50,
x21 = 50, x22 = 50
x32 = 10, x33 = 50, x34 = 50, x35 = 40

The corresponding transportation cost is

50 * 1 + 50 * 24 + 50 * 12 + 10 * 33 + 50 * 1 + 50 * 23 + 40 * 26 = 4420

It is clear that as soon as a value of X ij is determined, a row (column) is eliminated from further
consideration. The last value of Xij eliminates both a row and column. Hence a feasible solution
computed by North West Corner Method can have at most m + n – 1 positive Xij if the transportation
problem has m sources and n destinations.

Least Cost Method

The least cost method is also known as matrix minimum method in the sense we look for the row and
the column corresponding to which C ij is minimum. This method finds a better initial basic feasible
solution by concentrating on the cheapest routes. Instead of starting the allocation with the northwest
cell as in the North West Corner Method, we start by allocating as much as possible to the cell with the
smallest unit cost. If there are two or more minimum costs then we should select the row and the column
corresponding to the lower numbered row. If they appear in the same row we should select the lower
numbered column. We then cross out the satisfied row or column, and adjust the amounts of capacity
and requirement accordingly. If both a row and a column is satisfied simultaneously, only one is crossed
out. Next, we look for the uncrossed-out cell with the smallest unit cost and repeat the process until we
are left at the end with exactly one uncrossed-out row or column.

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Example 1.3:
The least cost method of determining initial basic feasible solution is illustrated with the help of problem
presented in the section 1.1.

Capacity
1 9 13 36 51 50
50
24 12 16 20 1 100 60
60 40
14 33 1 23 26
50 50 50 150 100 50

Requirement 100 60 50 50 40
50

The Least Cost method is applied in the following manner:

We observe that C11=1 is the minimum unit cost in the table. Hence X11=50 and the first row is
crossed out since the row has no more capacity. Then the minimum unit cost in the uncrossed-out row
and column is C25=1, hence X25=40 and the fifth column is crossed out. Next C33=1is the minimum unit
cost, hence X33=50 and the third column is crossed out. Next C22=12 is the minimum unit cost, hence
X22=60 and the second column is crossed out. Next we look for the uncrossed-out row and column now
C31=14 is the minimum unit cost, hence X31=50 and crossed out the first column since it was satisfied.
Finally C34=23 is the minimum unit cost, hence X34=50 and the fourth column is crossed out.

So that the basic feasible solution developed by the Least Cost Method has transportation cost is

1 * 50 + 12 * 60 + 1 * 40 + 14 * 50 + 1 * 50 + 23 * 50 = 2710

Note that the minimum transportation cost obtained by the least cost method is much lower than
the corresponding cost of the solution developed by using the north-west corner method.

Vogel Approximation Method (VAM):

VAM is an improved version of the least cost method that generally produces better solutions. The steps
involved in this method are:

Step 1: For each row (column) with strictly positive capacity (requirement), determine a penalty by
subtracting the smallest unit cost element in the row (column) from the next smallest unit cost element
in the same row (column).

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Step 2: Identify the row or column with the largest penalty among all the rows and columns. If the
penalties corresponding to two or more rows or columns are equal we select the topmost row and the
extreme left column.

Step 3: We select Xij as a basic variable if Cij is the minimum cost in the row or column with largest
penalty. We choose the numerical value of Xij as high as possible subject to the row and the column
constraints. Depending upon whether ai or bj is the smaller of the two ith row or jth column is crossed out.

Step 4: The Step 2 is now performed on the uncrossed-out rows and columns until all the basic variables
have been satisfied.

Example 1.4:

Consider the following transportation problem

Destination
Origin 1 2 3 4 ai
1 20 22 17 4 120
2 24 37 9 7 70
3 32 37 20 15 50
bj 60 40 30 110 240

Note: ai=capacity (supply)

bj=requirement (demand)

Now, compute the penalty for various rows and columns which is shown in the following table:

Destination
Origin 1 2 3 4 ai Column
Penalty
1 20 22 17 4 120 13
2 24 37 9 7 70 2
3 32 37 20 15 50 5
bj 60 40 30 110 240

Row Penalty 4 15 8 3

Look for the highest penalty in the row or column, the highest penalty occurs in the second column and
the minimum unit cost i.e. cij in this column is c12=22. Hence assign 40 to this cell i.e. x12=40 and cross
out the second column (since second column was satisfied. This is shown in the following table:
Destination
Origin 1 2 3 4 ai Column
Penalty
1 20 22 40 17 4 80 13
2 24 37 9 7 70 2
3 32 37 20 15 50 5
bj 60 40 30 110 240
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Row Penalty 4 15 8 3

The next highest penalty in the uncrossed-out rows and columns is 13 which occur in the first row and
the minimum unit cost in this row is c14=4, hence x14=80 and cross out the first row. The modified table
is as follows:

Destination
Origin 1 2 3 4 ai Column
Penalty
1 20 22 17 4 0 13
40 80
2 24 37 9 7 70 2
3 32 37 20 15 50 5
bj 60 40 30 110 240

Row Penalty 4 15 8 3

The next highest penalty in the uncrossed-out rows and columns is 8 which occurs in the third column
and the minimum cost in this column is c23=9, hence x23=30 and cross out the third column with
adjusted capacity, requirement and penalty values. The modified table is as follows:

Destination
Origin 1 2 3 4 ai Column
Penalty
1 20 22 17 4 0 13
40 80
2 24 37 9 7 40 17
30
3 32 37 20 15 50 17
bj 60 40 30 110 240

Row Penalty 8 15 8 8

The next highest penalty in the uncrossed-out rows and columns is 17 which occurs in the second row
and the smallest cost in this row is c24=15, hence x24=30 and cross out the fourth column with the
adjusted capacity, requirement and penalty values. The modified table is as follows:

Destination
Origin 1 2 3 4 ai Column
Penalty
1 20 22 17 4 0 13
40 80
2 24 37 9 7 10 17
30 30
3 32 37 20 15 50 17
bj 60 40 30 110 240
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MBA-H2040 Quantitative Techniques for Managers

Row Penalty 8 15 8 8

The next highest penalty in the uncrossed-out rows and columns is 17 which occurs in the second row
and the smallest cost in this row is c21=24, hence xi21=10 and cross out the second row with the adjusted
capacity, requirement and penalty values. The modified table is as follows:

Destination
Origin 1 2 3 4 ai Column
Penalty
1 20 22 17 4 0 13
40 80
2 24 37 9 7 0 17
10 30 30
3 32 37 20 15 50 17
bj 60 40 30 110 240

Row Penalty 8 15 8 8

The next highest penalty in the uncrossed-out rows and columns is 17 which occurs in the third row and
the smallest cost in this row is c31=32, hence xi31 =50 and cross out the third row or first column. The
modified table is as follows:

Destination
Origin 1 2 3 4 ai Column
Penalty
1 20 22 17 4 0 13
40 80
2 24 37 9 7 0 17
10 30 30
3 32 37 20 15 0 17
50
bj 60 40 30 110 240

Row Penalty 8 15 8 8

The transportation cost corresponding to this choice of basic variables is

22 * 40 + 4 * 80 + 9 * 30 + 7 * 30 + 24 * 10 + 32 * 50 = 3520

1.4 Modified Distribution Method

The Modified Distribution Method, also known as MODI method or u-v method, which provides a
minimum cost solution (optimal solution) to the transportation problem. The following are the steps
involved in this method.

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Step 1: Find out the basic feasible solution of the transportation problem using any one of the three
methods discussed in the previous section.

Step 2: Introduce dual variables corresponding to the row constraints and the column constraints. If
there are m origins and n destinations then there will be m+n dual variables. The dual variables
corresponding to the row constraints are represented by u i, i=1,2,…..m where as the dual variables
corresponding to the column constraints are represented by v j, j=1,2,…..n. The values of the dual
variables are calculated from the equation given below

ui + vj = cij if xij > 0

Step 3: Any basic feasible solution has m + n -1 xij > 0. Thus, there will be m + n -1 equation to
determine m + n dual variables. One of the dual variables can be chosen arbitrarily. It is also to be noted
that as the primal constraints are equations, the dual variables are unrestricted in sign.

Step 4: If xij=0, the dual variables calculated in Step 3 are compared with the c ij values of this allocation
as cij – ui – vj. If al cij – ui – vj theorem of complementary slackness it can be shown that
the corresponding solution of the transportation problem is optimum. If one or more cij – ui – vj < 0, we
select the cell with the least value of cij – ui – vj and allocate as much as possible subject to the row and
column constraints. The allocations of the number of adjacent cell are adjusted so that a basic variable
becomes non-basic.

Step 5: A fresh set of dual variables are calculated and repeat the entire procedure from Step 1 to Step 5.

Example 1.5:
For example consider the transportation problem given below:
Supply
1 9 13 36 51 50
24 12 16 20 1 100
14 33 1 23 26
150
Demand 100 70 50 40 40 300

Step 1: First we have to determine the basic feasible solution. The basic feasible solution using least
cost method is

x11=50, x22=60, x25=40, x31=50, x32=10, x33=50 and x34=40

Step 2: The dual variables u1, u2, u3 and v1, v2, v3, v4, v5 can be calculated from the corresponding cij
values, that is

u1+v1=1 u2+v2=12 u2+v5=1 u3+v1=14

u3+v2=33 u3+v3=1 u3+v4=23

Step 3: Choose one of the dual variables arbitrarily is zero that is u 3=0 as it occurs most often in the
above equations. The values of the variables calculated are
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u1= -13, u2= -21, u3=0

v1=14, v2=33, v3=1, v4=23, v5=22

Step 4: Now we calculate cij – ui – vj values for all the cells where xij=0 (.e. unallocated cell by the basic
feasible solution)
That is
Cell(1,2)= c12-u1-v2 = 9+13-33 = -11
Cell(1,3)= c13-u1-v3 = 13+13-1 = 25
Cell(1,4)= c14-u1-v4 = 36+13-23 = 26
Cell(1,5)= c15-u1-v5 = 51+13-22 = 42
Cell(2,1)= c21-u2-v1 = 24+21-14 = 31
Cell(2,3)= c23-u2-v3 = 16+21-1 = 36
Cell(2,4)= c24-u2-v4 = 20+21-23 = 18
Cell(3,5)= c35-u3-v5 = 26-0-22 = 4

Note that in the above calculation all the cij – ui – vj 12 – u1 – v2 = 9+13-

33 = -11.

Thus in the next iteration x12 will be a basic variable changing one of the present basic variables
non-basic. We also observe that for allocating one unit in cell (1, 2) we have to reduce one unit in cells
(3, 2) and (1, 1) and increase one unit in cell (3, 1). The net transportation cost for each unit of such
reallocation is
-33 -1 + 9 +14 = -11
The maximum that can be allocated to cell (1, 2) is 10 otherwise the allocation in the cell (3, 2)
will be negative. Thus, the revised basic feasible solution is

x11=40, x12=10, x22=60, x25=40, x31=60, x33=50, x34=40

1.5 Unbalanced Transportation Problem

In the previous section we discussed about the balanced transportation problem i.e. the total supply
(capacity) at the origins is equal to the total demand (requirement) at the destination. In this section we
are going to discuss about the unbalanced transportation problems i.e. when the total supply is not equal
to the total demand, which are called as unbalanced transportation problem.
In the unbalanced transportation problem if the total supply is more than the total demand then
we introduce an additional column which will indicate the surplus supply with transportation cost zero.
Similarly, if the total demand is more than the total supply an additional row is introduced in the
transportation table which indicates unsatisfied demand with zero transportation cost.
Example 1.6:

Consider the following unbalanced transportation problem

Warehouses
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Plant w1 w2 w3 Supply
20 17 25
X 400
10 10 20
Y 500

Demand 400 400 500

In this problem the demand is 1300 whereas the total supply is 900. Thus, we now introduce an
additional row with zero transportation cost denoting the unsatisfied demand. So that the modified
transportation problem table is as follows:

Warehouses
Plant w1 w2 w3 Supply
20 17 25
X 400
10 10 20
Y 500
Unsatisfied
0 0 0
Demand 400

Demand 400 400 500 1300

Now we can solve as balanced problem discussed as in the previous sections.

1.6. Degenerate Transportation Problem

In a transportation problem, if a basic feasible solution with m origins and n destinations has less than m
+ n -1 positive Xij i.e. occupied cells, then the problem is said to be a degenerate transportation
problem. The degeneracy problem does not cause any serious difficulty, but it can cause computational
problem wile determining the optimal minimum solution.
There fore it is important to identify a degenerate problem as early as beginning and take the
necessary action to avoid any computational difficulty. The degeneracy can be identified through the
following results:
“In a transportation problem, a degenerate basic feasible solution exists if and only if some
partial sum of supply (row) is equal to a partial sum of demand (column). For example the following
transportation problem is degenerate. Because in this problem
a1 = 400 = b1
a2 + a3 = 900 = b2 + b3

Warehouses
Plant w1 w2 w3 Supply (ai)
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20 17 25
X 400
10 10 20
Y 500
Unsatisfied
0 0 0
demand 400

Demand (bj) 400 400 500 1300

There is a technique called perturbation, which helps to solve the degenerate problems.

Perturbation Technique:

The degeneracy of the transportation problem can be avoided if we ensure that no partial sum of
ai (supply) and bj (demand) is equal. We set up a new problem where

ai = ai +d i = 1, 2, ……, m
bj = bj j = 1, 2, ……, n -1
bn = bn + md d>0

This modified problem is constructed in such a way that no partial sum of a i is equal to the bj.
Once the problem is solved, we substitute d = 0 leading to optimum solution of the original problem.
Example: 1.7
Consider the above problem

Warehouses
Plant w1 w2 w3 Supply (ai)
20 17 25
X 400 + d
10 10 20
Y 500 + d
Unsatisfied
0 0 0
demand 400 + d

Demand (bj) 400 400 500 + 3d 1300 + 3d

Now this modified problem can be solved by using any of the three methods viz. North-west Corner,
Least Cost, or VAM.

1.7 Transshipment Problem

There could be a situation where it might be more economical to transport consignments in several sages
that is initially within certain origins and destinations and finally to the ultimate receipt points, instead of
transporting the consignments from an origin to a destination as in the transportation problem.

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The movement of consignment involves tow different modes of transport viz. road and railways
or between stations connected by metre gauge and broad gauge lines. Similarly it is not uncommon to
maintain dumps for central storage of certain bulk material. These require transshipment.
Thus for the purpose of transshipment the distinction between an origin and destination is
dropped so that from a transportation problem with m origins and n destinations we obtain a
transshipment problem with m + n origins and m + n destinations.
The formulation and solution of a transshipment problem is illustrated with the following
Example 1.8.

Example 1.8:

Consider the following transportation problem where the origins are plants and destinations are depots.
Table 1
Depot
Plant X Y Z Supply

A 150
$1 $3 $15
B 300
$3 $5 $25
Demand 150 150 150 450

When each plant is also considered as a destination and each depot is also considered as an
origin, there are altogether five origins and five destinations. So that some additional cost data are
necessary, they are as follows:
Table 2
Unit transportation cost From Plant To Plant
To
Plant A Plant B
From

Plant A 0 55

Plant B 2 0

Table 3
Unit transportation cost From Depot To Depot
To
Depot X Depot Y Depot Z

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From

Depot X 0 25 2

Depot Y 2 0 3

Depot Z 55 3 0
Table 4
Unit transportation cost From Depot to Plant

To
Plant A Plant B
From

Depot X 3 15

Depot Y 25 3

Depot Z 45 55
Now, from the Table 1, Table 2, Table 3, Table 4
we obtain the transportation formulation of the transshipment problem, which is shown in the Table 5.

Table 5
Transshipment Table
Supply
A B X Y Z

A 0 55 1 3 15 150+450=600

B 2 0 3 5 25 300+450=750

X 3 15 0 25 2 450

Y 25 3 2 0 3 450

Z 45 55 55 3 0 450

Demand 450 450 150+450= 150+450= 150+450=

600 600 600

A buffer stock of 450 which is the total supply and total demand in the original transportation
problem is added to each row and column of the transshipment problem. The resulting transportation
problem has m + n = 5 origins and m + n = 5 destinations.
By solving the transportation problem presented in the Table 5, we obtain

x11=150 x13=300 x14=150 x21=3001 x22=450 x33=300

x35=150 x44=450 x55=450

The transshipment problem explanation is as follows:

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1. Transport x21=300 from plant B to plant A. This increase the availability at plant A to 450 units
including the 150 originally available from A.
2. From plant A transport x13=300 to depot X and x14=150 to depot Y.
3. From depot X transport x35=150 to depot Z.

Thus, the total cost of transshipment is:

2*300 + 3 * 150 + 1*300 + 2*150 = $1650

Note: The consignments are transported from pants A, B to depots X, Y, Z only according to the
transportation Table 1, the minimum transportation cost schedule is x13=150 x21=150 x22=150 with a
minimum cost of 3450.

Thus, transshipment reduces the cost of consignment movement.

1.8 Transportation Problem Maximization

There are certain types of transportation problem where the objective function is to be maximized
instead of minimized. These kinds of problems can be solved by converting the maximization problem
into minimization problem. The conversion of maximization into minimization is done by subtracting
the unit costs from the highest unit cost of the table.
The maximization of transportation problem is illustrated with the following Example 1.9.

Example 1.9:

A company has three factories located in three cities viz. X, Y, Z. These factories supplies consignments
to four dealers viz. A, B, C and D. The dealers are spread all over the country. The production capacity
of these factories is 1000, 700 and 900 units per month respectively. The net return per unit product is
given in the following table.
Dealers
Factory A B C D capacity

X 6 6 6 4 1000

Y 4 2 4 5 700

Z 5 6 7 8 900

Requirement 900 800 500 400 2600

Determine a suitable allocation to maximize the total return.

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This is a maximization problem. Hence first we have to convert this in to minimization problem.
The conversion of maximization into minimization is done by subtracting the unit cost of the table from
the highest unit cost.
Look the table, here 8 is the highest unit cost. So, subtract all the unit cost from the 8, and then
we get the revised minimization transportation table, which is given below.

Dealers
Factory A B C D capacity

X 2 2 2 4 1000 = a1

Y 4 6 4 3 700 =a2

Z 3 2 1 0 900 =a3

Requirement 900=b1 800=b2 500=b3 400=b4 2600

Now we can solve the problem as a minimization problem.

The problem here is degenerate, since the partial sum of a 1=b2+b3 or a3=b3. So consider the
corresponding perturbed problem, which is shown below.

Dealers
Factory A B C D capacity

X 2 2 2 4 1000+d

Y 4 6 4 3 700+d

Z 3 2 1 0 900+d

Requirement 900 800 500 400+3d 2600+3d

First we have to find out the basic feasible solution. The basic feasible solution by lest cost
method is x11=100+d, x22=700-d, x23=2d, x33=500-2d and x34=400+3d.
Once if the basic feasible solution is found, next we have to determine the optimum solution
using MODI (Modified Distribution Method) method. By using this method we obtain
u1+v1=2 u1+v2=2 u2+v2=6
u2+v3=4 u3+v3=1 u3+v4=0

Taking u1=0 arbitrarily we obtain

u1=0, u2=4, u3=1 and
v1=2, v2=3, v3=0

On verifying the condition of optimality, we know that

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C12-u1-v2 < 0 and C32-u3-v2 <0

So, we allocate x12=700-d and make readjustment in some of the other basic variables.

The revised values are:

x11=200+d, x12=800, x21=700-d, x23=2d, x33=500-3d, and x34=400+3d

u1+v1=2 u1+v2=2 u2+v1=4

u2+v3=4 u3+v3=1 u3+v4=0
Taking u1=0 arbitrarily we obtain
u1=0, u2=2, u3=-1
v1=2, v2=2, v3=2, v4=1
Now, the optimality condition is satisfied.

Finally, taking d=0 the optimum solution of the transportation problem is

X11=200, x12=800, x21=700, x33=500 and x34=400

Thus, the maximum return is:

6*200 + 6*800 + 4*700 + 7*500 + 8*400 = 15500

1.9 Summary

Transportation Problem is a special kind of linear programming problem. Because of the transportation
problem special structure the simplex method is not suitable. But which may be utilized to make
efficient computational techniques for its solution.
Generally transportation problem has a number of origins and destination. A certain amount of
consignment is available in each origin. Similarly, each destination has a certain demand/requirements.
The transportation problem represents amount of consignment to be transported from different origins to
destinations so that the transportation cost is minimized with out violating the supply and demand
constraints.
There are two phases in the transportation problem. First is the determination of basic feasible
solution and second is the determination of optimum solution.
There are three methods available to determine the basic feasible solution, they are
1. North West Corner Method
2. Least Cost Method or Matrix Minimum Method
3. Vogel’s Approximation Method (VAM)
In order to determine optimum solution we can use either one of the following method

1. Modified Distribution (MODI) Method

Or
2. Stepping Stone Method

Transportation problem can be generalized into a Transshipment Problem where transportation

of consignment is possible from origin to origin or destination as well as destination to origin or
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destination. The transshipment problem may be result in an economy way of shipping in some
situations.
1.10 Key Terms

Origin: is the location from which the shipments are dispatched.

Destination: is the location to which the shipments are transported.
Unit Transportation Cost: is the transportation cost per unit from an origin to destination.
Perturbation Technique: is a method of modifying a degenerate transportation problem in order to
solve the degeneracy.

1.11 Self Assessment Questions

Q1. Four companies viz. W, X, Y and Z supply the requirements of three warehouses viz. A, B and C
respectively. The companies’ availability, warehouses requirements and the unit cost of transportation
are given in the following table. Find an initial basic feasible solution using

a. North West Corner Method

b. Least Cost Method
c. Vogel Approximation Method (VAM)

Warehouses
Company A B C Supply

W 10 8 9 15

X 5 2 3 20

Y 6 7 4 30

Z 7 6 9 35

Requirement 25 26 49 100

Q2. Find the optimum Solution of the following Problem using MODI method.

Destination
Source 1 2 3 Capacity
A 42
8 9 10
B 30
9 11 11
C 28
10 12 9

Demand 35 40 25 100

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Q3. The ABT transport company ships truckloads of food grains from three sources viz. X, Y, Z to four
mills viz. A, B, C, D respectively. The supply and the demand together with the unit transportation cost
per truckload on the different routes are described in the following transportation table. Assume that the
unit transportation costs are in hundreds of dollars. Determine the optimum minimum shipment cost of
transportation using MODI method.

Mill
Source A B C D Supply

X 10 2 20 11 15

Y 12 7 9 20 25

Z 4 14 16 18 10

Demand 5 15 15 15

Q4. An organization has three plants at X, Y, Z which supply to warehouses located at A, B, C, D, and E
respectively. The capacity of the plants is 800, 500 and 900 per month and the requirement of the
warehouses is 400, 400, 500, 400 and 800 units respectively. The following table shows the unit
transportation cost.

A B C D E
X
$5 $8 $6 $6 $3
Y
$4 $7 $7 $6 $6
Z
$8 $4 $6 $6 $3

Determine an optimum distribution for the organization in order to minimize the total cost of
transportation.

Q5. Solve the following transshipment problem

Consider a transportation problem has tow sources and three depots. The availability, requirements and
unit cost are as follows:
Depot
Source D1 D2 D3 Availability
S1 30
9 8 1

S2 1 7 8 30

Requirement 20 20 20 60

In addition to the above, suppose that the unit cost of transportation from source to source and fro m
depot to depot are as:
Source
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MBA-H2040 Quantitative Techniques for Managers
S1 S2
S1
Source 0 1

S2 2 0

Depot
D1 D2 D3
D1
0 2 1
Depot
D2 2 0 9

D3 1 9 0

Find out minimum transshipment cost of the problem and also compare this cost with the corresponding
minimum transportation cost.

Q6. Saravana Store, T.Nagar, Chennai interested to purchase the following type and quantities of dresses

Dress V W X Y Z
Type
Quantity 150 100 75 250 200

Four different dress makers are submitted the tenders, who undertake to supply not more than the
quantities indicated below:

Dress A B C D
Maker
Dress 300 250 150 200
Quantity

Saravana Store estimates that its profit per dress will vary according to the dress maker as indicat es in
the following table:

V W X Y Z

A 2.75 3.5 4.25 2.25 1.5

B 3 3.25 4.5 1.75 1

C 2.5 3.5 4.75 2 1.25

D 3.25 2.75 4 2.5 1.75

Determine how should the orders to be places for the dresses so as to maximize the profit.
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1.12 Key Solutions

Q1. a. x11 = 15, x21 = 10, x22 = 10, x32 = 16, x33 = 14, x43 = 35
Minimum Cost is: 753

b. x13 = 15, x22 = 20, x33 = 30, x41 = 25, x42 = 6, x43 = 4
Minimum Cost is: 542

c. x13=15, x22=20, x33=30, x41=25, x42=6, x43=4

Minimum Cost is: 542

Q2. x11=2, x12=40, x21=30, x31=3, x33=25

Minimum Transportation Optimal cost is: 901.

Q3. x12=5, x14=10, x22=10, x23=15, x31=5, x34=5

Minimum Optimal Cost is: $435

Q4. x15=800, x21=400, x24=100, x32=400, x33=200, x34=300, x43=300 (supply shortage)
Minimum Cost of Transportation is: $9200

Q5. Transportation Problem

S1-D2=10, S1-D3=20, S2-D1=20, S2-D2=10 and
Minimum Transportation Cost is: 100

Transshipment Problem
x11=60, x12=10, x15=20, x22=50, x23=40, x33=40, x34=20, x44=60, x55=60 and
Minimum Transshipment Cost is: 100
Q6. 150 dresses of V and 50 dresses of Z by Dress Maker A
250 dresses of Y by Dress Maker B
150 dress of Z by Dress Maker C
100 dress of W and 75 dresses of X by Dress Maker D

Maximum Profit is: 1687.50

1.13 Further References

Hamdy A Taha. 1999. Introduction to Operations Research, PHI Limited, New Delhi.

Mustafi, C.K. 1988. Operations Research Methods and Practice, Wiley Eastern Ltd., New Delhi.

Mittal, K.V. 1976. Optimization Methods in Operations Research and Systems Analysis, Wiley Eastern
Ltd., New Delhi.

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UNIT II

2 ASSIGNMENT PROBLEM

LESSON STRUCTURE

2.1 Introduction
2.2 Assignment Problem Structure and
Solution
2.3 Unbalanced Assignment Problem
2.4 Infeasible Assignment Problem
2.5 Maximization in an Assignment
Problem
2.6 Crew Assignment Problem
2.7 Summary
2.8 Key Solutions
2.9 Self Assessment Questions
2.10 Key Answers
2.11 Further References

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Objectives
After Studying this lesson, you should be able
to:
Assignment Problem Formulation
How to solve the Assignment Problem
How to solve the unbalanced problem
using appropriate method
Make appropriate modification when
some problems are infeasible
Modify the problem when the objective is
to maximize the objective function
Formulate and solve the crew assignment
problems

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2.1 Introduction

The Assignment Problem can define as follows:

Given n facilities, n jobs and the effectiveness of each facility to each job, here the problem is to assign
each facility to one and only one job so that the measure of effectiveness if optimized. Here the
optimization means Maximized or Minimized. There are many management problems has a assignment
problem structure. For example, the head of the department may have 6 people available for assignment
and 6 jobs to fill. Here the head may like to know which job should be assigned to which person so that
all tasks can be accomplished in the shortest time possible. Another example a container company may
have an empty container in each of the location 1, 2,3,4,5 and requires an empty container in each o f the
locations 6, 7, 8,9,10. It would like to ascertain the assignments of containers to various locations so as
to minimize the total distance. The third example here is, a marketing set up by making an estimate of
sales performance for different salesmen as well as for different cities one could assign a particular
salesman to a particular city with a view to maximize the overall sales.
Note that with n facilities and n jobs there are n! possible assignments. The simplest way of
finding an optimum assignment is to write all the n! possible arrangements, evaluate their total cost and
select the assignment with minimum cost. Bust this method leads to a calculation problem of formidable
size even when the value of n is moderate. For n=10 the possible number of arrangements is 3268800.

2.2 Assignment Problem Structure and Solution

The structure of the Assignment problem is similar to a transportation problem, is as follows:

Jobs
1 2 … n
1 c11 c12 … c1n 1

2 c21 c21 … c2n 1

. . . . .
Workers
. . . .

. . . .

n cn1 cn2 … cnn 1

1 1 … 1

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The element cij represents the measure of effectiveness when ith person is assigned jth job. Assume that
the overall measure of effectiveness is to be minimized. The element x ij represents the number of ith
individuals assigned to the jth job. Since ith person can be assigned only one job and jth job can be
assigned to only one person we have the following

xi1 + xi2 + ……………. + xin = 1, where i = 1, 2, . . . . . . . , n

x1j + x2j + ……………. + xnj = 1, where j = 1, 2, . . . . . . . , n

and the objective function is formulated as

Minimize c11x11 + c12x12 + ……….. + cnnxnn

xij

The assignment problem is actually a special case of the transportation problem where m = n and
ai = bj = 1. However, it may be easily noted that any basic feasible solution of an assignment problem
contains (2n – 1) variables of which (n – 1) variables are zero. Because of this high degree of degeneracy
the usual computation techniques of a transportation problem become very inefficient. So, hat a separate
computation technique is necessary for the assignment problem.
The solution of the assignment problem is based on the following results:

“If a constant is added to every element of a row/column of the cost matrix of an assignment
problem the resulting assignment problem has the same optimum solution as the original assignment
problem and vice versa”. – This result may be used in two different methods to solve the assignment
problem. If in an assignment problem some cost elements c ij are negative, we may have to convert them
into an equivalent assignment problem where all the cost elements are non-negative by adding a suitable
large constant to the cost elements of the relevant row or column, and then we look for a feasible
solution which has zero assignment cost after adding suitable constants to the cost elements of the
various rows and columns. Since it has been assumed that all the cost elements are non-negative, this
assignment must be optimum. On the basis of this principle a computational technique known as
Hungarian Method is developed. The Hungarian Method is discussed as follows.

Hungarian Method:

The Hungarian Method is discussed in the form of a series of computational steps as follows, when the
objective function is that of minimization type.

Step 1:

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MBA-H2040 Quantitative Techniques for Managers
From the given problem, find out the cost table. Note that if the number of origins is not equal to the
number of destinations then a dummy origin or destination must be added.

Step 2:
In each row of the table find out the smallest cost element, subtract this smallest cost element from each
element in that row. So, that there will be at least one zero in each row of the new table. This new table
is known as First Reduced Cost Table.

Step 3:
In each column of the table find out the smallest cost element, subtract this smallest cost element from
each element in that column. As a result of this, each row and column has at least one zero element. This
new table is known as Second Reduced Cost Table.

Step 4:
Now determine an assignment as follows:

1. For each row or column with a single zero element cell that has not be assigned or
eliminated, box that zero element as an assigned cell.
2. For every zero that becomes assigned, cross out all other zeros in the same row and for
column.
3. If for a row and for a column there are two or more zero and one can’t be chosen by
inspection, choose the assigned zero cell arbitrarily.
4. The above procedures may be repeated until every zero element cell is either assigned
(boxed) or crossed out.

Step 5:
An optimum assignment is found, if the number of assigned cells is equal to the number of rows (and
columns). In case we had chosen a zero cell arbitrarily, there may be an alternate optimum. If no
optimum solution is found i.e. some rows or columns without an assignment then go to Step 6.

Step 6:
Draw a set of lines equal to the number of assignments which has been made in Step 4, covering all the
zeros in the following manner

1. Mark check (

2. Examine the checked (

respective columns that contains those zeros.

3. Examine the checked (

check (

4. The process may be repeated until now more rows or column can be checked.

5. Draw lines through all unchecked rows and through all checked columns.

Step 7:
Examine those elements that are not covered by a line. Choose the smallest of these elements and
subtract this smallest from all the elements that do not have a line through them.
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Add this smallest element to every element that lies at the intersection of two lines. Then the
resulting matrix is a new revised cost table.

Example 2.1:

Problem
A work shop contains four persons available for work on the four jobs. Only one person can work on
any one job. The following table shows the cost of assigning each person to each job. The objective is to
assign person to jobs such that the total assignment cost is a minimum.

Jobs
1 2 3 4

20 25 22 28
A
15 18 23 17
Persons B
19 17 21 24
C
25 23 24 24
D

Solution

As per the Hungarian Method

Step 1: The cost Table

Jobs
1 2 3 4

A 20 25 22 28

Persons B 15 18 23 17

C 19 17 21 24

D 25 23 24 24

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Step 2: Find the First Reduced Cost Table

Jobs
1 2 3 4

A 0 5 2 8

0 3 8 2
Persons B
2 0 4 7
C
2 0 1 1
D

Step 3: Find the Second Reduced Cost Table

Jobs
1 2 3 4

A 0 5 1 7

0 3 7 1
Persons B
2 0 3 6
C
2 0 0 0
D

Step 4: Determine an Assignment

By examine row A of the table in Step 3, we find that it has only one zero (cell A1) box this zero and
cross out all other zeros in the boxed column. In this way we can eliminate cell B1.

Now examine row C, we find that it has one zero (cell C2) box this zero and cross out (eliminate) the
zeros in the boxed column. This is how cell D2 gets eliminated.

There is one zero in the column 3. Therefore, cell D3 gets boxed and this enables us to eliminate cell
D4.

Therefore, we can box (assign) or cross out (eliminate) all zeros.

The resultant table is shown below:

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Jobs
1 2 3 4

A 0 5 1 7

Persons B 0 3 7 1

C 2 3 6

D 2 0 0

Step 5: 0

The solution obtained in Step 4 is not optimal. Because we were able to make three assignments when
four were required.

Step 6:
0
Cover all the zeros of the table shown in the Step 4 with three lines (since already we made three
assignments).

Check row B since it has no assignment. Note that row B has a zero in column 1, therefore check
column1. Then we check row A since it has a zero in column 1. Note that no other rows and columns are
checked. Now we may draw three lines through unchecked rows (row C and D) and the checked column
(column 1). This is shown in the table given below:

Jobs
1 2 3 4

A 0 5 1 7

Persons B 0 3 7 1

C 2 3 6

D 2 0 0
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MBA-H2040 Quantitative Techniques for Managers

Step 7:
Develop the new revised table.

Examine those elements that are not covered by a line in the table given in Step 6. Take the smallest
element in this case the smallest element is 1. Subtract this smallest element from the uncovered cells
and add 1 to elements (C1 and D1) that lie at the intersection of two lines. Finally, we get the new
revised cost table, which is shown below:

Jobs
1 2 3 4

A 0 4 0 6

Persons B 0 2 6 0

C 3 0 3 6

D 3 0 0 0
Step 8:

Now, go to Step 4 and repeat the procedure until we arrive at an optimal solution (assignment).

Step 9:
Determine an assignment

Examine each of the four rows in the table given in Step 7, we may find that it is only row C which has
only one zero box this cell C2 and cross out D2.

Note that all the remaining rows and columns have two zeros. Choose a zero arbitrarily, say A1 and box
this cell so that the cells A3 and B1 get eliminated.

Now row B (cell B4) and column 3 (cell D4) has one zero box these cells so that cell D4 is eliminated.

Thus, all the zeros are either boxed or eliminated. This is shown in the following table

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Jobs
1 2 3 4

A 0 4 0 6

Persons B 0 2 6

C 3 3 06

D 3 0 0

Since the number of assignments equal to the number of rows (columns), the assignment shown
in the above tale is optimal. 0

The total cost of assignment is: 78 that is A1 + B4 + C2 + D3

20 + 17 + 17 + 24 = 78

2.3 Unbalanced Assignment Problem 0

In the previous section we assumed that the number of persons to be assigned and the number of jobs
were same. Such kind of assignment problem is called as balanced assignment problem. Suppose if
the number of person is different from the number of jobs then the assignment problem is called as
unbalanced.
If the number of jobs is less than the number of persons, some of them can’t be assigned any job. So that
we have to introduce on or more dummy jobs of zero duration to make the unbalanced assignment
problem into balanced assignment problem. This balanced assignment problem can be solved by using
the Hungarian Method as discussed in the previous section. The persons to whom the dummy jobs are
assigned are left out of assignment.
Similarly, if the number of persons is less than number of jobs then we have introduce one or more
dummy persons with zero duration to modify the unbalanced into balanced and then the problem is
solved using the Hungarian Method. Here the jobs assigned to the dummy persons are left out.

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Example 2.2:

Solve the following unbalanced assignment problem of minimizing the total time for performing all the
jobs.
Jobs
1 2 3 4 5

A 5 2 4 2 5

B 2 4 7 6 6

Workers C 6 7 5 8 7

D 5 2 3 3 4

E 8 3 7 8 6

F 3 6 3 5 7

Solution

In this problem the number of jobs is less than the number of workers so we have to introduce a dummy
job with zero duration.

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The revised assignment problem is as follows:

Jobs
1 2 3 4 5 6

A 5 2 4 2 5 0

B 2 4 7 6 6 0

Workers C 6 7 5 8 7 0

D 5 2 3 3 4 0

E 8 3 7 8 6 0

F 3 6 3 5 7 0

Now the problem becomes balanced one since the number of workers is equal to the number jobs. So
that the problem can be solved using Hungarian Method.

Step 1: The cost Table

Jobs
1 2 3 4 5 6

A 5 2 4 2 5 0

Workers B 2 4 7 6 6 0

C 6 7 5 8 7 0

D 5 2 3 3 4 0

E 8 3 7 8 6 0

F 3 6 3 5 7 0
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MBA-H2040 Quantitative Techniques for Managers

Step 2: Find the First Reduced Cost Table

Jobs
1 2 3 4 5 6

A 5 2 4 2 5 0

B 2 4 7 6 6 0

Workers C 6 7 5 8 7 0

D 5 2 3 3 4 0

E 8 3 7 8 6 0

F 3 6 3 5 7 0

Step 3: Find the Second Reduced Cost Table

Jobs
1 2 3 4 5 6

A 3 0 1 0 1 0

B 0 2 4 4 2 0

Workers C 4 5 2 6 3 0

D 3 0 0 1 0 0

E 6 1 4 6 2 0

F 1 4 0 3 3 0
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MBA-H2040 Quantitative Techniques for Managers

Step 4: Determine an Assignment

By using the Hungarian Method the assignment is made as follows:

Jobs
1 2 3 4 5 6

A 3 0 1 0 1 0

B 2 4 4 2 0

Workers C 40 5 2 6 3

D 3 0 0 1 0

E 6 1 4 6 2 00

F 1 4 3 3 0

0
Step 5:

The solution obtained in Step 4 is not optimal. Because we were able to make five assignments
when six were required.

Step 6:

Cover all the zeros of the table shown in the Step 4 with five lines (since already we made five
assignments).

Check row E since it has no assignment. Note

0 that row B has a zero in column 6, therefore check
column6. Then we check row C since it has a zero in column 6. Note that no other rows and columns are
checked. Now we may draw five lines through unchecked rows (row A, B, D and F) and the checked
column (column 6). This is shown in the table given below:

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MBA-H2040 Quantitative Techniques for Managers
Jobs
1 2 3 4 5 6

A 3 0 1 0 1 0

B 2 4 4 2 0

Workers C 40 5 2 6 3

D 3 0 0 1 0

E 6 1 4 6 2 00

F 1 4 3 3 0

0
Step 7:
Develop the new revised table.

Examine those elements that are not covered by a line in the table given in Step 6. Take t he
smallest element in this case the smallest element is 1. Subtract this smallest element from the
uncovered cells and add 1 to elements (A6, B6, D6 and F6) that lie at the intersection of two lines.
Finally, we get the new revised cost table, which is shown below:

Jobs
1 2 3 4 5 6

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MBA-H2040 Quantitative Techniques for Managers

A 3 0 1 0 1 1

B 0 2 4 4 2 1

Workers C 3 4 1 5 2 0

D 3 0 0 1 0 1

E 5 0 3 5 1 0

F 1 4 0 3 3 1
Step 8:

Now, go to Step 4 and repeat the procedure until we arrive at an optimal solution (assignment).

Step 9:
Determine an assignment

Jobs
1 2 3 4 5 6

3 0 1 0 1 1
A

B 2 4 4 2 1

Workers C 30 4 1 5 2

D 3 0 0 1 1

E 5 3 5 1 0 0

F 1 4 3 3 1

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Since the number of assignments equal to the number of rows (columns), the assignment shown in the
above tale is optimal.

Thus, the worker A is assigned to Job4, worker B is assigned to job 1, worker C is assigned to
job 6, worker D is assigned to job 5, worker E is assigned to job 2, and worker F is assigned to job 3.
Since the Job 6 is dummy so that worker C can’t be assigned.

The total minimum time is: 14 that is A4 + B1 + D5 + E2 + F3

2 + 2 + 4 + 3 + 3 = 14

Example 2.3:

A marketing company wants to assign three employees viz. A, B, and C to four offices located at
W, X, Y and Z respectively. The assignment cost for this purpose is given in following table.

Offices
W X Y Z

A 160 220 240 200

Employees B
100 320 260 160

C 100 200 460 250

Solution

Since the problem has fewer employees than offices so that we have introduce a dummy
employee with zero cost of assignment.

The revised problem is as follows:

Offices
W X Y Z

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A 160 220 240 200

Employees B
100 320 260 160

C 100 200 460 250

D 0 0 0 0

Now the problem becomes balanced. This can be solved by using Hungarian Method as in the
case of Example 2.2. Thus as per the Hungarian Method the assignment made as follows:

Employee A is assigned to Office X, Employee B is assigned to Office Z, Employee C is

assigned to Office W and Employee D is assigned to Office Y. Note that D is empty so that no one is
assigned to Office Y.

The minimum cost of assignment is: 220 + 160 + 100 = 480

2.4 Infeasible Assignment Problem

Sometimes it is possible a particular person is incapable of performing certain job or a specific

job can’t be performed on a particular machine. In this case the solution of the problem takes int o
account of these restrictions so that the infeasible assignment can be avoided.

The infeasible assignment can be avoided by assigning a very high cost to the cells where
assignments are restricted or prohibited. This is explained in the following Example 2.4.

Example 2.4:

A computer centre has five jobs to be done and has five computer machines to perform them.
The cost of processing of each job on any machine is shown in the table below.

Jobs
1 2 3 4 5

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1 70 30 X 60 30

Computer 2 X 70 50 30 30
Machines

3 60 X 50 70 60

4 60 70 20 40 X

5 30 30 40 X 70

Because of specific job requirement and machine configurations certain jobs can’t be done on
certain machines. These have been shown by X in the cost table. The assignment of jobs to the machines
must be done on a one to one basis. The objective here is to assign the jobs to the available machines so
as to minimize the total cost without violating the restrictions as mentioned above.

Solution

Step 1: The cost Table

Because certain jobs cannot be done on certain machines we assign a high cost say for example
500 to these cells i.e. cells with X and modify the cost table. The revised assignment problem is as
follows:

Jobs
1 2 3 4 5

1 70 30 500 60 30

Computer 2 500 70 50 30 30
Machines

3 60 500 50 70 60

4 60 70 20 40 500

5 30 30 40 500 70
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Now we can solve this problem using Hungarian Method as discussed in the previous sections.

Step 2: Find the First Reduced Cost Table

Jobs
1 2 3 4 5

1 40 0 470 30 0

Computer 2 470 40 20 0 0
Machines

3 10 450 0 20 10

4 40 50 0 20 480

5 0 0 10 470 40

Step 3: Find the Second Reduced Cost Table

Jobs
1 2 3 4 5

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MBA-H2040 Quantitative Techniques for Managers

1 40 0 470 30 0

Computer 2 470 40 20 0 0
Machines

3 10 450 0 20 10

4 40 50 0 20 480

5 0 0 10 470 40

Step 4: Determine an Assignment

Jobs
1 2 3 4 5

1 40 0 470 30 0

Computer 2 470 40 20 0
Machines

3 10 450 200 10

4 40 50 0 20 480

5 0 100 470 40

Step 5:

The solution obtained in Step 4 is not optimal. Because we were able to make four assignments
when five were required.

Step 6:
Cover all the zeros of the table shown in the Step 4 with four lines (since already we made four
assignments). 0

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MBA-H2040 Quantitative Techniques for Managers
Check row 4 since it has no assignment. Note that row 4 has a zero in column 3, therefore check
column3. Then we check row 3 since it has a zero in column 3. Note that no other rows and columns are
checked. Now we may draw four lines through unchecked rows (row 1, 2, 3 and 5) and the checked
column (column 3). This is shown in the table given below:
Jobs
1 2 3 4 5

1 40 0 470 30 0

Computer 2 470 40 20 0
Machines

3 10 450 200 10

4 40 50 0 20 480

5 0 100 470 40

Step 7:
Develop the new revised table.

Examine those elements that are not covered by a line in the table given in Step 6. Take the
smallest element in this case the smallest element is 10. Subtract this smallest element from the
uncovered cells and add 1 to elements (A6, B6, D6 and F6) that lie at the intersection of two lines.
Finally, we get the new revised cost table, which is shown below:
Jobs
1 2 3 4 5
0

1 40 0 471 30 0

Computer 2 470 40 21 0 0
Machines

3 0 440 0 10 0

4 30 40 0 10 470

5 0 0 11 470 40
Step 8:

Now, go to Step 4 and repeat the procedure until we arrive at an optimal solution (assignment).
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Step 9:
Determine an assignment

Jobs
1 2 3 4 5

1 40 0 471 30 0

Computer 2 470 40 21 0
Machines

3 440 0 10 0

4 30 40 10 470

5 00 11 470 40

Since the number of assignments equal to the number of rows (columns), the assignment shown
in the above tale is optimal.
0
Thus, the Machine1 is assigned to Job5, Machine 2 is assigned to job4, Machine3 is assigned to
job1, Machine4 is assigned to job3 and Machine5 is assigned to job2.

The minimum assignment cost is: 170

0
2.5 Maximization in an Assignment Problem

There are situations where certain facilities have to be assigned to a number of jobs so as to
maximize the overall performance of the assignment. In such cases the problem can be converted into a
minimization problem and can be solved by using Hungarian Method. Here the conversion of
maximization problem into a minimization can be done by subtracting all the elements of the cost table
from the highest value of that table.

Example 2.5:

Consider the problem of five different machines can do any of the required five jobs with
different profits resulting from each assignment as illustrated below:

Machines
1 2 3 4 5

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1 40 47 50 38 50

2 50 34 37 31 46
Jobs

3 50 42 43 40 45

4 35 48 50 46 46

5 38 72 51 51 49

Find out the maximum profit through optimal assignment.

Solution

This is a maximization problem, so that first we have to find out the highest value in the table
and subtract all the values from the highest value. In this case the highest value is 72.

The new revised table is given below:

Machines
1 2 3 4 5

1 32 35 22 34 22

2 22 38 35 41 26
Jobs

3 22 30 29 32 27

4 37 24 22 26 26

5 34 0 21 21 23

This can be solved by using the Hungarian Method.

By solving this, we obtain the solution is as follows:

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Jobs Machines

1 3

2 5

3 1

4 4

5 2

The maximum profit through this assignment is: 264

2.6 Crew Assignment Problem

The crew assignment problem is explained with the help of the following problem
Problem:

A trip from Chennai to Coimbatore takes six hours by bus. A typical time table of the bus service
in both the direction is given in the Table 1. The cost of providing this service by the company based on
the time spent by the bus crew i.e. driver and conductor away from their places in addition to service
times. The company has five crews. The condition here is that every crew should be provided with more
than 4 hours of rest before the return trip again and should not wait for more than 24 hours for the return
trip. Also the company has guest house facilities for the crew of Chennai as well as at Coimbatore.

Find which line of service is connected with which other line so as to reduce the waiting time to
the minimum.

Table 1

Departure from Route Number Arrival at Arrival at Route Number Departure from
Chennai Coimbatore Chennai Coimbatore
06.00 1 12.00 11.30 a 05.30
07.30 2 13.30 15.00 b 09.00
11.30 3 17.30 21.00 c 15.00
19.00 4 01.00 00.30 d 18.30
00.30 5 06.30 06.00 e 00.00

Solution
For each line the service time is constant so that it does not include directly in the computation. Suppose
if the entire crew resides at Chennai then the waiting times in hours at Coimbatore for different route
connections are given below in Table 2.
If route 1 is combined with route a, the crew after arriving at Coimbatore at 12 Noon start at 5.30
next morning. Thus the waiting time is 17.5 hours. Some of the assignments are infeasible. Route c
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leaves Coimbatore at 15.00 hours. Thus the crew of route 1 reaching Coimbatore at 12 Noon are unable
to take the minimum stipulated rest of four hours if they are asked to leave by route c. Hence 1-c is an
infeasible assignment. Thus it cost is M (a large positive number).

Table 2

Route a b c d e

1 17.5 21 M 6.5 12

2 16 19.5 M 5 10.5

3 12 15.5 21.5 M 6.5

4 4.5 8 4 17.5 23

5 23 M 8.5 12 17.5

Similarly, if the crews are assumed to reside at Coimbatore then the waiting times of the crew in
hours at Chennai for different route combinations are given below in Table 3.

Table 3

Route a b c d e

1 18.5 15 9 5.5 M

2 20 16.5 10.5 7 M

3 M 20.5 14.5 11 5.5

4 7.5 M 22 18.5 13

5 13 9.5 M M 18.5

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Suppose, if the crew can be instructed to reside either at Chennai or at Coimbatore, minimum
waiting time from the above operation can be computed for different route combination by choosing the
minimum of the two waiting times (shown in the Table 2 and Table 3). This is given in the following
Table 4.
Table 4

Route a b c d e

1 17.5* 15 9 5.5 12*

2 16* 16.5 10.5 5* 10.5*

3 12* 15.5* 14.5 11 5.5

4 4.5* 8* 14* 17.5* 13

5 13 9.5 8.5* 12* 17.5*

Note: The asterisk marked waiting times denotes that the crew are based at Chennai; otherwise they are
based at Coimbatore.

Now we can solve the assignment problem (presented in Table 4) using Hungarian Method.

Step 1: Cost Table (Table 5)

Table 5

Route a b c d e

1 17.5* 15 9 5.5 12*

2 16* 16.5 10.5 5* 10.5*

3 12* 15.5* 14.5 11 5.5

4 4.5* 8* 14* 17.5* 13

5 13 9.5 8.5* 12* 17.5*

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Step 2: Find the First Reduced cost table (Table 6)

Table 6

Route a b c d e

1 12 9.5 3.5 0 6.5

2 11 11.5 5.5 0 5.5

3 6.5 10 9 5.5 0

4 0 3.5 9.5 13 8.5

5 4.5 1 0 3.5 9

Step 3: Find the Second Reduced cost table (Table 7)

Table 7

Route a b c d e

1 12 8.5 3.5 0 6.5

2 11 10.5 5.5 0 5.5

3 6.5 9 9 5.5 0

4 0 2.5 9.5 13 8.5

5 4.5 0 0 3.5 9

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Step 4: Determine an Assignment (Table 8)

Table 8

Route a b c d e

12 8.5 3.5 0 6.5

1

2 11 10.5 5.5 0 5.5

3 6.5 9 9 5.5

4 2.5 9.5 13 8.5

5 4.5 0 3.5 90

Step 5: The solution obtained in Step 4 is not optimal since the number of assignments are less than the
number of rows (columns).

Step 6: Check ( 0
check ( lumn d also. Then check row 1 since it has zero in column d. Draw the lines through the
unchecked rows and checked column using 4 lines (only 4 assignments are made). This is shown in
Table 9.
Table 9

Route a 0b c d e

12 8.5 3.5 0 6.5

1

2 11 10.5 5.5 0 5.5

3 6.5 9 9 5.5

4 2.5 9.5 13 8.5

5 4.5 0 3.5 90

123
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MBA-H2040 Quantitative Techniques for Managers

Step 7: Develop a new revised table (Table 10)

Take the smallest element from the elements not covered by the lines in this case 3.5 is the
smallest element. Subtract all the uncovered elements from 3.5 and add 3.5 to the elements lie at the
intersection of two lines (cells 3d, 4d and 5d). The new revised table is presented in Table 10.

Table 10

Route a b c d e

1 8.5 5 0 0 3

2 7.5 7 2 0 2

3 6.5 9 9 9 0

4 0 2.5 9.5 16.5 8.5

5 4.5 0 0 7 9

Step 8: Go to Step 4 and repeat the procedure until an optimal solution if arrived.

Step 9: Determine an Assignment (Table 11)

Table 11

Route a b c d e

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1 8.5 5 0 0 3

2 7.5 7 2 2

3 6.5 9 9 90

4 2.5 9.5 16.5 8.5

5 4.5 0 7 90
The assignment illustrated in the above
Table 11 is optimal since the number of assignments is equal to the number of rows (columns).

Thus, the routes to be prepared to achieve the minimum waiting time are as follows:

10 – c, 2 – d, 3 – e, 4 – a and 5 – b

By referring Table 5, we can obtain the waiting times of these assignments as well as the residence
(guest house) of the crews. This is presented in the following Table 12.
Table 12
Routes Residence of the Crew Waiting Time
0
1–c Coimbatore 9
2–d Chennai 5
3–e Coimbatore 5.5
4–a Chennai 4.5
5-b Coimbatore 9.5

2.7 Summary

The assignment problem is used for the allocation of a number of persons to a number of jobs so that the
total time of completion is minimized. The assignment problem is said to be balanced if it has equal
number of person and jobs to be assigned. If the number of persons (jobs) is different from the number
of jobs (persons) then the problem is said to be unbalanced. An unbalanced assignment problem can be
solved by converting into a balanced assignment problem. The conversion is done by introducing
dummy person or a dummy job with zero cost.
Because of the special structure of the assignment problem, it is solved by using a special
method known as Hungarian Method.

2.8 Key Terms

Cost Table: The completion time or cost corresponding to every assignment is written down in a table
form if referred as a cost table.
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Hungarian Method: is a technique of solving assignment problems.

Assignment Problem: is a special kind of linear programming problem where the objective is to
minimize the assignment cost or time.

Balanced Assignment Problem: is an assignment problem where the number of persons equal to the
number of jobs.

Unbalanced Assignment Problem: is an assignment problem where the number of jobs is not equal to
the number of persons.

Infeasible Assignment Problem: is an assignment problem where a particular person is unable to

perform a particular job or certain job cannot be done by certain machines.

2.9 Self Assessment Questions

Q1. A tourist company owns a one car in each of the five locations viz. L1, L2, L3, L4, L5 and a
passengers in each of the five cities C1, C2, C3, C4, C5 respectively. The following table shows the
distant between the locations and cities in kilometer. How should be cars be assigned to the passengers
so as to minimize the total distance covered.

Cities
C1 C2 C3 C4 C5

L1 120 110 115 30 36

Locations L2 125 100 95 30 16

L3 155 90 135 60 50

L4 160 140 150 60 60

L5 190 155 165 90 85

Q2. Solve the following assignment problem

1 2 3 4 5

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1
Rs.3 Rs.8 Rs.2 Rs.10 Rs.3

2 Rs.8 Rs.7 Rs.2 Rs.9 Rs.7

3 Rs.6 Rs.4 Rs.2 Rs.7 Rs.5

4 Rs.8 Rs.4 Rs.2 Rs.3 Rs.5

5 Rs.9 Rs.10 Rs.6 Rs.9 Rs.10

Q3. Work out the various steps of the solution of the Example 2.3.

Q4. A steel company has five jobs to be done and has five softening machines to do them. The cost of
softening each job on any machine is given in the following cost matrix. The assignment of jobs to
machines must be done on a one to one basis. Here is the objective is to assign the jobs to the machines
so as to minimize the total assignment cost without violating the restrictions.

Jobs
1 2 3 4 5

1 80 30 X 70 30

Softening 2 70 X 60 40 30
Machines

3 X 80 60 80 70

4 70 80 30 50 X

5 30 30 50 X 80

Q5. Work out the various steps of the solution of the problem presented in Example 2.5.

Q6. A marketing manager wants to assign salesman to four cities. He has four salesmen of varying
experience. The possible profit for each salesman in each city is given in the following table. Find out an
assignment which maximizes the profit.

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Cities
1 2 3 4

1 25 27 28 38

Salesmen 2 28 34 29 40

3 35 24 32 33

4 24 32 25 28

Q7. Shiva’s three wife, Rani, Brinda, and Fathima want to earn some money to take care of personal
expenses during a school trip to the local beach. Mr. Shiva has chosen three chores for his wife:
washing, cooking, sweeping the cars. Mr. Shiva asked them to submit bids for what they feel was a fa ir
pay for each of the three chores. The three wife of Shiva accept his decision. The following table
summarizes the bid received.

Chores
Washing Cooking Sweeping
1 2 3

Rani 25 18 17

Wife’s Brinda 17 25 15

Fathima 18 22 32

Q8. Solve the following problem

Office
O1 O2 O3 O4

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E1 2600 3200 3400 3000

Employees E2 2000 4200 3600 2600

E3 2000 3000 5600 4000

Q9. The railway operates seven days a week has a time table shown in the following table. Crews
(Driver and Guard) must have minimum rest of six hours between trans. Prepare the combination of
trains that minimizes waiting time away from the city. Note that for any given combination the crew will
be based at the city that results in the smaller waiting time and also find out for each combination the
city where the crew should be based at.

Train No. Departure at Arrival at Train No. Departure at Arrival at

Bangalore Chennai Chennai Bangalore
101 7 AM 9 AM 201 9 AM 11 AM
102 9 AM 11 AM 202 10 AM 12 Noon
103 1.30 PM 3.30 PM 203 3.30 PM 5.30 PM
104 7.30 PM 9.30 PM 204 8 PM 10 PM

2.10 Key Solutions

Q1. L1 – C1, L2 – C3, L3 – C2, L4 _ C4, L5 – C5 and

Minimum Distance is: 450

Q2. 1 – 5, 2 – 3, 3 – 2, 4 – 4, 5 – 1 and
Minimum Cost is: Rs.21

Q4. 1 – 2, 2 – 4, 3 – 3, 4 – 4, 5 – 1 and
Minimum Assignment Cost is:

Q6. 1 - 1, 2 – 4, 3 – 3, 4 – 2 and
Maximum Profit is: 139

Q7. Rani – Cooking, Brinda – Sweeping, Fathima – Washing and

Minimum Bids Rate is: 51

Q8. E1 – O2, E2 – O4, E3 – O1

Since E4 is empty, Office O3 cannot be assigned to any one.
Minimum Cost is: 7800

Q9. Trains Cities

201 – 103 Bangalore

202 – 104 Chennai
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203 – 101 Bangalore
204 – 102 Bangalore

2.11 Further References

Hamdy A Taha, 1999. Introduction to Operations Research, PHI Limited, New Delhi.

Cooper, L and D. Steinberg, 1974. Methods and Applications of Linear Programmings, Saunders,
Philadelphia, USA.

Mustafi, C.K. 1988. Operations Research Methods and Practices, Wiley Eastern Limited, New Delhi.

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UNIT II

3 INTRODUCTION TO INVENTORY MANAGEMENT

LESSON STRUCTURE

3.1 Introduction
3.2 Objectives of Inventory
3.3 Inventory is an Essential Requirement
3.4 Basic Functions of Inventory
3.5 Types of Inventory
3.6 Factors Affecting Inventory
3.7 Summary
3.8 Key Terms Objectives
3.9 Self Assessment Questions After Studying this lesson, you should be able
3.10 Further References to:

Understand what is inventory

Describe various inventory concepts
Describe the objectives of inventory
Explain the functions of inventory
Describe requirements of inventory
Explain different types of inventory
Describe different factors affecting
inventory

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3.1 Introduction

Simply inventory is a stock of physical assets. The physical assets have some economic value, which
can be either in the form of material, men or money. Inventory is also called as an idle resource as long
as it is not utilized. Inventory may be regarded as those goods which are procured, stored and used for
day to day functioning of the organization.
Inventory can be in the form of physical resource such as raw materials, semi-finished goods
used in the process of production, finished goods which are ready for delivery to the consumers, human
resources, or financial resources such as working capital etc.
Inventories means measures of power and wealth of a nation or of an individual during centuries
ago. That is a business man or a nation’s wealth and power were assessed in terms of grammes of gold,
heads of cattle, quintals of rice etc.
In recent past, inventories mean measure of business failure. Therefore, businessmen have
started to put more emphasis on the liquidity of assets as inventories, until fast turnover has beco me a
goal to be pursues for its own sake.
Today inventories are viewed as a large potential risk rather than as a measure of wealth due to
the fast developments and changes in product life. The concept of inventories at present has necessitated
the use of scientific techniques in the inventory management called as inventory control.
Thus, inventory control is the technique of maintaining stock items at desired levels. In other
words, inventory control is the means by which material of the correct quality and quant ity is made
available as and when it is needed with due regard to economy in the holding cost, ordering costs, setup
costs, production costs, purchase costs and working capital.
Inventory Management answers two questions viz. How much to order? and when to order?
Management scientist insisting that the inventory is an very essential requirement. Why? This is
illustrated in the next section with the help of materials conversion process diagram.
3.2 Objectives of Inventory

Inventory has the following main objectives:

To supply the raw material, sub-assemblies, semi-finished goods, finished goods, etc. to
its users as per their requirements at right time and at right price.
To maintain the minimum level of waste, surplus, inactive, scrap and obsolete items.
To minimize the inventory costs such as holding cost, replacement cost, breakdown cost
and shortage cost.
To maximize the efficiency in production and distribution.
To maintain the overall inventory investment at the lowest level.
To treat inventory as investment which is risky? For some items, investment may lead to
higher profits and for others less profit.

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3.3 Inventory is an Essential Requirement

Inventory is a part and parcel of every facet of business life. Without inventory no business activity can
be performed, whether it being a manufacturing organization or service organization such as libraries,
banks, hospitals etc. Irrespective of the specific organization, inventories are reflected by way of a
conversion process of inputs to outputs. The conversion process is illustrated in the figure 3.1 as given
below.
From the figure 3.1 we can see that there may be stock pints at three stages viz. Input,
Conversion Process and Output. The socks at input are called raw materials whereas the stocks at the
output are called products. The stocks at the conversion process may be called finished or semi-finished
goods or sometimes may be raw material depending on the requirement of the product at conversion
process, where the input and output are based on the market situations of uncertainty, it becomes
physically impossible and economically impractical for each stock item to arrive exactly where it is
required and when it is required.
Random Fluctuations

Conversion
Inputs Inventory process Inventory
Sock-points

Comparing Actual Material

Stock levels to planned levels
Material Sock-Points

Land
Outputs
Labour
Capital
Management

Feed Back Product Inventory

Stock-points
Corrective action: More or less Stocks

Fig: 3.1 Materials Conversion Process

Even it is physically possible to deliver the stock when it is required, it costs more expensive. This is the
basic reason for carrying the inventory. Thus, inventories play an essential and pervasive role in any
organization because they make it possible:
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To meet unexpected demand

To achieve return on investment
To order largest quantities of goods, components or materials from the suppliers at
advantageous prices
To provide reasonable customer service through supplying most of the requirements from
stock without delay
To avoid economically impractical and physically impossible delivering/getting right
amount of stock at right time of required
To maintain more work force levels
To facilitate economic production runs
To advantage of shipping economies
To smooth seasonal or critical demand
To facilitate the intermittent production of several products on the same facility
To make effective utilization of space and capital
To meet variations in customer demand
To take the advantage of price discount
To hedge against price increases
To discount quantity

3.4 Basic Functions of Inventory

The important basic function of inventory is

Increase the profitability- through manufacturing and marketing support. But zero
inventory manufacturing- distribution system is not practically possible, so it is
important to remember that each rupee invested in inventory should achieve a specific
goal. The other inventory basic functions are

Geographical Specialization
Decoupling
Balancing supply and demand and
Safety stock

Inventory Investment Alternative

Investment is most important and major part of asset, which should be required to produce a minimum
investment return. The MEC (Marginal Efficiency of Capital) concept holds that an organization should
invest in those alternatives that produce a higher investment return than capital to borrow. The following
figure 3.2 shows that investment alternative A on the MEC curve is acceptable.

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100

Accepted Inventory Investment

A Cost of Capital

Reject Inventory Investment

0 20 40 60 80 100
Total Investment Alternatives (in %)
Fig 3.2 Typical MEC curve

The curve shows that about 20% of the inventory investment alternatives will produce a return
on investment above the capital cost.

Geographical Specialization

Another basic inventory function is to allow the geographical specialization individual operating units.
There is a considerable distance between the economical manufacturing location and demand areas due
to factors of production such as raw material, labour, water, power. So that the goods from various
manufacturing locations are collected at a simple warehouse or plant to assemble in final product or to
offer consumers a single mixed product shipment. This also provides economic specialization between
manufacturing and distribution units/locations of an organization.
Decoupling
The provision of maximum efficiency of operations within a single facility is also one of the important
basic functions of the inventory. This is achieved by decoupling, which is done by breaking operations
apart so that one operation(s) supply is independent of another(s) supply.
The decoupling function serves in two ways of purposes, they are
1. Inventories are needed to reduce the dependencies among successive stages of operations so that
shortage of materials, breakdowns or other production fluctuations at one stage do not cause later stage
to shut down. This is illustrated in the following figure 3.3 in an engineering unit.

Raw Die casting Drilling De-burning Packing Finished

Material Products

Inventory Inventory

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Fig: 3.3 Decoupling of operation using inventory
The figure shows that the de-burning, packing could continue to operate from inventories should
die-casting and drilling be shut down or they can be decoupled from the production processes that
precede them.

2. One organizational unit schedules its operations independently of another organizational unit.
For example: Consider an automobile organization, here assembly process can be schedule separately
from engine built up operation, and each can be decoupled from final automobile assembly operations
through in process inventories.

Supply and Demand Balancing

The function of Balancing concerns elapsed time between manufacturing and using the product.
Balancing inventories exist to reconcile supply with demand. The most noticeable example of balancing
is seasonal production and year round usage like sugar, rice, woolen textiles, etc. Thus the investment of
balancing inventories links the economies of manufacturing with variations of usage.
Safety Stock
The safety stock also called as buffer stock. The function of safety stock concerns short range variations
in either replacement or demand. Determination of the safety stock size requires a great deal of
inventory planning. Safety stock provides protection against two types of uncertainty, they are

1. Sales in excess of forecast during the replenishment period

2. Delays in replenishment
Thus, the inventories committed to safety stocks denote the greatest potential for improved
performances. There are different techniques are available to develop safety stocks.
3.5 Types of Inventory

Inventory may be classified into manufacturing, service and control aspects, which is illustrated in the
figure 3.4 as given below:

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MBA-H2040 Quantitative Techniques for Managers

Raw Materials/Production Inventory

Work-in-Process Inventory

Manufacturing M.R.O Inventory

Aspect

Finished Goods Inventory

Miscellaneous Inventory

Lot Size Stocks

Anticipation Stocks
Inventory Service Aspect

Fluctuation Stocks

Risk Stocks

A-Items Inventory

B-Items Inventory
Control Aspect

C-Items Inventory
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Each inventory type is discussed in detail are as follows:

Raw Material/Manufacturing Inventory

There are five types of Manufacturing Inventory, they are

Production Inventory

Items going to final product such a raw materials, sub-assemblies purchased from outside are called
production inventory.

Work-in-Process Inventory

The items in the form of semi-finished or products at different stage of production process are known as
work-in-process inventory.

M.R.O. Inventory

Maintenance, Repair and Operating supplies such as spare parts and consumable stores, which do not go
into final product but are consumed during the production process.

Finished Goods Inventory

Finished Goods Inventory includes the products ready for dispatch to the consumers or
distributors/retailers.

Miscellaneous Inventory

Items excluding those mentioned above, such as waste, scrap, obsolete, and un-saleable items arising
from the main production process, stationery used in the office and other items required by office,
factory and other departments, etc. are called miscellaneous inventory.

Service Inventory

The service inventory can be classified into four types, they are:

Lot Size Stocks

Lot size means purchasing in lots. The reasons for this is to
Obtain quantity discounts
Minimize receiving and handling costs
Reduce purchase and transport costs

For example: It would be uneconomical for a textile factory to buy cotton everyday rather than in
bulk during the cotton season.

Anticipation Stocks

Anticipation stocks are kept to meet predictable changes in demand or in availability of raw materials.

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For example: The purchase of potatoes in the potato season for sale of roots preservation products
throughout the year.
Fluctuation Stocks

Fluctuation stocks are carried to ensure ready supplies to consumers in the face of irregular fluctuations
in their demands

Risk Stocks

Risk stocks are the items required to ensure that there is no risk of complete production breakdown. Risk
stocks are critical and important for production.

Control Inventory

A good way of examining an inventory control is: to make ABC classification, which is also known as
ABC analysis. ABC analysis means the “control” will be “Always Better” if we start with the ABC
classification of inventory.
The ABC concepts classifies inventories into three groups in terms of percentage of total value
and percentage of number of inventory items, this is illustrated in the figure 3.5 and 3.6 as given below.

Values

A A
10% 70%

A items 20% 20%

B B

B items
70% 10% C
C items
C

Percentage of Numbers Numbers

Fig: 3.5 ABC Classification (Frequency Form) Fig: 3.6 ABC Classification (Tabular Form)

The three groups of inventory items are called A-items group, B-items group, C-items group,
which are explained as follows:

A-items Group: This constitutes 10% of the total number of inventory items and 70% of total money
value for all the items.

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B-items Group: This constitutes 20% of the total number of inventory items and 20 % of tot al money
value for all the items.

C-items Group: This constitutes 70% of the total number of inventory items and 10 % of total money
value for all the items. This is just opposite of A-items group.

The ABC classification provides us clear indication for setting properties of control to the items,
and A-class item receive the importance first in every respect such as tight control, more security, and
high operating doctrine of the inventory control.
The coupling of ABC classification with VED classification enhances the inventory control
efficiency. VED classification means Vital, Essential and Desirable Classification. From the above
description, it may be noted that ABC classification is based on the logic of proportionate value while
VED classification based on experience, judgment, etc. The ABC /VED classification is presented in the
following figure 3.7.

V E D Total
A 3 5 2 10
B 5 7 8 20
C 10 40 20 70
Total 18 52 30 100

Fig: 3.7 ABC/VED Classifications

This is an example of a particular case
The values are expressed in percentage

Note that the total number of categories becomes nine.

3.6 Factors Affecting Inventory

The main problem of inventory control is to answer tow questions viz.

1. How much to order? and
2. When to order?
These questions are answered by developing a inventory model, which is based on the
consideration of the main aspects of inventory viz. demand and cost. There are many factors related with
these tow main factors (Demand and Cost). In this section we will discuss these different factors.
The different factors are:

Economic Parameters
Demand
Ordering Cycle
Delivery Lag
Time Horizon
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Stages of Inventory
Number of Supply Echelons
Number and Availability of Items
Government’s and Organization’s Policy
Economic Parameters

There are different types of economic parameters, they are:

Purchase Price
Procurement Costs
Selling Price
Holding Costs
Shortage costs
Information Processing System Operating Costs
Purchase Cost
The cost of the item is the direct manufacturing cost if it is produced in in-house or the cost paid to the
supplier for the item received. This cost usually equal to the purchase price. When the marketing pr ice
goes on fluctuating, inventory planning is based on the average price mostly it is called as a fixed price.
When price discounts can be secured or when large production runs may result in a decrease in the
production cost, the price factor is of special interest.
Procurement Costs
The costs of placing a purchase order is known as ordering costs and the costs of initial preparation of a
production system (if in-house manufacturing) is called as set up cost. These costs are called as
procurement cost, but these costs vary directly with each purchase order placed or with set up made and
are normally assumed independent of the quantity ordered or produced.
Procurement costs include costs of transportation of items ordered, expediting and follow up,
goods receiving and inspection, administration (includes telephone bills, computer cost, postage, salaries
of the persons working for tendering, purchasing, paper work, etc.), payment processing etc. This cost is
expressed as the cost per order/setup.
Holding Costs
The holding costs also called as carrying costs. The cost associated with holding/carrying of stocks is
called holding cost or carrying cost or possession cost. Holding costs includes handling/carrying cost,
maintenance cost, insurance, safety measures, warehouse rent, depreciation, theft, obsolescence, salaries,
interest on the locked money, etc. Thus, by considering all these elements the storage cost is expressed
either as per unit of item held per unit of time or as a percentage of average money value of invest ment
held. Therefore the size of all these holding costs usually increases or decreases in proportion to the
amount of inventory that is carried.
Shortage Costs

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These costs are penalty costs as a result of running out of stock at the time of item is required. There are
different forms of shortage cost, which is illustrated in the following figure 3.8. One form of the
shortage costs is called as back order on the selling side or backlogging cost on the production side when
the unsatisfied demand can be satisfied at later stage that is consumers has to wait till they gests the
supply.
The second form of shortage costs is called as lost sales costs on the selling side or no
backlogging costs on the production side, when the unsatisfied demand is lost or the consumers goes
some where else instead of waiting for the supply.
Shortage Costs

Selling Side Production Side

Back order Costs Lost Sales Costs Backlogging No Backlogging

Costs Costs

Fig: 3.8 Nature of Shortage Costs

These includes the costs of production stoppage, overtime payments, idle machine, loss of
goodwill, loss of sales opportunity, special order at higher price, loss of profits etc.
Information System Operation Costs
Today there are more inventory records should be maintain in the organization, so that some person
must update the records either by hand or by using computer. If the inventory levels are not recorded
daily, this operating cost is incurred in obtaining accurate physical inventory record counts. The
operating costs are fixed.
Demand
A commodity demand pattern may be deterministic or probabilistic.

Deterministic Demand
In this case, the demand is assumed that the quantities of commodity needed over subsequent periods of
time are known with certainty. This is expressed over equal time periods in terms of known constant
demands or in terms of variable demands. The two cases are called as static and dynamic demands.
Probabilistic Demand
This occurs when requirements over a certain time period are not known with certainty but their patt ern
can be denoted by a known probability distribution. In this case, the probability distribution is said to be
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stationary or non-stationary over time periods. The terms stationary and non-stationary are equivalent to
the terms static and dynamic in the deterministic demand.

For a given time period the demand may be instantaneously satisfied at the beginning of the time period
or uniformly during that time period. The effect of uniform and instantaneous demand directly reflects
on the total cost of carrying inventory.

Ordering Cycle

The ordering cost is related with the inventory situation time measurement. An ordering cycle can be
identified by the time period between two successive placements of orders. The later may be initiated in
one of two ways as:
Periodic Review
Continuous Review

Periodic Review
In this case, the orders are placed at equally intervals of time.

Continuous Review
In this case, an inventory record is updated continuously until a certain lower limit is reached at this
point a new order is placed. Some times this is referred as the two-bin system.

Delivery Lag

The requirement of the inventory is felt and an order is placed, it may be delivered instantaneously or
some times it may be needed before delivery if affected. The time period between the placement of the
requisition for an item and its receipt for actual use is called as delivery lag. The delivery lags also
known as lead time.
There are four different types of lead time, they are
Administrative Lead Time
Transportation Lead Time
Suppliers Lead Time
Inspection Lead Time
The Inspection Lead Time and Administrative Lead Time can be fixed in nature, where as the
Transportation Lead Time and Suppliers Lead Time can never be fixed. It means generally the lead time
may be deterministic or probabilistic.
Time Horizon
Time horizon is, the planning period over which inventory is to be controlled. The planning period may
be finite or infinite in nature. Generally, inventory planning is done on annual basis in most of the
organizations.
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Stages of Inventory
In the sequential production process, if the items/parts are stocked at more than one point they are called
multi-stage inventories. This is illustrated in the following figure 3.9.

Raw Die casting Drilling De-burning Packing Finished

Material Products

Inventory Inventory

Fig: 3.9 Multistage Inventories

Number of Supply Echelons
Already we saw that there are several stocking points in the inventory system. These stocking points are
organized in such that one points act as a supply source for some other points. For example, the
production factories supplies the products to warehouse and the warehouse supplies to the retailer and
then to the consumers. In this the each level of movement of the product is called on echelon. This is
illustrated in the figure 3.10 given below.

Consumer

Consumer
Retailer

Consumer
Warehouse

Retailer
Production
Factory
Warehouse

Fig: 3.10 Multi Echelon Supply Systems

Number and Availability of Items

Due to different marker situations some times supply position is poorly affected, which in turn affects
the poison of inventory in the organizations.
Generally inventory includes more than one item. Therefore the number of items in inventory
affects the situation when these items complete for limited total capital or limited space.
Government’s and Organization’s Policy
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There are different governments and as well as organization policies such as import and export,
availability of capital, land, labour, pollutions systems, etc. The government has laid down some po licy
norms for items to be imported as well as for other items like highly inflammable, explosive and other
important materials. Similarly, an organization also has certain policies based on the availability of
capital, labour, etc. All these policies affect organization inventories level.
We have discussed different factors that affect the inventory in an organization (above). These
factors are responsible for the development of proper inventory system is called as characteristics of
inventory.

3.7 Summary
This lesson illustrated the introduction of inventory and inventory management/control. This lesson also
illustrated the objectives of inventory, inventory functions, inventory types and the various factors
affecting the inventory.
3.8 Key Terms

Carrying Cost: Cost of maintaining one unit of an item in the stock per unit of time (normally one
year). The carrying cost also called as Holding Cost.

Decoupling: Use of inventories to break apart operations so that one operations supply is independent of
another.

Backlog: Accumulation of unsatisfied demands

Delivery Lag: Time between the placing of an order for the item and receipt of the items for use.

ABC Classification: Classifications of inventories in terms of annual usage value in different categories
of high value (A), medium value (B) and low value (C).

VED Classification: Vital Essential Desirable Classification. This is based on experience/judgment.

VED classification when coupled with ABC classification enhances the inventory control efficiency.

3.9 Self Assessment Questions

Q1. What is inventory and their Objectives?

Q2. Discuss different types of inventory.
Q3. What are the major functions of inventory in an organization?
Q4. Explain different factors affect the inventory?
Q5. Some business peoples think that inventory as necessary evil while others think inventory as an
asset. What is your view?

3.10 Further References

Hamdy A Taha, 1999. Introduction to Operations Research, PHI Limited, New Delhi.
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MBA-H2040 Quantitative Techniques for Managers
Mustafi, C.K. 1988. Operations Research Methods and Practices, Wiley Eastern Limited, New Delhi.
Levin, R and Kirkpatrick, C.A. 1978. Quantitative Approached to Management, Tata McGraw Hill,
Kogakusha Ltd., International Student Editon.
Levin and Rubin. Quantitative Techniques for Managers, PHI, New Delhi.

UNIT II

4 INVENTORY MODELS

LESSON STRUCTURE

4.1 Introduction
4.2 Deterministic Inventory Model
4.3 Deterministic Single Item Inventory Model
4.3.1 Economic Order Quantity Model I
4.3.2 Economic Order Quantity Model II
4.3.3 Economic Production Quantity Model
4.3.4 Price Discounts Model
4.3.5 Dynamic Demand Models
4.4 Deterministic Multi Items Inventory Model
4.4.1 Unknown Cost Structure Model
4.4.2 Known Cost Structure Model Objectives
4.5 Probabilistic Inventory Models After Studying this lesson, you should be able
4.5.1 Single Period Probabilistic Model to:
4.5.2 Single Period Discrete Probabilistic Understand Simple Deterministic
Demand Model Inventory Models
4.6 Summary Understand Simple Probabilistic
4.7 Key Terms Inventory Models
4.8 Self Assessment Questions Develop Simple Deterministic Inventory
4.9 Further References Models
Illustrate the use of Simple Inventory
Models in Practical Situations
Briefly explain Single Item Inventory
Models
Briefly explain Multi Item Inventory
Models
Describe static and dynamic Inventory
Models
Develop Single Period Probabilistic
Models

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4.1 Introduction

The methodology for inventory situation modeling is based on four concepts, they are:

1. Examine the inventory situation, list characteristics and assumption related to the
inventory situation.
2. Develop the total annual relevant cost equation in narrative form as:

Total annual Procurement Carrying cost Stock out costs

relevant cost = Item cost + cost + (cycle stocks + (cost/sales back
+ safety order)
stocks)

3. Convert the total annual relevant cost equation from narrative form into the shorthand
logic of mathematics.
4. Optimize the cost equation by finding the optimum for how much to order (also called
order quantity), when to re-order (also called re-order point) and the total annual
relevant cost.

In general, the situation of inventory can be classified into tow types viz. deterministic and
stochastic.

Deterministic- in this variables are known with certainty

Stochastic – in this variables are probabilistic

This lesson briefly outlines Deterministic Inventory Models and Probabilistic (Discrete
Demand Distribution Model) Inventory Models.

In this section we will discuss deterministic inventory models and later we will discuss
probabilistic inventory models (section 4.5).

4.2 Deterministic Inventory Models

There are different deterministic inventory models, they are:

a. Deterministic single item Inventory Models

i. EOQ – Economic Order Quantity Model – I
ii. EOQ – Economic Order Quantity Model – II (instantaneous supply
when shortages are allowed)
iii. EPQ – Economic Production Model (Gradual supply case and shortage
not allowed)
iv. Price Discounts Model (instantaneous supply with no shortages)
v. Dynamic Demand Models

b. Deterministic multi-item Inventory Models

i. Unknown cost structure Model
ii. Known cost structure Model

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4.3 Deterministic Single Item inventory Models

Inventory models with all the known parameters with certainty are known as deterministic
inventory model. In this section we will discuss the deterministic inventory models for sing
item.
4.3.1 Economic Order Quantity (EOQ) Model I
The EOQ concept applies to the items which are replenished periodically into inventory in
lots covering several periods’ needs, subject to the following conditions:

Consumption of item or sales or usage is uniform and continuous

The item is replenished in lots or batches, either by manufacturing or by purchasing

Description

The EOQ model is described under the following situations:

a. Demand is deterministic and it is denoted by D units per year.

b. Price per Unit or cost of purchase is C.
c. Planning period is one year.
d. Ordering Cost or Procurement Cost or Replenishment Cost is C o. Suppose if the items
are manufactured it is known as set up cost.
e. Holding Cost (or carrying cost) is Ch per unit of item per one year time period. The
Ch is expressed either in terms of cost per unit per period or in terms of percentage
charge of the purchase price.
f. Shortage Cost (mostly it is back order cost) is Cs per unit per year.
g. Order Size is Q.
h. Cycle period of replenishment is t.
i. Delivery lad/Lead Time is L (expressed in units of time)

In this section we will discuss about instantaneous supply when shortages are not allowed.
That is whatever is demanded, is supplied immediately after the lead time. If we assume these
constraints, a graph of inventory against time will be look like a regular saw-tooth pattern as
given below (Fig: 4.1).

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Inventory

Inventory

Reorder Point

Q
Q/2

L L Time
Reorder Level
t t t

Fig: 4.1. Saw-Tooth Inventory Model

- In this model we assumed that the shortages are not allowed, it means that shortage
cost is prohibitive or Cs is too much large or infinite.
- Everything is so known and regular, there is no need of safety stock.
- Inventory will run out altogether just as the next lot is received.

The different levels of inventories for this model are fixed as follows:
- Minimum level = Safety Stock (Buffer Stock)
- Maximum level = Minimum level + EOQ
- Reorder level = Minimum level + Lead Time Consumption

-- In this case safety stock is not needed, so that safety stock is zero i.e. Minimum
level = 0.
-- Maximum Inventory is the ORDER SIZE (lot size).
-- Maximum Inventory is the ORDER SIZE (lot size).
Therefore, the average inventory per cycle = ½(Maximum level + Minimum level).
Here cycle is the intermittent pattern, in which inventory vary from maximum
to minimum and then back to maximum.

-- Maximum inventory is Q
Therefore, the average inventory per cycle = ½(Q+O) =Q/2, and the average
inventory is time
independent.

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In this case, the Total Annual Relevant Cost is as follows:

Total annual Annual Purchase

= + Annual Ordering
relevant cost Cost (PC) +
Cost (OC)
(TC) Annual Carrying
Cost (CC)

Quantity Ordering Number of Carrying Cost

Average
= (Price/Unit) Purchased + Cost/Order Orders placed / + per unit
number of
Per Year year
units carried

-------------- eq.1
Note that,
Number of Orders/Year = Annual Demand/Order Size

= D/Q
Thus, the eq.1 is written as:

TC = CD + Co D/Q + Ch Q/2 ------------------- eq.2

The EOQ or Order Size is that quantity, which minimizes the Total Cost. Total Cost is the
sum of Fixed Cost and Variable Cost. The Fixed Cost (CD) is independent of Order Size
while the variable Cost is dependent on the Order Size (Q). Since, the fixed cost does not play
any in minimization or maximization process, only variable cost will be minimized here.

For the total cost to be minimum, the first order derivative of TC is zero, that is,

dTC/dQ = -CoD/Q2 +Ch/2 = 0 ----- eq.3 or CoD/Q = ChQ/2 --------- eq.4

or

Annual Ordering Cost = Annual Carrying Cost ----------- eq.5

The eq.5 may also be obtained from the following fig: 4.2

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TOTAL COST
Total Cost Curve

Annual Carrying
Cost Curve

TC
Annual Ordering Cost
Curve

Annual Purchase Cost

Curve

Q* ORDER SIZE = Q

Fig: 4.2. Inventory Control Cost Trade-offs

Now, if we examine the eq.2 that is the total cost equation, we obtain the relationship
between the fixed cost and variable cost. This relationship is shown in the above fig.4.2. Note
that the total cost curve has the lowest value just above the intersection of the ordering cost
curve and carrying cost curve, and also at the intersection annual cost is equal to the annual
carrying cost.

From the eq.4, now we will get

EOQ = Q* = 2CoD ----------- eq.6

Ch
The cycle period t = Optimal Order Quantity or t* = Q* = 2Co ----------
eq.7
Annual Demand D ChD

N = Total number of orders per year , which is the reciprocal of cycle period (1/t*)

That is
N=D = ChD ------------------ eq.8

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Q 2Co

The annual cost = TC = CD + 2CoChD ----------- eq.9

Lead Time Consumption = (Lead time in years) * (Demand Rate per year)

Minimum Level = O
Maximum Level = Q*
Reorder Level = LD

Let us see few example of this case.

Example 4.1

A manufacturer uses Rs.20, 000 worth of an item during the year. Manufacturer estimated the
ordering cost as Rs.50 per order and holding costs as 12.5% of average inventory value. Find
the optimal order size, number of orders per year, time period per order and total cost.

Solution

Given that:
D = Rs.20, 000
Co = Rs.50
Ch = 12.5% of average inventory value / unit

Total Cost = TC = 25D + (0.125) Q , where Q is order size in Rs.

Q D

By applying the equations (eq.6) to (eq.9), we will get Q*, t*, N

Ñ

Q* = 2CoD
Ch

= 2 * 50 * 20000 = Rs.4000
0.125

t* = 2Co
ChD

= 2 * 50 = 1 years = 73 days
(0.125) * (20000) 5

N=1 =5
t*

Note: TC means in this case variable cost only

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TC* = 2 * 50 * 0.125 * 20000 = Rs.500

Therefore
Order Size = Q = Rs.4000
Number of order / year = N = 5
Time period / order = t* = 73 days
Total Cost = TC* = Rs.500
Example 4.2
A manufacturer uses an item at a uniform rate of 25,000 units per year. Assume that no
shortage is allowed and delivery is at an infinite rate. The ordering, receiving and hauling cost
is Rs.23 per order, while inspection cost is Rs.22 per order. Interest costs is Rs.0.056 and
deterioration and obsolescence cost is Rs.0.004 respectively per year for each item actually
held in inventory plus Rs.0.02 per year per unit based on the maximum number of units in
inventory.

Determine the EOQ. If lead time is 40 days, find reorder level.

Solution

Given that

Demand = D = 25000 units/year

Ordering Cost = Co = 23 + 22 = Rs.45 per order
Storage cost Ch = 0.056 + 0.004 = Rs0.060 (based on actual inventory (=average
inventory)
Storage cost Ch = Rs.0.02 per unit/year (based on maximum inventory)

Total Variable Cost = TC = 25 * 25000 + 0.060 * Q + 0.02 * Q

Q 2

= 625000 + 0.1*Q
Q 2
Thus,
Q* = 2CoD = Q* = 2*25*25000 =3535.5 units (3535 units
approximately)
Ch 0.1

Reorder level = L*D = 40*25000 = 2739.7 units

365

That is = 2740 units

Therefore
EOQ = Q* = 3535 units

Reorder level = 2740 units

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Look in to the fig.4.2; in this the total cost curve is almost flat near the minimum cost
point. This indicates that small variations in optimal order size will not change the total cost
appreciably. For this purpose we will examine the model of sensitivity in the next section.
Model Sensitivity

In order to examine sensitivity of the model, we compare the sensitivity of the total costs (TC)
for any operating system with the total variable costs for an optimal inventory system (TC*)
by using the ratio TC/TC*. To do this, we have to calculate TC/TC* as a function of Q/Q*.

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Therefore
CoD + ChQ CoD + ChQ*
TC = Q 2 Q* 2 ---------- eq.10

Now by substituting Q* = 2CoD/Ch into equation eq.10 and solving algebraically we get
the relationship as

TC = 1 Q* + Q ---------------------- eq.11
TC* 2 Q Q* , which is shown in the following figure fig.4.3

TC/TC*

2.0

1.5

1.0

0.5

0.5 1.0 1.5 2.0 2.5 3.0 Q/Q*

Fig: 4.3 Inventory Sensitivity (in case of simple lot size)

According to this if Q is off from optimal either direction by a factor of 2; costs are
increased by only 25%. This has an important practical implication.

The model sensitivity is explained with the help of the following example, so that we
will understand more.

Example 4.3
Consider the Example 4.1. The sensitivity of total cost if order size is Rs.4000, then we will
get that

TC/TC* = 1 4000 + 4000 =1

2 4000 4000

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This indicates that even though order quantity deviates from optimal by Rs.4000 or 100%, the
costs are only 25% higher than the optimal. This excess cost of the non-optimal order quantity
can be found as:
Excess Cost (Marginal Cost) = 0.25(TC*) = 0.25(500) = Rs.125.

4.3.2 The EOQ Model II

Here we are going to discuss, Instantaneous Supply When shortages are allowed. In this case,
stock outs are permitted which means that shortage cost is finite or it is not more. The entire
Model I assumptions (a to i) are also good applicable here. The Inventory situation with
shortages is represented diagrammatically in the following figure fig.4.4.
Look the figure there are two triangles viz. ABC and CEF.
The triangle ABC denotes inventory, whereas
The triangle CEF denotes the shortage
I = inventory level
S = shortage level
Q = order size = I + S
Cycle period = t = t 1 + t2
Where t1 is the proportion of cycle period for inventory holding
t2 is the time of stock out

Inventory Reorder Point

Q t2 t2

B t1 C F t1 S

S Shortage

D E

t t

Fig: 4.4 Inventory Situation with Shortages

Total Variable Cost = Annual Ordering Cost + Annual Holding Cost + Annual
Shortage Cost

= CoD + I2Ch + (Q-I)2Cs ---------------- eq.12

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Q 2Q 2Q
From this we will get

EOQ = Q* = ( 2CoD ) ( Co+Ch) -------- eq.13

Ch Cs

Inventory Level = I* = ( 2CoD ) ( Cs ) -------- eq.14

Ch Co+Ch

Shortage Level = Q* - I* ------------------ eq.15

Cycle Period = t* = Q* ----------------- eq.16

D

Number of Orders/Year = 1
t*

Therefore
Total Variable Cost = TC* = 2CoChCsD
(Ch + Cs) -------------- eq.18

Thus, if we compare the total variable cost of Model I and Model II we will see that

2CoChD > 2CoChCsD ---- This implies that the annual

(Ch + Cs)
Cost when shortage is allowed is less than the annual inventory management cost when
shortages are not allowed. That is shortage should be allowed whenever the shortage cost is
not very large for reducing the total cost.

Example 4.4

Consider the following problem.

Problem
The demand for an inventory item each costing Re5, is 20000 units per year. The ordering
cost is Rs.10. The inventory carrying cost is 30% based on the average inventory per year.
Stock out cost is Rs.5 per unit of shortage incurred. Find out various parameters.

Solution

Given that
Demand = D = 20000
Ordering Cost = Co = Rs.10
Carrying Cost = Ch = 30% of Re 5 = 30 * 5 = 1.5
100

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Stock out Cost = Cs = Rs.5

Now we have to determine the various parameter of EOQ Model II such as EOQ, Inventory
Level, Shortage Level, Cycle Period, number of orders/year and Total Cost.

EOQ = Q* = (2CoD ) ( Co+Ch)

Ch Cs

= 2*10*20000 0.30 + 10 = 1657 units

0.30 5

Inventory Level = I* = ( 2CoD ) (Cs )

Ch Co+Ch

Inventory Level = I* = 2*10*20000 5 = 804 units

0.30 10+0.30

Shortage Level = Q* - I* = 1657 – 804 = 853 units

Cycle Period = t* = Q* = 1657 = 30.24 days = 30 days

D 20000

Number of Orders/Year = 1 = 1 = D = 20000 = 12 Orders/year

t* Q*/D Q* 1657

Total Cost = 2CoChCsD

(Ch + Cs)

= 2*10*0.30*5*20000 = RS.336.4
0.30+5

4.3.3 Economic Production Quantity (EPQ) Model

Here we will discuss about Graduate Supply case when Shortages are not allowed. EOQ
model is more common in retail situation, while economic production quantity EPQ is
basically associated with manufacturing environment. EPQ shows that over a period of time
inventory gradually built and the consumption go side by side where production rate is higher
than that of consumption rate.

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Assumption (a) to (i) of EOQ Model I also hold good for this model. In this model the
Order Size (Q) is taken as Production Size, the annual production rate is taken as P such that P
> D, otherwise, if P
illustrated in the following figure fig: 4.5.

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Maximum Inventory Level

Rate of
Decrease of
Inventory=D

Rate of increase of
Inventory = P-D

t1 t2 t1 t2

A D C Time

t t

Fig: 4.5 Gradual Replacement Inventory Situation

In the above figure, t = Cycle Time

t1 = Production Time
t2 = Depletion Time and
t = t1 + t2 of maximum inventory level BD.
Production Time = t 1 = Q
P
Cycle Time = t = Q
D
Maximum Inventory Level = BD = (P – D) * t 1
= (P – D) * Q
P
Minimum Inventory Level = 0

Average Inventory Carried = (P – D) Q + O

P (P – D) Q
=
2 2P

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Total Variable Cost/Year = Annual Setup Cost + Annual Carrying Cost

CoD (P – D) Q
= + Ch ----- eq.19
Q P 2
Thus,

EPQ = Q* = 2CoD ------------------------ eq.20

Ch(P-D)
P

Total Variable Cost = TC* = 2CoCh(P-D) D --------- eq.21

P

The economic production quantity model (gradual supply case and shortage not
allowed) is explained with the help of following Example 4.5.

Example 4.5

Problem
An inventory item unit is used at the rate of 200/day, and can be manufactured at a rate o f
700/day. It costs Rs.3000 to set up the manufacturing process and Rs.0.2 per unit per day held
in inventory based on the actual inventory any time. Assume that shortage is not allowed.
Find out the minimum cost and the optimum number of units per manufacturing run.

Solution
Given that
Demand, D = 200 units
Production, P = 700 units
Set up Cost, Co = Rs.3000
Holding Cost, Ch = Rs.0.2

Ñ Minimum Cost = TC* = 2CoCh(P-D) D

= 2*3000*0.2(700-200) (200) = Rs.414

700

EPQ = Q* = 2CoD = 2CoD * P

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Ch(P-D) Ch(P-D)
P

= 2*3000*200*700 = 2898.2 = 2898 units

0.2(700-200)

Minimum Cost = Rs.414

Therefore
Number of units per Manufacturing Run = 2898 units

4.3.4 Price Discounts Model

In this section we will discuss, instantaneous supply with no shortages. We know very well
that whenever we make bulk purchasing of items there may be some discount in price is
usually offered by the suppliers. As far as discount concern, there are two types:
1. Incremental Discount – discount allowed only for items which are in excess of the
specified amount. In this case, all the prices offered in different slabs are applicable in
finding the total cost.
2. All units Discount – discount allowed fro all the items purchased. In this, only one
price at any one slab is applicable for finding the total cost.

Here we are going to discuss only all units’ discount type.

Advantages of Bulk Purchase

Buying in bulk may results in the following advantages:

less unit price

less ordering cost
cheaper transportation
fewer stock outs
sellers preferential treatment

Disadvantages of Bulk Purchase

Bulk purchase also has the following disadvantages in addition to the above
advantages:
high carrying cost
lower stock turnover
huge capital required
less flexibility
older stocks
heavy deterioration
heavy depreciation

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In case of purchased items, if the discounts are allowed, the price C may vary according to the
following
pattern:

C = P0 if purchase quantity Q = Q0 < q1

= P1 if purchase quantity q1 1 < q2

……………………………………….

………………………………………..

= Pn if purchase quantity qn < Qn

where Pj-1 is > Pj, for j = 1, 2, …….., n. -------- eq.22

Pj = Price per unit for the jth lot size

Suppose, shortages are not permitted, the total cost per year is obtained by the following set of
relations:

TC(Qj) = DPj + CoD + 1 ChQj , where qj j<qj+1 ----------- eq.23

and Ch=ipj, i being percentage change for j=0 to n. Since price (or unit cost) varies with
purchase size (Q), the fixed cost term CD in equation eq.23 can’t be omitted for minimizing
the total cost (TC).

Equation eq.23 for quantity discounts are represented in the figure fig: 4.6.

Total
Cost
(TC)

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O q1 q2 q3 q4 Quantity (Q)

Fig: 4.6 Quantity Discount

The heavy curve on the various price discounts shows feasible portion of the total cost
which is a step function. Therefore, for determining the overall optimum, the following steps
of procedure is adopted:

Step 1: Find EOQ for the lowest price

That is compute Q*n = 2CoD

iPn

If Q*n n, the optimum order quantity is Q *n.

If Q*n < qn, then go to Step 2.

Step 2: Compute Q*n -1 = 2CoD for the next lowest price.

iP n-1

If Q*n -1 *
n-1, then compare the total cost TC n-1 for purchasing Q n -1 with the total
cost TCn for purchasing quantity q n and select least cost purchase quantity.
If Q*n -1 < qn-1 then go to Step 3.

Step 3: Compute Q*n -2 = 2CoD for the next lowest price.

iP n-2

If Q*n -2 n-2, then compare the total cost TC n-2, TCn-1 and TCn for purchase
quantities Q*n -2 , qn-1 and qn respectively and select the optimum purchase quantity.

If Q*n -1 < qn-2 then go to Step 4.

Step 4: Continue the procedure until Q*n -j n-j. Then compare the total costs TC n-j with TCn-
*
j+1 , …. , TCn-1 , TCn for purchase quantities Q n -j , qn-j+1, …. , q n-1, qn respectively, and select
the optimum purchase quantity.

The price discount model is explained with the help of the following examples.

Example 4.6
Consider the following problem, which explains the price discount model.
Problem

Suppose, annual demand for an item is 1500 units, ordering cost is Rs.250, inventory carrying
charge is 12% of the purchase price per year and the purchase prices are:

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P1 = Rs.5 for purchasing Q1 < 250

P2 = Rs.4.25 for purchasing 250
P3 = Rs.3.75 for purchasing 500

Find out the optimum purchase quantity.

Solution
Given that
Demand, D = 1500 units
Ordering Cost, Co = Rs.250
Carrying Cost, Ch = 12% = i
This problem belongs to the Step 1. So that as per Step 1

Q*3 = 2CoD = 2*250*1500 = 1290 units

iPn (0.12)(3.75)

Note that 1290 > 500, Optimum Purchase Quantity = 1290 units.

Example 4.7

Problem
Consider the problem in Example 4.6 with ordering cost of Rs.10 only. Find out the optimum
purchase quantity.

Solution

Given that
Demand, D = 1500 units
Ordering Cost, Co = Rs.10
Carrying Cost, Ch = 12% = i

In this case,

Q*3 = 2CoD = 2*10*1500 = 258 units

iPn (0.12)(3.75)

Since 258 < 500 = q3, so that we may have to compute

Q*2 = 2CoD = 2*10*1500 = 242 units

iPn (0.12)(4.25)

Since 242 < 250 = q2, next we may have to compute

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Q*1 = 2CoD = 2*10*1500 = 224 units

iPn (0.12)(5)

Since 224 > 0, now we have to compare the total cost for purchasing Q *1 = 224, q2 =
250 and q3 = 500 units respectively.

From equation eq.23

TC (Qj) = DPj + CoD + 1 ChQj , where qj j<qj+1

We will get

TC1 (for purchasing 224) = 5*1500 + 10*1500 + 1 (0.12) (5)224 = 7634.2

224 2

TC2 (for Q2=250) = 4.25*1500 + 10*1500 + 1 (0.12) (4.25)250 = 6498.75

250 2

TC3 (for Q3=500) = 3.75*1500 + 10*1500 + 1 (0.12) (3.75)500 = 5767.5

500 2

The EPQ for his problem is Q*3 = 500 units

4.3.5 Dynamic Demand Models

In this model, assume that demand is known with certainty, and although may vary from one
period to the next period. There are five types of dynamic demand inventory models, they are:

i) Production Inventory Model (Incremental Cost Method)

ii) Dynamic Inventory Model (Prescribed Rule Method)
iii) Dynamic Inventory Model (Fixed EOQ Method)

The above five dynamic demand models of inventory are discussed in details in the following
subsequent sections.

i) Production Inventory Model

This is also called as Incremental Cost Method. This situation is explained with the help of
the following example 4.8.

Example 4.8
Consider the following problem.

Problem
A production factory has a fixed weekly cyclic demand as follows:

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Days Mon Tue Wed Thu Fri Sat Sun

Demand 9 17 2 0 19 9 14
in units

Here the policy is to maintain constant daily production seven days a week. Shortage cost is
Rs.4 per unit per day and storage cost depends upon the size of Q, the quantity carried, as
follows:

Cost per unit for one =1 =4 =10

day(Rs.)
Q 1 4 20

And the chargers are based on the situation at the end of the day.

Determine the optimal starting stock level.

Solution

Let the production rate be the average of the total sales which is

= 9 + 17 + 2 + 0 + 19 + 9 + 14 = 10 units/days
Day On hand Demand Inventory Shortage Carrying
stock start cost (Rs.) cost (Rs.)
of day
Mon 8 9 -1 4 0
7
Tue -1+10=9 17 -8 32 0
Wed -8+10+=2 2 0 0 0
Next
Thu 0+10=10 0 10 0 44
we will
Fri 10+10=20 19 1 0 1
find the
Sat 1+10=11 9 2 0 2
total
Sun 2+10=12 14 -2 8 0
weekly
Mon -2+10=8 Total Cost 44 + 43 = 87
cost for
different starting stocks, which is illustrated in the following tables.

Table 4.1 shows for starting stock 8, Table 4.2 shows for starting stock 9 and Table
4.3 shows for starting stock 10.

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stock start cost (Rs.) cost (Rs.)
of day
Mon 9 9 0 0 0
Tue 0+10=10 17 -7 28 0
Wed -7+10+=3 2 1 0 1
Table
Thu 1+10=11 0 11 0 44
4.1
Fri 11+10=21 19 2 0 2
Cost
Sat 2+10=12 9 3 0 3
Analysi
Sun 3+10=13 14 -1 4 0
s with
Initial Mon -1+10=9 Total Cost 32 + 50 = 82
Stock 8

Day On hand Demand Inventory Shortage Carrying

stock start cost (Rs.) cost (Rs.)
of day
Mon 10 9 1 0 1
Tue 1+10=11 17 -6 24 0
Wed -6+10+=4 2 2 0 2
Thu 2+10=12 0 12 0 48
Fri 12+10=22 19 3 0 3
Sat 3+10=13 9 4 0 16
Sun 4+10=14 14 0 0 0
Mon 0+10=10 Total Cost 24 + 70 = 94

Table 4.2 Cost Analysis with Initial Stock 9

Table 4.3 Cost Analysis with Initial Stock 10

Therefore

The optimal solution for starting stock of 9 units is on MONDAY.

Minimum Total Cost for this is Rs.82.

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Procedure for solving such incremental problem is cost analysis, which is self
explanatory.

ii) Dynamic Inventory Model (Prescribed Rule Method)

Some times, the organization dealing with inventory may prescribe some rule of procurement
of items of inventory. For example

- Procuring every month

- Procuring every three months

The prescribed rule method is explained with the help of the following Example 4.9.
Example 4.9
Consider the following problem.

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Problem

An organization estimates the demand of an item as follows:

Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
Demand 140 98 62 134 20 72 22 164 139 170 248 51 1320

The organization has decided that their ordering cost is Rs.54 and carrying charge per unit per
month is 2% at the end of each month. The cost of item per unit is Rs.20. Assume that the
supply is instantaneous, there in no stock outs and no lead time. Only full month requirement
is ordered.
Solution

The following table is used for determining the total cost for the policy of quarterly ordering.

Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
Starting 0 160 62 0 92 72 0 303 139 0 299 51 --
Inventory
300 -- -- 226 -- -- 325 -- -- 469 -- -- 1320
Replenishment
140 98 62 134 20 72 22 164 139 170 248 51 1320
Requirements
160 62 0 92 72 0 303 139 0 299 51 0 1178
Ending
Inventory

Table 4.4 Total Cost Analysis for Quarterly Policy

Therefore
Total Carrying Cost = 1178*(0.02)*(20) = Rs.471.2
Total Replenishment Cost = 4*54 = Rs.216
Total Annual Cost = 216 + 471.2 = Rs.687.2

iii) Dynamic Inventory Model (Fixed EOQ Method)

The Fixed EOQ Method is explained with the help of the following Example 4.10.

Example 4.10
Consider the problem of Example 4.9.

Problem
An organization estimates the demand of an item as follows:

Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
Demand 140 98 62 134 20 72 22 164 139 170 248 51 1320

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The organization has decided that their ordering cost is Rs.54 and carrying charge per unit per
month is 2% at the end of each month. The cost of item per unit is Rs.20. Assume that the
supply is instantaneous, there in no stock outs and no lead time. Only full month requirement
is ordered.

Solution

Average Monthly Demand = = 1320 = 110 units/month

th 12

EOQ = 2*54*110 = 172 (approximately)

(0.02)*(20)
In this case the organization has to ordered full month requirement, therefore 172 lies between
140 and 248 units, but 172 is more closer to 140 than 248, so that the organization order one
month requirement at the beginning of the January.
Similarly, at the beginning of the February, the organization order two month
requirement.

The detailed result is illustrated in the following Table 4.5

Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Total
Starting 0 0 62 0 92 72 0 164 0 0 0 0 --
Inventory
140 160 -- 226 -- -- 186 -- 139 170 248 51 1320
Replenishment

Requirements 140 98 62 134 20 72 22 164 139 170 248 51 1320

Ending 0 62 0 92 72 0 164 0 0 0 0 0 390

Inventory

Table 4.5 EOQ Total Cost Analysis

Therefore

Total Ordering Cost = 8*54 = Rs.432

Total Carrying Cost = 390*0.4 = Rs.156

Thus, the Total Cost is reduced if EOQ policy is used instead of three month
(quarterly) rule.

4.4 Deterministic Multi Item Inventory Models

When there is more than one item in the inventory is called as multi item inventory. Since this
contains more items, the inventory control requires special type of care. This type of

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inventory problems may different types of constraints like capital, cost structure, storage
space, purchasing load etc. As the number of constraints increase the problem becomes more
complex. In this section we will discuss some examples of this type of inventory.
There are two types of multi item inventory model which is based on the structure of
the cost, they are:
1. Model with Unknown Cost Structure
2. Model with Known Cost Structure

4.4.1 Unknown Cost Structure Model

In India most of the organizations do not maintain the proper inventory records which may
provide sufficient cost information to generate the two basic parameters viz. procurement cost
and carrying cost of inventory control. Some organizations in some situations have not
developed cost structure related to inventory control, but still they wish to minimize total cost
of inventory. There may be critical situations, in which an organization may need to take
immediate actions to improve the situation without considering the structure of cost.
The use of inventory models without cost information is impossible, but we will show
here that it is possible to get many of benefits of inventory techniques even when carrying
cost and ordering cost are not known. In such a problem, there are two different approaches,
they are:

1. Minimize the Total Carrying Cost while keeping the number of orders/year fixed
or
2. Minimize the Total Number of orders/year while keeping the same level of
inventory.

Minimize the Total Carrying Cost while keeping the number of orders/year fixed Model

As per the EOQ model

Q* = 2CoD or Q* = 2CoD *
Ch Ch

2Co = Constant, because ordering cost and carrying cost are deterministic
values.
Ch

Therefore ------------ eq.24

The equation eq.24 tells that EOQ is proportional to the square root of demand for any
inventory item of control.

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For this equation, we get

Q* = Q* = = Square root of Demand ----------- eq.25
ber of orders/year

the inventory items. Thus, we take

Sum of square roots of Demand of each inventory item -
eq.26
Sum of the number of orders/year for each item

This model is explained with the help of the following Example 4.11.
Example 4.11
Consider the following problem.
Problem
An organization has the following procurement pattern of six items irrespective of their
demand level. Reduce the inventory levels while keeping total number of orders/year fixed.

Item No. Number of Demand Order Size Average

Orders/Year (Rs.) (Rs.) Inventory
1 5 2000,000 500000 250000
2 5 700,000 260000 130000
3 5 100,000 23500 11750
4 5 9,000 10000 5000
5 5 5,000 700 350
6 5 2,700 500 250
Solution

---------- eq.27

Therefore

Thus, = 2783 = 92.7

Now we will analyze the ordering quantity, which is illustrated in the following Table
4.6.

Demand EOQ= Number of Average

Item No. (D) (Rs.) orders/year Inventory =
=D/EOQ
Number of
orders/year
1 2000,000 1414 92.7 131077.8 15.258 4369
2 700,000 836 92.7 77497.2 9.0 2583
3 100,000 316 92.7 29293.2 3.41 976
4 9,000 95 92.7 8806.5 1.0 293

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5 5,000 70 92.7 6489 0.77 216

6 2,700 52 92.7 4820.4 0.56 160

Table 4.6 Analysis of Ordering Quantity

Thus, according to the policy of the organization ordering for six items a year each
item, Total Average Inventory becomes Rs.397350.
But, as per the new schedule as obtained in the above Table , the Average Inventory is
Rs.8597 which is much less and at the same time total Number of Orders remains same.
Therefore, substantial savings can still be achieved when cost information is known.

Minimize the Total Number of orders/year (or purchasing workload) while keeping the
same level of inventory Model

We will know that

or Q*

Now onwards, we will take ------- eq.28 for all inventory items.

This model is explained with the help of the previous Example 4.11.

Here we will discuss about how to minimize the number of orders or purchasing
workload.
Problem
An organization has the following procurement pattern of six items irrespective of their
demand level. Reduce the inventory levels while keeping total number of orders/year fixed.

Item No. Number of Demand Order Size Average

Orders/Year (Rs.) (Rs.) Inventory
1 5 2000,000 500000 250000
2 5 700,000 260000 130000
3 5 100,000 23500 11750
4 5 9,000 10000 5000
5 5 5,000 700 350
6 5 2,700 500 250

Solution

Here K= Sum of the order size

Sum of square root of Demand

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K= 50000+260000+23500+10000+700+500 = 794700 = 285.555

1414+836+316+95+70+52 2783

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Item Demand Number of Average

No. (D) (Rs.) orders/year Inventory =
=D/EOQ EOQ/2
1 2000,000 1414 285.555 403774.77 4.95 201887.385
2 700,000 836 285.555 238723.98 2.93 119361.99
3 100,000 316 285.555 90235.38 1.10 45117.69
4 9,000 95 285.555 27127.725 0.33 13563.8625
5 5,000 70 285.555 19988.85 0.25 9994.425
6 2,700 52 285.555 14848.86 0.18 7424.43

Table 4.7 Analysis for Reducing Number of Orders

Thus, from the Table 4.7, it is obvious that the total purchasing workload has reduced by
35%. Therefore, there is a definite saving of cost by applying these methods for multiple
items even when cost information is not known.

4.4.2 Known Cost Structure Model

We may classify the models with known cost structures into two main types, they are:

Model without Limitations

Model with Limitations

Here we will discuss these models, if we know the complete cost structure. In this model let
us consider the following symbolic notation:
Dj - Demand
Coj - Ordering Cost
Chj - Holding Cost or Carrying Cost for jth item respectively.

Model without Limitations

In any situation the items may be purchased according to their individual economic order
quantities, if there are no restrictions for the items being storing.
In this case,

Total Variable Cost per annum for n-items can be represented as

n
CojDj + ChjQj and ------------------- eq.29
J=1 Qj 2

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The optimum Order Size for each item is

Qj* = 2CojDj for j = 1,………, n ---------------- eq.30

Chj

Model with Limitations

We know that the different constraints on inventories are available capital, order size per year,
storage space, etc. In this case we will consider a single constraint for the discussion of this
model. Note that the constraints capital and storage space are interchangeable.

Let
Qj is the order quantity for item j
Fj is the storage space (or floor space) for one unit of item j
(or) Fj – the capital requirement for one unit of item j, since the storage
space and
the capital are interchangeable.
F is the total available storage space (floor space) or available capital

Then the constraints are as follows:

n
1Q1 + F2Q2 + ………… FnQn ------------- eq.31
j=1

Here the objective is to minimize the total inventory cost expressed by the equation eq.29. So
that in order to solve this problem first we have to convert the constraint problem into
unconstrained minimization problem and then the optimum result is obtained.

The problem is to minimize the function known as Lagrange Function:

n n
L( 1, Q2, …, Qn CojDj + ChjQj - F) --------- eq.32
j=1 Qj 2 j=1

Then, the values of optimal sizes are

Qj* = 2CojDj for j = 1,………, n ------------ eq.33

(Chj j)

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The known cost structures model is explained with the following Example 4.12.

Example 4.12
Consider the following problem.

Problem
A retail shop purchases three items of inventory viz. A, B and C respectively. The shop works
on the limitations that the shop is not able to invest more than Rs.40000 at any time. The other
shop relevant information is given in the following table:

Item A B C
Demand rage (units/year) – Dj 20000 1000 2000
Purchase Cost/unit – Cj 40 200 100
Ordering Cost/Order – Coj 100 150 200
Holding or Carrying Cost - J 40% 40% 40%

Solution

In the absence of constraints, the Optimal Order Sizes are:

Q1 = 2*100*20000 = 500
(.40) (40)

Q2 = 2*150*1000 = 61
(.40)(200)

Q3 = 2*200*2000 = 141
(.40) (100)

Now we know the optimal sizes, so that with these optimal sizes we may determine
the maximum investment, that is

Maximum Investment = 500 * 40 + 61 * 200 + 141 * 100

= 20000 + 12200 + 14100

= Rs. 46300

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Note that the Maximum Investment Rs.46300 is greater than the allowable investment
capacity i.e. Rs.40000 in inventory.

Therefore, equation eq.33 is used with the following alteration

Qj* = 2*Coj*Dj for j = 1, 2, 3. Since, there are only three items. --- eq.34

Note that here

Qj* = 2*Coj*Dj * Cj = 40000

j=1

or

40*20000*100 + 150*1000*200 + 200*2000*100 = 40000

or

Therefore, now the order size becomes

Q*1 = 368

Q*2 = 45

Q*3 = 104

That is,

If limitations are not imposed on the purchase of quantities,

The optimal Total Cost = 2*100*20000 + 2*150*1000 + 2*200*2000

500 61 141

= 8000 + 4918 + 5674

= Rs.18592
But, under the limitations,

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The optimal Total Cost = 2*100*20000 + 2*150*1000 + 2*200*2000

368+2*0.17*40 45+2*0.17*200 104+2*0.17*100

= 18934.19, which is higher than the total cost without

limitations.

Note:
Many times the application of the equation

Q*j = 2CojDj for j = 1,………, n ------------ eq.33

(Chj j)

to find optimal order quantities under limitations does not help to obtain the result. Therefore,
we have to apply trial and error procedure in the following manner:

i) First determine the EOQ’s for all type of inventory items without considering the
j. If these values satisfy the constraint
(eq.31), then this solution becomes optimal because the constraint is not active.
ii) If the constraint is not satisfied by the values obtained under (i) above, we give

Qjs. Qjs satisfy the constraint, these are optimal quantities. Otherwise, we
interp

4.5 Probabilistic Inventory Models

In previous sections, we have discussed simple deterministic inventory models where each
and every influencing factor is completely known. Generally in actual business environment
complete certainty never occurs. Therefore, here we will discuss some practical situations of
inventory problems by relaxing the condition of certainty for some of the factors.
The major influencing factors for the inventory problems are Demand, Price and Lead
Time. There are also other factors like Ordering Cost, Carrying Cost or Holding Cost and
Stock out Costs, but their nature is not so much disturbing. Because of this their estimation
provides almost, on the average, as known as values. Even Price can also be averaged out to
reflect the condition of certainty. But there are situations where Price fluctuations are too
much in the market and hence they influence the inventory decisions. Similarly, the demand
variations or consumption variation of an item as well as the lead time variation influence the
overall inventory policy. In this section we will discuss single period probabilistic models.
4.5.1 Single Period Probabilistic Models

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Single Period Discrete Probabilistic Model deals with the inventory situation of the items like
perishable goods, seasonal goods and spare parts requiring one time purchase only. These
items demand may by discrete or continuous. In these models the lead time is very much
important because purchases are made only once.
In single period model, the problem is analyzed using incremental (or
marginal) analysis and the decision procedure consists of a sequence of steps. In such cases,
there are two types of cost involved. There are Under Stocking Cost and Over Stocking Cost.
These two costs describe opportunity losses incurred when the number of units stocked is not
exactly equal to the number of units actually demanded.

In this section we will use the following symbols:

D = Demand for each unit of item (or a random variable)

Q = Number of units stocked or to be purchased
C1 = Under Stocking Cost some times also known as over ordering cost. This is an
opportunity loss associated with each unit left unsold i.e.
C1 = S – Ch/2 – Cs
C2 = Over Stocking Cost some times also known as under ordering cost. This is an
opportunity loss due to not meeting the demand, i.e
C2 = C + Ch – V
Where
C = cost/unit
Ch = carrying cost/unit for the entire period
Cs = shortage cost
V = salvage value
S = selling price

In this section we are going to discuss only discrete demand distribution.

4.5.2 Single Period Discrete Probabilistic Demand Model (Discrete Demand

Distribution)

Here we will discuss the following methods of solving the single period discrete probabilistic
demand.

a. Incremental Analysis Method

b. Payoff Matrix Method

a. Incremental Analysis Method

The Cost equation is developed as follows:

For any quantity in stock Q, only D units are consumed (or demanded). Then for
specific period of time, the cost associated with Q units in stock is either:

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i) (Q-D)C2, where D is the number of units demanded or consumed is less that or

equal to the number of units Q in stock. That is D

ii) (D-Q)C1, where the number of units required is greater than the number of units Q
in stock. That is D > Q.

We know that D is a random variable, so its probability distribution of demand is known.

ity that the demand is D units, such that total probability is one.

------- eq. p1
D=0
The total expected cost is the sum of expected cost of under-stocking and over-stocking.
Therefore

The Total Expected Cost, say f(Q), is given by

Q
- - -------------------- eq.p2
D=0 D=Q+1

Suppose, Q* is the optimal quantity stocked, then the total expected cost f(Q*) will be
minimum. Thus, if we stock one unit more or less than the optimal quantity, the total expected
cost will be higher than the optimal.

Thus,
Q*+1
- -Q*-
D=0 D=Q*+2

Q*
- - -

D=0 D=Q*+1 D=0

D=Q*+1

Q*
- C1 --------------- eq.p3
D=0

Thus,
f(Q*+1) – – C1 --------- eq.p4

Q*
- is a cumulative probability.
D=0

Similarly, we obtain

f(Q*-1) – f(Q*) = C1 – -1) ------ eq.p5

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We will obtain the following from the above equations eq.p4 and eq.p5

-1) C1 --------------------- eq.p6

C2+C1

Therefore, the optimal stock level Q* satisfies the relationship (eq.p6).

Note that for practical application of (eq.p6), the three step procedure is as follows:
Step 1:
From the data, prepare a table showing t

Step 2:
Calculate the ratio C1 which is called as service level.
C2+C1
Step 3:
Determine the value of Q which satisfies the inequality eq.p6.

This situation is explained with the following Example 4.13.

Example 4.13

An organization stocks seasonal products at the start of the season and cannot reorder. The
inventory item costs him Rs.35 each and he sells at Rs.50 each. For any item that cannot be
met on demand, the organization has estimated a goodwill cost of Rs.25. Any unsold item will
have a salvage value of Rs.20. Holding cost during the period is estimated to be 10% of the
price. The probability distribution of demand is as follows:

Units Stocked 2 3 4 5 6
Probability of 0.35 0.25 0.20 0.15 0.05

Determine the Optimum Number of Items to be stocked.

Solution

Now we have to follow the above sequence of steps.

Step 1:
We will prepare the Table 4.8 containing the data regarding demand distribution as
follows:

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Units Stocked Probability of Cumulative

2 0.35 0.35
3 0.25 0.60
4 0.20 0.80
5 0.15 0.95
6 0.05 1.00
Table 4.8 Probability Distribution of Demand

Step 2:
Calculate the ratio C1 which is called as service level.
C2+C1

We see that
S=50, C=35, Ch=0.1*35= 3.5, V=20, Cs=25

Therefore
C2 = C+Ch-V = 35+3.5-20 = 18.5

C1 = S-C-Ch + Cs = 50-35-3.5 + 25 = 38.25

2 2

Thus, C1 = 38.25 = 0.6740

C2+C1 18.5+38.25
Step 3:
Look into the Table 4.8, the ratio 0.6740 lies between cumulative probabilities of 0.60 and
0.80 which in turn reflect the values of Q as 3 and 4 (units stocked).

That is

Therefore, the optimal number of units to stock is 4 units.

Cost of Under Stocking Estimation

Suppose, in the previous Example 4.13, the under stocking cost is not known, but the decision
maker policy is to maintain a stock level of say 5 units. We can determine for what values of
C1(under estimating cost) does Q*=5?

In this case, we have the following inequality:

C1
C2+C1

That is C1
18.5+C1

Or

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0.80 C1
18.5+C1

So that the Minimum Value of C1 is determine by letting

C1 = 0.80 or C1 = (0.80)(18.5) = Rs.74

18.5+C1 (1-0.80)

Similarly, the Maximum Value of C1 is determine by letting

C1 = 0.95 or C1 = (0.95)(18.5) = Rs.351.5

18.5+C1 (1-0.95)

Therefore 74

Perishable Products Inventory

Many of the organization manage merchandise which contains negligible utility if it is not
sold almost immediately. The examples of such kind of products are newspaper, fresh
produce, printed programmes for special events and other perishable products. Generally such
inventory items have high mark-up. The major difference between the wholesale cost and the
retail price is due to the risk vendor faces in stocking the inventory. Vendor faces
obsolescence costs on the one hand and opportunity costs on the other.
All this kind of problems can be very easily solved with the help of the above
discussed model. This is explained in the following Example 4.14.

Example 4.14

A boy selling newspaper, he buys papers for Rs.0.45 each and sells them for Rs.0.70 each.
The condition here is the boy cannot return unsold newspapers. The following table shows the
daily demand distribution. If each days demand is independent of the pervious days demand,
how many news papers should he order each day?

Number of 240 250 260 270 280 290 300 310 320 330
Customers
Probability 0.01 0.03 0.06 0.10 0.20 0.25 0.15 0.10 0.05 0.05

Solution

Step 1:

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Number of 240 250 260 270 280 290 300 310 320 330
Customers
Probability 0.01 0.03 0.06 0.10 0.20 0.25 0.15 0.10 0.05 0.05
Cumulative 0.01 0.04 0.10 0.20 0.40 0.65 0.80 0.90 0.95 1.00
Probability
Table 4.9 Probability Discrete Distribution of Demand
Step 2:

C1 = 0.25 = 0.25 = 0.357

C2+C1 0.45+0.25 0.70

Step 3:
Thus, the Value of Q such that
-1)
Q* = 280

Therefore The newspaper boy should buy 280 papers each day.

b. Payoff Matrix Method

The Payoff Matrix Method of single period Discrete Probabilistic Demand Model is explained
with the help of the following Example 4.15.

Example 4.15

Consider the example 4.13 i.e.

An organization stocks seasonal products at the start of the season and cannot reorder.
The inventory item costs him Rs.35 each and he sells at Rs.50 each. For any item that cannot
be met on demand, the organization has estimated a goodwill cost of Rs.25. Any unsold item
will have a salvage value of Rs.20. Holding cost during the period is estimated to be 10% of
the price. The probability distribution of demand is as follows:

Units Stocked 2 3 4 5 6
Probability of 0.35 0.25 0.20 0.15 0.05

Determine the Optimum Number of Items to be stocked.

In this case the organization has five reasonable courses of action. The organization
can stock the items from 2 to 6 units. There is no possible reason to stock more than 6 items

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since the organization can never sell more than 6 items and there is no possible reason for
ordering less than 2 items. Since there are five courses of action for stocking and five levels of
demand, it follows that there are 25 combinations of one course of action and one level of
demand. For these 25 combinations, we can determine the organization payoffs in the form of
payoff matrix.
As per the information of cost given in the problem, the payoffs are obtained for the
following two situations:
When demand is not more than the stock level
When demand is more than the stock quantity.

That is
Payoffs For Q Q<D
Item Cost -35Q -35Q
Sale of items 50D 50Q
Goodwill Cost - -25(D-Q)
Salvage Cost 20(Q-D) -
Holding Cost -3.5(Q-D)-3.5D/2 -3.5Q/2
Total payoff -18.50Q+31.75D 38.25Q-25D
The payoff matrix will be 5X5. Each element of the matrix can be computed by above
total payoffs for demand less than, equal to, or greater than the order size (Q). When demand
is less than or equal to the order size, we have the following contributions to the payoff.
Here the organization buys the items for Rs.Rs.35Q and the organization sells D of
them for Rs.50D, the organization earns salvage of Rs.20 (Q-D) for unsold items, and the
organization incurs holding cost of Rs.(.10)(35)(Q-D) on unsold items an average holding
cost of (.10)(35)D/2 on the sold items during the period. Thus the total payoff becomes -
128.5Q+31.75D for demand less or equal to order size.
If demand is more than the order size, the contributory payoff will consist of the
following:

- Purchase Cost Rs.35Q

- Selling Profit of Rs.50Q
- Goodwill Cost Rs.25(D-Q) and
- Holding Cost of Rs. (0.10)(35)Q/2

Thus, the total payoff for demand more than order size is 38.25Q-25D.

The payoff matrix is as follows (Table 4.10):

Units Demanded D
2 3 4 5
6
Units stocked or 2 26.50 1.50 -23.50 -48.5 -

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73.5
Order Size (Q) 3 8.0 39.75 14.75 -10.25 -
35.25
4 -10.5 21.25 53.0 28.0
3.0
5 -29.0 2.75 34.5 66.25
41.25
6 -47.5 -15.75 16.0 47.75
79.5

Probability of Demand 0.35 0.25 0.20 0.15

0.05

Table 4.10 Payoff Matrix

Now we will determine the expected payoff for each order size or courses of action.
The procedure for computing the expected values is simple, as follows:

Procedure: For any given course of action multiply each possible payoff for that
course of action by the corresponding probability of the given level of demand and add all of
these products up.

Thus, for first course of action of order size 2 units, the expected value of payoff is:

(26.5)(0.35) + (1.5)(0.25) + (-23.5)(0.2) + (-48.5)(0.15) + (-73.5)(0.05) = Rs.-6

For order size 3 units

(8.0)(0.35) + (39.75)(0.25) + (14.75)(0.2) + (-10.25)(0.15) + (-35.25)(0.05) =
Rs.12.3875

For order size 4 units

(-10.5)(0.35) + (21.25)(0.25) + (53)(0.2) + (28)(0.15) + (3)(0.05) = Rs.20.2625

For order size 5 units

(-29)(0.35) + (2.75)(0.25) + (34.5)(0.2) + (66.25)(0.15) + (41.25)(0.05) =
Rs.9.4375

For order size 6 units

(-47.5)(0.35) + (-15.75)(0.25) + (16)(0.2) + (47.75)().15) + (79.5)(0.05) = Rs.-
6.225

Therefore, we compute all the expected values:

Order Size Q 2 3 4 5 6
Expected value Rs.-6 Rs.12.3875 Rs.20.2625 Rs.9.4375 Rs.-
6.225

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Here the objective is to select course of action which provides the highest payoff.
Thus, the organization should order for 4 units for the highest expected payoff value of
Rs.20.2625.

Note: If we compare the two methods i.e. incremental analysis and payoff matrix, if we see
the solution that incremental analysis provides only the optimum level of purchase quantity
and does not indicate about the level of expected profit. But, the payoff matrix method
provides both the answers i.e. optimum purchase quantity as well as the optimum expected
profit.
The interesting is here, we may also convert the payoff matrix to opportunity cost
matrix, where the opportunity cost is, in short, a cost sustained because the decision taken is
not the best in terms of the level of demand which actually occurs.
The computation of opportunity cost matrix from the payoff matrix is very easy. Take
any column of the payoff matrix corresponding to a specific level of demand and select the
largest payoff if the payoffs are profits, the smallest payoff if the payoffs are costs. Then
subtract each payoff in the same column from the largest payoff to get the corresponding
opportunity costs in the case of profits. If it is cost, subtract the smallest payoff from each
payoff in the same column to get the opportunity costs.
In this Example 4.15, we may obtain the opportunity cost matrix as follows (Table
4.11):

Units Demanded D
2 3 4 5 6
Order size
2 0 38.25 76.5 114.75 153.0
3 18.5 0 38.25 76.5 114.75
4 37.0 18.5 0 38.25 76.5
5 55.5 37.0 18.5 0 38.0
6 74.0 55.5 37.0 18.5 0

Probability of
Demand 0.35 0.25 0.20 0.15 0.05

Table 4.11 Opportunity Cost Matrix

Now, we have to determine the expected opportunity costs for each alternative courses
of action. The objective is to select the course of action which provides minimum expected
opportunity costs.
Therefore,
The expected opportunity cost for the first alternative course of action of order size 2
is:

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(0)(.35) + (38.25)(.25) + (76.5)(.2) + (114.75)(0.15) + (153)(.05) = Rs.49.725

For order size 3 units

(18.5)(.35) + (0)(.25) + (38.25)(.2) + (76.5)(.15) + (114.75)(.05) = Rs.31.3375

For order size 4 units

(37)(.35) + (18.5)(.25) + (0)(.2) + (38.25)(.15) + (76.5)(.05) = Rs.27.1375

For order size 5 units

(55.5)(.35) + (37)(.25) + (18.5)(.2) + (0)(.15) + (38)(.05) = Rs.34.275

For order size 6 units

(74)(.35) + (55.5)(.25) + (37)(.2) + (18.5)(.15) + (0)(.05) = Rs.49.95

That is, the following are the obtained expected opportunity costs;

Order Size Q 2 3 4 5 6
Expected Cost Rs. Rs.31.3375 Rs.27.1375 Rs.34.275 Rs.49.95
49.725

Thus, the decision is to select the minimum expected cost is that, the organization
should store 4 units for the lowest cost of Rs.27.1375

Relationship between the Payoff Matrix and Opportunity Cost Matrix

Here, we may find a relationship between the payoff matrix and the opportunity cost
matrix, as follows:

Let
EOC = K – EP
Where,
EOC = Expected Opportunity Cost
EP = Expected Payoff or profit
K = Constant or
K = (26.5)(.35) + (39.75)(.25) + (53)(.2) + (66.25)(.15) + (79.5)(.05)
= 43.735

That is K = sum of the expected value of the largest elements in each column
of the
payoff matrix.

= the expected value of the payoffs for all the best courses of action.
Or
The expected opportunity cost for a given courses of action= K(43.735)-Expected pay of for
each
courses of action -
(eq1)

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Thus, it is obvious from the above equation eq1 that the maximum value of EP will
simultaneously produce, the minimum of EOC. The two analyses namely, the payoff matrix
method and the opportunity cost matrix method produce the same result.
Suppose, if the original matrix is in terms of costs it can by similar reasoning, be
shown that the above relationship (eq1) will be of the following form:
EOC = EP – K
In this case EP is in terms of costs.

4.6 Summary

In this lesson various deterministic inventory models have been developed for various
operating conditions. Here we discussed single item inventory and as well as multi item
inventory models. In this lesson we also discussed probabilistic discrete demand models for
single period inventory items.

4.7 Key Terms

Inventory – stores of goods or stocks.

Ordering Cost - Cost involved in placing an order.
Procurement Cost – Same as ordering cost.
Replenishment Cost – Same as ordering cost.
Set up Cost – Cost associated with the setting of machine for production.
Shortage Cost – Costs associated with the demand when stocks have been depleted, it
is
generally called as back order costs.
Safety Stock – Extra Stocks.
Perishable Product – The inventories that deteriorate with time.
Deterministic Model – An inventory model where all the factors are completely
known.
Discrete Probability Distribution – A probability distribution in which the variable
is allowed
to take only limited number of values.
Expected Opportunity Cost – Expected value of the variable indicating opportunity
costs.
Expected payoff – Expected value of the variable indicating payoffs.
Expected Value – The average value or mean.
Minimum Value – This is also known as safety stock or the buffer stock.
Maximum Value – Level of inventory beyond which inventory is not allowed.
Payoff – The benefit which accrues form a given combination of decision alternative
courses of
action and state of nature.
Reorder Level – The stock level which is sufficient for the lead time consumption,
and an order
is initiated when inventory dips to this level.
Under Stocking Cost – Cost relating to the out of stock situation under the
probabilistic

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situation.
Over Stocking Cost – This is the cost of keeping more units than demanded.
Opportunity Cost Matrix – Matrix of opportunity Costs.

4.8 Self Assessment Questions

Q1. A Production unit uses Rs.10,000 worth of an item during the year. The production units
estimated the ordering cost as Rs.25 per order and holding cost as 12.5 percent of the average
inventory value. Determine the optimal order size, number of orders per year, time period per
order and total cost.

Answer
Order Size = Q* = Rs.2000
No. of orders per year = N = 5
Time period per order = t* = 73 days
Total Cost = TC* = Rs.250

Q2. The usage of an inventory item each costing Re 1, is 10000 units/year and the ordering
cost is Rs.10, carrying charge is 20% based on the average inventory per year, stock out cost
is Rs.5 per unit of shortage incurred. Determine EOQ, inventory level, shortage level, cycle
period, number of order per year and the total cost.

Answer
EOQ = Q* = 1020 units
Inventory Level = I* = 980 units
Shortage Level = 40 units
Cycle Period = t* = 37 days
No. of orders/year = 10
Total Cost = Rs.400

Q3. The demand for a unit of item is at the rate of 200 per day and can be produced at a rate
of 800 per day. It costs Rs.5000 to set up the production process and Rs.0.2 per unit per day
held in inventory based on the actual inventory any time. Assume that the shortage is not
allowed. Find out the minimum cost and the optimum number of units per production run.

Answer
Hint: D=200 P=800 Co=Rs.5000 Ch=Rs.0.2

Q* = 3651 units
TC* = Rs.547.7

Q4. The demand for an item is 2400 units per year. The ordering cost is Rs.100, inventory
holding cost is 24 percent of the purchase price per year. Determine the optimum purchase
quantity if the purchase prices are as follows:

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P1 = Rs.10 for purchasing Q1 < 500

P2 = Rs.9.25 for purchasing 500
P3 = Rs.8.75 for purchasing 750

Answer
Economic Purchase Quantity = EPQ = Q* = 750 units

Q5. A company follows the following procurement pattern of five items irrespective of their
level of demand. Reduce the inventory levels while keeping the same total number of orders
per annum.

Item Demand/Year Number of Order size ($) Average

($) orders/year Inventory
1 1000,000 5 250,000 125,000
2 640,000 5 160,000 80,000
3 90,000 5 22,500 11,250
4 2,500 5 625 350
5 1,600 5 400 200

Answer

According to the company policy, ordering five times a year each item, total average
inventory becomes $.216800.
But after the analysis of ordering quantity the average inventory becomes $.7698.32,
which is much less, at the same time the number of orders almost remain same. Thus,
substantial savings can still be achieved when cost information is not known.

Q6. Suppose the carrying cost is 30% per unit/year, unit price is Rs.4, and the ordering cost is
Rs.30 per order for an item used in an organization in the following pattern:

Month Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Demand 200 220 150 170 210 200 180 220 170 200 160 140

Determine the ordering schedule and the total inventory cost using the following method.

1. Prescribed Rule Method

2. Fixed EOQ Method

Q7. The following numbers indicate the annual values in dollars of some thirty inventory
items of materials selected at random. Carry out an ABC analysis and list out the values of
three items viz. A-items, B-items and C-items.

1 2 3 9 75 3
4 6 13 2 3 12

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100 2 7 40 15 55
1 12 25 15 8 10
1 20 30 1 4 5

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Q8. An organization stoking two products. The organization has limited storage space and
can’t store more than 40 units. The following are the demand distribution for the products:

Product1 Product2
Demand Probability of Demand Demand Probability of Demand
10 0.10 10 0.05
20 0.20 20 0.20
30 0.35 30 0.30
40 0.25 40 0.13
50 0.10 50 0.10

If the inventory holding cost is Rs.10 (product 1) and Rs15 (product 2) per unit of the ending
inventories, the shortage costs are Rs.20 and Rs.50 per unit at the ending shortage for the first
and second products respectively. Determine the economic order quantities for both the
products.

4.9 Further References

Hamdy A Taha, 1999. Introduction to Operations Research, PHI Limited, New Delhi.

Mustafi, C.K. 1988. Operations Research Methods and Practices, Wiley Eastern Limited,
New Delhi.

Levin, R and Kirkpatrick, C.A. 1978. Quantitative Approached to Management, Tata

McGraw Hill, Kogakusha Ltd., International Student Edition.

Peterson R and Silver, E. A. 1979. Decision Systems for Inventory Management and
Production Planning.

Handley, G and T.N. Whitin. 1983. Analysis of Inventory Systems, PHI.

Starr, M.K. and D.W. Miller. 1977. Inventory Control Theory and Practice, PHI.

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UNIT III

NETWORK PROBLEMS
Introduction
A network consists of several destinations or jobs which are linked with one another. A
manager will have occasions to deal with some network or other. Certain problems pertaining
to networks are taken up for consideration in this unit.

LESSON 1

SHORTEST PATH PROBLEM

LESSON OUTLINE
The description of a shortest path problem.
The determination of the shortest path.

LEARNING OBJECTIVES
After reading this lesson you should be able to
- understand a shortest path problem
- understand the algorithm for a shortest path problem
- work out numerical problems

THE PROBLEM
Imagine a salesman or a milk vendor or a post man who has to cover certain previously earmarked places to
perform his daily routines. It is assumed that all the places to be visited by him are connected well for a suitable
mode of transport. He has to cover all the locations. While doing so, if he visits the same place again and again
on the same day, it will be a loss of several resources such as time, money, etc. Therefore he shall place a
constraint upon himself not to visit the same place again and again on the same day. He shall be in a position to
determine a route which would enable him to cover all the locations, fulfilling the constraint.
The shortest route method aims to find how a person can travel from one location to another, keeping
the total distance traveled to the minimum. In other words, it seeks to identify the shortest route to a series of
destinations.

EXAMPLE
Let us consider a real life situation involving a shortest route problem.
A leather manufacturing company has to transport the finished goods from the factory
to the store house. The path from the factory to the store house is through certain

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intermediate stations as indicated in the following diagram. The company executive wants to
identify the path with the shortest distance so as to minimize the transportation cost. The
problem is to achieve this objective.

95 Store house

2 4
Factory 40 40
35 65 70 6
40
1
100
5
20
3
Linkages from Factory to Store house

The shortest route technique can be used to minimize the total distance from a node designated as the
starting node or origin to another node designated as the final node.
In the example under consideration, the origin is the factory and the final node is the store house.
STEPS IN THE SHORTEST ROUTE TECHNIQUE
The procedure consists of starting with a set containing a node and enlarging the set by choosing a node in each
subsequent step.
Step 1:
First, locate the origin. Then, find the node nearest to the origin. Mark the distance between the origin and the
nearest node in a box by the side of that node.
In some cases, it may be necessary to check several paths to find the nearest node.
Step 2:
Repeat the above process until the nodes in the entire network have been accounted for. The last distance placed
in a box by the side of the ending node will be the distance of the shortest route. We note that the distances
indicated in the boxes by each node constitute the shortest route to that node. These distances are used as
intermediate results in determining the next nearest node.
SOLUTION FOR THE EXAMPLE PROBLEM
Looking at the diagram, we see that node 1 is the origin and the nodes 2 and 3 are neighbours
to the origin. Among the two nodes, we see that node 2 is at a distance of 40 units from node
1 whereas node 3 is at a distance of 100 units from node 1. The minimum of {40, 100} is 40.
Thus, the node nearest to the origin is node 2, with a distance of 40 units. So, out of the two
nodes 2 and 3, we select node 2. We form a set of nodes {1, 2} and construct a path
connecting the node 2 with node 1 by a thick line and mark the distance of 40 in a box by the
side of node 2. This first iteration is shown in the following diagram.

40

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95 Store house

2 4
40 40
6
Factory 35 65 70
1 40
5
100
3
20
ITERATION No. 1

Now we search for the next node nearest to the set of nodes {1, 2}. For this purpose, consider those
nodes which are neighbours of either node 1 or node 2. The nodes 3, 4 and 5 fulfill this condition. We calculate
the following distances.
The distance between nodes 1 and 3 = 100.
The distance between nodes 2 and 3 = 35.
The distance between nodes 2 and 4 = 95.
The distance between nodes 2 and 5 = 65.
Minimum of {100, 35, 95, 65} = 35.
Therefore, node 3 is the nearest one to the set {1, 2}. In view of this observation, the set of nodes is enlarged
from {1, 2} to {1, 2, 3}. For the set {1, 2, 3}, there are two possible paths, viz. Path 1
3
100 + 35 = 135 units.
Minimum of {75, 135} = 75. Hence we select the path 1
distance 75 is marked in a box by the side of node 3. We obtain the following diagram at the end of Iteration
No. 2.

40
95 Store house

2 4
Factory 40 40
6
35 65 70
1 40
5
100
3
20
75

ITERATION No. 2
REPEATING THE PROCESS
We repeat the process. The next node nearest to the set {1, 2, 3} is either node 4 or node 5.
Node 4 is at a distance of 95 units from node 2 while node 2 is at a distance of 40 units
from node 1. Thus, node 4 is at a distance of 95 + 40 = 135 units from the origin.

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As regards node 5, there are two paths viz. 2

know the shortest routes from nodes 2 and 3 to the origin. The minimum distances have been indicated in boxes
near these nodes. The path 3 volves the shortest distance. Thus, the distance between nodes 1 and 5 is 95
units (20 units between nodes 5 and 3 + 75 units between node 3 and the origin). Therefore, we select node 5
and enlarge the set from {1, 2, 3} to {1, 2, 3, 5}. The distance 95 is marked in a box by the side of node 5. The
following diagram is obtained at the end of Iteration No. 3.
40
95 Store house

2 4
40 40
6
35 65 70
1 40
5
Factory 100
3
20 95
75

ITERATION No. 3
Now 2 nodes remain, viz., nodes 4 and 6. Among them, node 4 is at a distance of 135 units from the
origin (95 units from node 4 to node 2 + 40 units from node 2 to the origin). Node 6 is at a distance of 135
units from the origin (40 + 95 units). Therefore, nodes 4 and 6 are at equal distances from the origin. If we
choose node 4, then travelling from node 4 to node 6 will involve an additional distance of 40 units. However,
node 6 is the ending node. Therefore, we select node 6 instead of node 4. Thus the set is enlarged from {1, 2, 3,
5} to {1, 2, 3, 5, 6}. The distance 135 is marked in a box by the side of node 6. Since we have got a path
beginning from the start node and terminating with the stop node, we see that the solution to the given problem
has been obtained. We have the following diagram at the end of Iteration No. 4.

40
95 Store house

2 4
40 40
6
35 65 70
1 40 135
5
Factory 100
3
20 95
75
ITERATION No. 4
MINIMUM DISTANCE
Referring to the above diagram, we see that the shortest route is provided by the path 1 2
3 5 6 with a minimum distance of 135 units.

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QUESTIONS
1. Explain the shortest path problem.

2. Explain the algorithm for a shortest path problem

3. Find the shortest path of the following network:

30
3 5
40
40
1 30 50 30

45 6
25

35
2 4

4. Determine the shortest path of the following network:

2
16 5
7
9 7
1 4
15 6
8 4
25
3

LESSON 2
MINIMUM SPANNING TREE PROBLEM
LESSON OUTLINE
The description of a minimum spanning tree problem.
The identification of the minimum spanning tree.

LEARNING OBJECTIVES

After reading this lesson you should be able to

- understand a minimum spanning tree problem
- understand the algorithm for minimum spanning tree problem
- locate the minimum spanning tree

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- carry out numerical problems

Tree: A minimally connected network is called a tree. If there are n nodes in a network, it
will be a tree if the number of edges = n-1.

Minimum spanning tree algorithm

Problem : Given a connected network with weights assigned to the edges, it is required to
find out a tree whose nodes are the same as those of the network.
The weight assigned to an edge may be regarded as the distance between the two
nodes with which the edge is incident.
Algorithm:
The problem can be solved with the help of the following algorithm.
The procedure consists of selection of a node at each step.
Step 1: First select any node in the network. This can be done arbitrarily. We will start with
this node.
Step 2: Connect the selected node to the nearest node.
Step 3: Consider the nodes that are now connected. Consider the remaining nodes. If there is
no node remaining, then stop. On the other hand, if some nodes remain, among them find out
which one is nearest to the nodes that are already connected. Select this node and go to Step
2.
Thus the method involves the repeated application of Steps 2 and 3. Since the number
of nodes in the given network is finite, the process will end after a finite number of steps. The
algorithm will terminate with step 3.
How to break ties:
While applying the above algorithm, if some nodes remain in step 3 and if there is a tie in the
nearest node, then the tie can be broken arbitrarily.
As a consequence of tie, we may end up with more than one optimal solution.
Problem 1:
Determine the minimum spanning tree for the following network.
60 5
2
70
60 60 80
100 7

1 3
40 120 50

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80 50 60
30
90
Solution:
Step 1: First select node 1. (This is done arbitrarily)
Step 2: We have to connect node 1 to the nearest node. Nodes 2, 3 and 4 are adjacent to node
1. They are at distances of 60, 40 and 80 units from node 1. Minimum of {60, 40, 80} = 40.
Hence the shortest distance is 40. This corresponds to node 3. So we connect node 1 to node
3 by a thick line. This is Iteration No. 1.

60 5
2 70
60 60 80
100 7

1 3
40 120 50

8
80 50 60
30
90 6
4

Iteration No. 1
Step 3: Now the connected nodes are 1 and 3. The remaining nodes are 2, 4, 5, 6, 7 and 8.
Among them, nodes 2 and 4 are connected to node 1. They are at distances of 60 and 80 from
node 1. Minimum of {60, 80} = 60. So the shortest distance is 60. Next, among the nodes 2,
4, 5, 6, 7 and 8, find out which nodes are connected to node 3. We find that all of them are
connected to node 3. They are at distances of 60, 50, 80, 60, 100 and 120 from node 3.
Minimum of {60, 50, 80, 60, 100, 120} = 50. Hence the shortest distance is 50.
Among these nodes, it is seen that node 4 is nearest to node 3.
Now we go to Step 2. We connect node 3 to node 4 by a thick line. This is Iteration
No.2.

60 5
2
70
60 60 80
100 7

1 3

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40 120 50

8
80 50 60
30

4
90 6

Iteration No. 2
Next go to step 3.
Now the connected nodes are 1, 3 and 4. The remaining nodes are 2, 5, 6, 7 and 8.
Node 2 is at a distance of 60 from node 1. Nodes 5, 6, 7 and 8 are not adjacent to node 1. All
of the nodes 2, 5, 6, 7 and 8 are adjacent to node 3. Among them, nodes 2 and 6 are nearer to
node 3, with equal distance of 60.
Node 6 is adjacent to node 4, at a distance of 90. Now there is a tie between nodes 2
and 6. The tie can be broken arbitrarily. So we select node 2. Connect node 3 to Node 2 by
a thick line. This is Iteration No. 3.

60 5
2
70
60 60 80
100 7

1 3
40 120 50

8
80 50 60
30

4
90 6

Iteration No. 3

We continue the above process.

Now nodes 1, 2, 3 and 4 are connected. The remaining nodes are 5, 6, 7 and 8. None
of them is adjacent to node 1. Node 5 is adjacent to node 2 at a distance of 60. Node 6 is at a
distance of 60 from node 3. Node 6 is at a distance of 90 from node 4. There is a tie between

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nodes 5 and 6. We select node 5. Connect node 2 to node 5 by a thick line. This is Iteration
No. 4.

60 5
2
70
60 60 80
100 7

1 3
40 120 50

8
80 50 60
30

4
90 6

Iteration No. 4

Now nodes 1, 2, 3, 4 and 5 are connected. The remaining nodes are 6, 7 and 8. Among them,
node 6 is at the shortest distance of 60 from node 3. So, connect node 3 to node 6 by a thick
line. This is Iteration No. 5.

60 5
2
70
60 60 80
100 7

1 3
40 120 50

8
80 50 60
30

4
90 6

Iteration No. 5
Now nodes 1, 2, 3, 4, 5 and 6 are connected. The remaining nodes are 7 and 8. Among them,
node 8 is at the shortest distance of 30 from node 6. Consequently we connect node 6 to node
8 by a thick line. This is Iteration No. 6.

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60 5
2
70
60 60 80
100 7

1 3
40 120 50

8
80 50 60
30

4
90 6

Iteration No. 6
Now nodes 1, 2, 3, 4, 5, 6 and 8 are connected. The remaining node is 7. It is at the shortest
distance of 50 from node 8. So, connect node 8 to node 7 by a thick line. This is Iteration
No.7.

60 5
2
70
60 60 80
100 7

1 3
40 120 50

8
80 50 60
30

4
90 6

Iteration No. 7
Now all the nodes 1, 2, 3, 4, 5, 6, 7 and 8 are connected by seven thick lines. Since no node
is remaining, we have reached the stopping condition. Thus we obtain the following minimum
spanning tree for the given network.

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2

60
7

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40 50

50 60
30

Minimum Spanning Tree

QUESTIONS
1. Explain the minimum spanning tree algorithm.
2. From the following network, find the minimum spanning tree.

75 6
2

80 55 90
100
1 3
70 40

25 60 5

4
30

3. Find the minimum spanning tree of the following network:

12
5
2 15
5 8
2 10 13 8
1 3 6

9 4 10
5 7

4
4

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