Linear

programming

Definition of a limiting factor

It is often assumed in budgeting that a company can produce as many units of its
products (or services) as is necessary to meet the available sales demand. Sales
demand is therefore normally the factor that sets a limit on the volume of
production and sales in each period.

Sometimes, however, there could be a shortage of a key production resource,

such as an item of direct materials, or skilled labour, or machine capacity. In
these circumstances, the factor setting a limit to the volume of sales and profit in
a particular period is the availability of the scarce resource, because sales are
restricted by the amount that the company can produce.

If the company makes just one product and a production resource is in limited
supply, profit is maximized by making as many units of the product as possible
with the limited resources available.

However, when a company makes and sells more than one different product with
the same scarce resource, a budgeting problem is to decide how many of each
different product to make and sell in order to maximise profits.

Maximising profit when there is a single limiting factor

When there is just one limiting factor (other than sales demand), total profit will
be maximized in a period by maximising the total contribution earned with the
available scarce resources.

The objective should be to maximise total contribution.

Which will be achieved by making the optimum use of the scarce resource and
maximising the contribution earned from each unit of the scarce resource that is
used.

Products should therefore be ranked in order of priority for manufacture and sale
according to the contribution earned by each product (or service) for each unit of
the scarce resource that the product uses.

The products or services should be produced and sold in this order of priority, up
to the maximum expected sales demand for each product.

The planned output and sales should be decided by working down through the
priority list until all the units of the limiting factor (scarce resource) have been

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used.

In other words, in order to maximise profit, the aim should be to maximise the
contribution for each unit of limiting factor used.

Test your understanding 1

Material M is restricted to 12,000 kilos.

Product A B C

Contribution per unit $ 10 16 24

Kilos of M per unit 2 4 8

Required:

Calculate the maximum contribution, which can be achieved.

Test your understanding 2

Suppose in Test your understanding 1 that sales of B are restricted to 4,000

units.

Required:

Calculate the maximum contribution, which can now be achieved.

Limitations of this approach include the following:

 Assumes constant variable cost per unit and constant total fixed costs.
 Takes no account of loss of customer goodwill.
 Can deal with only one scarce resource.
 Applies only to situations where capacity constraints cannot be removed in
the short term.

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Multi-Limiting Factors
Linear Programming
In situations in which more than one factor is limited, an alternative approach is
used to determine the optimal production so as to maximise contribution (and
therefore profit). This technique is linear programming:

Linear programming is a technique for solving problems of profit maximisation or

cost minimisation and resource allocation. 'Programming' has nothing to do with
computers: the word is simply used to denote a series of events.

Objective function—quantifies the objective. For example:

 Profit maximisation (which is always by maximising contribution);

 Cost minimisation.

Based on the assumption that the objective and the constraints may be
expressed as linear equations.

The syllabus only includes situations involving two variables— this allows the
equations to be plotted as straight lines on a graph.

The graph can be used to identify the optimal solution

Drawing the Graph

Step 1 Define unknowns

Step 2 Formulate the objective function (use contribution not profit).

Step 3 Express constraints in terms of inequalities (even non-negativity).

Step 4 Plot all constraints on a graph and identify the feasible region

Having drawn the graph, the optimal solution can be solved using one of two
methods:

The objective function method—also referred to as the

 iso- contribution method

 The simultaneous equation method.

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Test your understanding 3

Suppose a profit- seeking firm has two constraints: labour, limited to 16,000
hours, and materials, limited to 15,000 kgs. The firm manufactures and sells two
products, X and Y. To make X, the firm uses three kgs of material and four
hours of labour, whereas to make Y, the firm uses five kgs of material and
four hours of labour. The contribution per unit made by each product are $30
for X and $40 for Y. The cost of materials is normally $8 per kg, and the labour
rate is $10 per hour.

Required:

Calculate the optimal product mix, which will maximise the total contribution.

Test your understanding 4 (HW)

Mr. Wong is a tailor who makes two products (jacket & shirt) in his shop; each
product passes through a cutting process and sewing process. The contributions
made by each product are $20 for jacket and $15 for shirt. His shop has two
constraints: cutting hours are limited to 20 and sewing hours are limited to 40. To
make a jacket, it requires one cutting hour and four sewing hours. To make a
shirt, it requires two hours for cutting and two hours for sewing.

Required

Formulate the linear programming problem.

Test your understanding 5 (HW)

A small factory makes two components, C1 and C2, and has the following
constraints on weekly production:

Operative time 240 staff hours

Raw material A 500 kg

Raw material B 400 liters

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C1 uses two staff hours, 5 kg of A and 5 litres of B to make each unit.

C2 uses three staff hours, 5 kg of A and 4 litres of B to make each unit.

The contributions to profit from each unit of C1 and C2 are $150 and $100,
respectively. It is known that all production can be sold.

a) Represent the above situation as a linear programming model, if the object is

to maximise total weekly profit. (Denote the units of C1 and C2 produced
each week by X1 and X2 respectively.) (5 marks)

b) Show the constraints from (a) above on a graph and indicate the feasible
region (5 marks)

c) Determine the product mix, which will maximise weekly profit, and the
maximum Weekly profit, in (a) above. (5 marks)

Linear programming: shadow prices and slack

Slack & Surplus

Slack occurs when maximum availability of resource is not used: If, at the optimal
solution, the resource used equals the resource available, there is no spare
capacity of a resource and so there is no slack.

Surplus occurs when more than minimum requirement is used: If a minimum

quantity of a resource must be used and, at the optimal solution, more than that
quantity is used, there is a surplus on the minimum requirement.

Shadow prices

In a linear programming problem, every constraint has a shadow price. (A

shadow price is also called a dual price.) So in terms of linear programming, the
shadow price is the extra contribution or profit that may be earned by relaxing
one unit a binding resource constraint.

For example, suppose that direct labour hours are a constraint in a linear
programming problem, and the maximum labour time available is restricted to

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20,000 hours. If the objective function is to maximise contribution, the shadow

price of direct labour is the amount by which total contribution could be increased
in 20,001 labour hours were available (and the amount by which total contribution
would be reduced if only 19,999 labour hours were available).

Similarly suppose that in a linear programming problem there is a maximum

sales demand of 1,800 units for Product Y. The shadow price of sales demand
for Product Y is the amount by which total contribution in the optimal solution
would increase if the maximum sales demand were 1,801 units (of the amount by
which total contribution would fall if maximum sales demand were 1,799 units).

Note the following points.

1) The shadow price therefore represents the maximum premium above the
basic rate that an organisation should be willing to pay for one extra unit of a
resource.

2) Since shadow prices indicate the effect of a one unit change in a constraint,
they provide a measure of the sensitivity of the result.

3) The shadow price of a constraint that is not binding at the optimal solution is
zero.

4) Shadow prices are only valid for a small range before the constraint
becomes non-binding or different resources become critical.

5) Depending on the resource in question, shadow prices enable management

to make better informed decisions about the payment of overtime premiums,
bonuses, premiums on small orders of raw materials and so on.

Calculating a shadow price

The shadow price of an item cannot be a negative value. However, if it is not a

limiting factor in the optimal solution to the linear programming problem, the
shadow price of an item will be $0.

When an item is an actual limiting factor in the solution to a linear programming

problem, this means that in the optimal solution, the limit of the constraint has
been reached. The item therefore has a shadow price with a positive value.

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When the graphical method of solving a linear programming problem is used, the
shadow prices of the constraining items (effective limiting factors) are calculated
as follows.

The shadow price for each constraining item (effective limiting factor) should be
calculated one at a time.

Identify the constraints in the optimal solution to the linear programming problem.

Take one of the constraints in that solution and increase the limit of the constraint
by one unit.

Calculate the optimal solution when this constraint has been increased. The
optimal solution will be at the point on the graph where the same constraint lines
intersect, so calculate the solution using simultaneous equations.

Compare the value of the objective function with the new constraint with the
value of the objective function in the original linear programming problem. The
amount by which the total value of the objective function (total contribution) has
increased is the shadow price of the item. The same technique can be used to
calculate the shadow price of any other effective limiting factor in the original
solution.

Test your understanding 6

Robert Miles operates a small machine shop. Next month he plans to

manufacture two new products (A and B) upon which the unit contribution is
estimated to be $50 and $70, respectively. For their manufacture both products
require inputs of machine processing time, raw materials, and labour.

Each unit of product A requires 3 hours of machine processing time, 16 units of

raw materials and 6 units of labour. The corresponding per unit requirements for
product B are 10, 4 and 6. Robert forecasts that next month he can make
available 330 hours of machine processing time, 400 units of raw materials and
240 units of labour. The technology of the manufacturing process is such that at
least 12 units of product B must be made in any given month.

Robert Miles wishes to formulate a linear programming model so as to determine

the number of units of products A and B that he should manufacture next month
to maximise contribution.

Calculate Slack and surplus if any

Calculate shadow price

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Test your understanding 7

The Cosmetic Co is a company producing a variety of cosmetic creams and

lotions. The creams and lotions are sold to a variety of retailers at a price of
$23·20 for each jar of face cream and $16·80 for each bottle of body lotion. Each
of the products has a variety of ingredients, with the key ones being silk powder,
silk amino acids and aloe vera. Six months ago, silk worms were attacked by
disease causing a huge reduction in the availability of silk powder and silk amino
acids. The Cosmetic Co had to dramatically reduce production and make part of
its workforce, which it had trained over a number of years, redundant.

The company now wants to increase production again by ensuring that it uses
the limited ingredients available to maximise profits by selling the optimum mix of
creams and lotions. Due to the redundancies made earlier in the year, supply of
skilled labour is now limited in the short-term to 160 hours (9,600 minutes) per
week, although unskilled labour is unlimited. The purchasing manager is
confident that they can obtain 5,000 grams of silk powder and 1,600 grams of silk
amino acids per week. All other ingredients are unlimited. The following
information is available for the two products:

Cream Lotion

Materials required:

- silk powder (at $2·20 per gram) 3 grams 2 grams

- Silk amino acids (at $0·80 per gram) 1 gram 0·5 grams
- Aloe Vera (at $1·40 per gram) 4 grams 2 grams

Labour required:

- skilled ($12 per hour) 4 minutes 5 minutes

- unskilled (at $8 per hour) 3 minutes 1·5 minutes

Each jar of cream sold generates a contribution of $9 per unit, whilst each bottle
of lotion generates a contribution of $8 per unit. The maximum demand for
lotions is 2,000 bottles per week, although demand for creams is unlimited. Fixed
costs total $1,800 per week. The company does not keep inventory although if a
product is partially complete at the end of one week, its production will be
completed in the following week.

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O

n the graph paper provided, use linear programming to calculate the optimum
number of each product that the Cosmetic Co should make per week,
assuming that it wishes to maximise contribution. Calculate the total
contribution per week for the new production plan. All workings MUST be
rounded to 2 decimal places. (14 marks)

B. Calculate the shadow price for silk powder and the slack for silk amino acids.
All workings MUST be rounded to 2 decimal places. (6 marks)

Test your understanding 8

Higgins Co (HC) manufactures and sells pool cues and snooker cues. The cues
both use the same type of good quality wood (ash) which can be difficult to
source in sufficient quantity. The supply of ash is restricted to 5,400 kg per
period. Ash costs $40 per kg.

The cues are made by skilled craftsmen (highly skilled labour) who are well
known for their workmanship. The skilled craftsmen take years to train and are
difficult to recruit. HC’s craftsmen are generally only able to work for 12,000
hours in a period. The craftsmen are paid $18 per hour.

HC sells the cues to a large market. Demand for the cues is strong, and in any
period, up to 15,000 pool cues and 12,000 snooker cues could be sold. The
selling price for pool cues is $41 and the selling price for snooker cues is $69.

Manufacturing details for the two products are as follows:

Pool cues Snooker cues

Craftsmen time per cue 0·5 hours 0·75 hours

Ash per cue 270 g 270 g

Other variable costs per cue $1·20 $4·70

HC does not keep inventory.

Required:

A. Calculate the contribution earned from each cue.

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D

etermine the optimal production plan for a typical period assuming that HC is
seeking to maximise the contribution earned. You should use a linear
programming graph (using the graph paper provided), identify the feasible
region and the optimal point and accurately calculate the maximum
contribution that could be earned using whichever equations you need.
(12
marks)

Some of the craftsmen have offered to work overtime, provided that they are
paid double time for the extra hours over the contracted 12,000 hours. HC
has estimated that up to 1,200 hours per period could be gained in this way.

Required:
C. Explain the meaning of a shadow price (dual price) and calculate the shadow
price of both the labour (craftsmen) and the materials (ash).

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