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 maximised 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
maximised 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 used.

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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 I is restricted to 12,000 kilos.

Product A B C

Contribution per unit $ 16 10 24

Kilos of I per unit 4 2 8

Required:

Calculate the maximum contribution, which can be achieved.

Test your understanding 2

Suppose in Example 2 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.

Multi-Limiting Factors
Linear Programming
In situations in which more than one factor is limited, an alternative approach is used to

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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 ona 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.

Test your understanding 3

A company makes two products, cabinets and chests. Each product passes through two
departments, carpentry and polishing. The time spent in each department is as follows.

Departmental time (hours)

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Carpentry Polishing

Cabinets 3 2

Chests 4 6

There are 4,800 hours available in each department.Annual production of cabinets must
not exceed 1,200 units. Apart from this, all items produced can be sold.

The contribution to profit and fixed overheads is $100 for a cabinet and $150 for a chest.

Required:

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

Test your understanding 4

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

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 litres

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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: slack is the amount of
the unused resource or other constraint, were constraint is a less than or equal to
constraint

Surplus occurs when more than minimum requirement is used: surplus is the excess over
the minimum amount of constraint where constraint more than or equal to a constraint

Shadow prices

In a linear programming problem, every constraint has a shadow price. (A shadow price
is also called a dual price.) A shadow price is the amount by which the value of the
objective function would change in the optimal solution if the constraint was one unit
extra (or one unit less).

For example, suppose that direct labour hours are a constraint in a linear programming
problem, and the maximum labour time available is restricted to 20,000 hours. If the

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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).

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.

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

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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

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

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– 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.

A. On 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:

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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.

B. Determine 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).