Chapter 2: Optimization

Techniques and New

Management Tools

Instructor: Maharouf Oyolola

• As Discussed in the previous chapter, the
objective of a business firm is to maximize
profits or the value of the firm or minimize
cost, subject to some constraints.
• In this chapter, we present optimization
techniques, or methods for maximizing or
minimizing the objective function of a firm.
 Methods of expressing Economic
relationships
• Economic relationships can be expressed
in the form of equations, tables, or graphs.
• When the relationship is simple, a table
and/or graph may be sufficient.
• However, when the relationship is
complex, expressing the relationship in
equational form may be necessary.
 Examples
• Example of simple demand equation:
• Qd= a-b*P
• Example of a complex equation:
• TR=100Q-10Q2
•
 Total, Average, and
Marginal Relationships
The relationship between total, average, and
marginal concepts and measures is crucial in
optimization. This relationship is basically the
same whether we deal with revenue, product,
cost, and marginal cost
Total Revenue schedule of the firm
Q TR=100Q-10Q2 TR
0 100(0)-10(0)2 0
1 100(1)-10(1)2 90
2 100(2)-10(2)2 160
3 100(3)-10(3)2 210
4 100(4)-10(4)2 240
5 100(5)-10(5)2 250
6 100(6) -10(6)2 240
7 100(7)-10(7)2 210
 the total revenue curve of the firm

300
revenue(TR)

200
total

TR
100
0
0 2 4 6 8
output (Q)
Total, Average, and Marginal Costs
of a firm
Q TC AC MC

0 $20 - -

1 140 140 120

2 160 80 20

3 180 60 20

4 240 60 60
 Optimization with calculus
• Determining a Maximum or a Minimum by
calculus
• Optimization often requires finding the
maximum or the minimum value of a
function. For example, a firm might want to
maximize its revenue, minimize the cost of
producing a given output, or, more likely,
maximize its profits.
 Multivariate Optimization

• The Unconstrained Optimization

• Assume a car dealer for FORD and HONDA
would like to maximize his/her profit. As a
manager you want to know how many Honda
and Ford should I sell to maximize my profit?
• The unconstrained optimization does not take
into account factors that might impede the
freedom of the firm such as the legal
environment, the space, the personnel.
 The Constrained Optimization
.It is unrealistic to assume that the manager
of the firm faces no constraints. Most of
the time, however, managers face some
constraints in their optimization decisions.

• As a manager, you want to know how

many cars (FORD and HONDA) should I
order from the manufacturers to maximize
my profit?
As the manager of the car dealing company,
here are some of the constraints you might
be dealing with
• 1) Do I have enough space for the cars I order?
• 2) Do I have enough personnel to take care of
the cars?
• As we discussed last week, the objective of the
firm is to maximize its profit. Therefore, minimize
its costs.
• In the optimization with constraint, you take the
aforementioned factors into consideration while
deciding how many cars you should order to
maximize your profit.
 Example 2
• If you are the manager of a coffee shop.
Your objective is to maximize the firm’s
profit. Assume your order, milk, which is
one of your inputs directly from the
manufacturer. Milk is perishable good.
How many milks should I order to
maximize my profit?
 Problems
• In-class Problems
• Problem #4 page 77