1

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 1
 Optimization Techniques
• Methods for maximizing or minimizing
an objective function
• Examples
– Consumers maximize utility by purchasing
an optimal combination of goods
– Firms maximize profit by producing and
selling an optimal quantity of goods
– Firms minimize their cost of production by
using an optimal combination of inputs
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 2
 Expressing Economic
Relationships

Persamaan: TR = 100Q - 10Q2

Q 0 1 2 3 4 5 6
Tabel: TR 0 90 160 210 240 250 240
TR
300

250

Grafik: 200

150

100

50

0
0 1 2 3 4 5 6 7

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 3
 Total, Average, and Marginal
Revenue
Q TR AR MR
0 0 - -
TR = PQ
1 90 90 90
AR = TR/Q 2 160 80 70
MR = TR/Q 3 210 70 50
4 240 60 30
5 250 50 10
6 240 40 -10

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 4
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 5
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 6
 TR
300

250

Total Pendapatan 200

150

100

50

0
0 1 2 3 4 5 6 7

AR, MR
120

Pendapatan Rata- 100

80

rata dan Marginal 60

40

20

0
0 1 2 3 4 5 6 7
-20

-40

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 7
 Total, Average, and
Marginal Cost
Q TC AC MC
0 20 - -
AC = TC/Q
1 140 140 120
2 160 80 20
MC = TC/Q 3 180 60 20
4 240 60 60
5 480 96 240

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 8
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 9
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 10
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 11
 Geometric Relationships
• The slope of a tangent to a total curve
at a point is equal to the marginal value
at that point
• The slope of a ray from the origin to a
point on a total curve is equal to the
average value at that point

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 12
 Geometric Relationships
• A marginal value is positive, zero, and
negative, respectively, when a total
curve slopes upward, is horizontal, and
slopes downward
• A marginal value is above, equal to, and
below an average value, respectively,
when the slope of the average curve is
positive, zero, and negative
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 13
 Profit Maximization

Q TR TC Profit
0 0 20 -20
1 90 140 -50
2 160 160 0
3 210 180 30
4 240 240 0
5 250 480 -230

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 14
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 15
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 16
 Steps in Optimization
• Define an objective mathematically as a
function of one or more choice variables
• Define one or more constraints on the
values of the objective function and/or
the choice variables
• Determine the values of the choice
variables that maximize or minimize the
objective function while satisfying all of
the constraints
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 17
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 18
 New Management Tools
• Benchmarking
• Total Quality Management
• Reengineering
• The Learning Organization

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 19
• Benchmarking
Finding out, in an open and authentic way,
how other firms may be doing something
better (cheaper) so that your firm can copy
and possibly improve on its technique.

• Total Quality Management (TQM)

Constantly improving the quality of
products and the firm’s processes so as to
consistently deliver increasing value to
customers. “How can we do this cheaper,
faster, or better?”.
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 20
• Reengineering
Seeks to completely reorganize the firm. “If you were
able to start all over again, how would you do it?”.
Reengineering involves the radical redesign of all of
the firm’s processes to achieve major gains in
speed, quality, service, and profitability.
• The Learning Organization
A learning organization values continuing learning,
both individual and collective, and believes that
competitive advantage derives from and requires
continuous learning in our information age. (Peter
Senge).
A learning organization is based on five basic
ingredients:
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 21
 The Learning Organization
1) To develop a new mental model by putting aside old
ways of thinking and being willing to change.
2) To achieve personal mastery by learning to be open
with others and listen to them rather than telling them
what to do.
3) To develop system thinking, or an understanding of how
the firm really works.
4) To develop a shared vision or a strategy that all the
firm’s employees share.
5) To strive for team learning, or seeing how all the firm’s
employees can be made to work and learn together to
realize the shared vision and carry out the strategy of
the firm.
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 22
 Other Management Tools
• Broadbanding
• Direct Business Model
• Networking
• Performance Management

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 23
 Other Management Tools
• Pricing Power
• Small-World Model
• Strategic Development
• Virtual Integration
• Virtual Management

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 24
• Broadbanding
The elimination of multiple salary grades to
encourage movement among jobs within the
firm, increasing labor flexibility and lowering
costs
• Direct Business Model
A firm deals directly with the consumer,
eliminating the time and cost of third-party
distribution.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 25
• Networking
The forming of temporary strategic alliances to
allow each firm to contribute its best
competency.
• Pricing Power
The ability of a firm to raise prices faster than
the rise in its costs or to lower its costs faster
than the fall in the prices at which the firms
sell, - thus increasing its profits.
• Small-World Model
The idea is to find the key or well-connected
individuals at each level of the firm and
establish links among them.
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 26
• Virtual Integration
The blurring of the traditional boundaries and
roles between the manufacturer and its
suppliers, on the one hand, and the
manufacturer and its customers, on the other,
in the value chain by treating suppliers and
customers as if they were part of the
company. This greatly reduces or eliminates
the need for inventories and satisfies
consumer demand.
• Virtual Management
The ability of a manager to simulate consumer
behavior using computer models based on the
emerging science or theory of complexity
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 27
 Chapter 2 Appendix

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 28
 Concept of the Derivative

The derivative of Y with respect to X is

equal to the limit of the ratio Y/X as
X approaches zero.

dY Y
 lim
dX X 0 X
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 29
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 30
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 31
 Rules of Differentiation
Constant Function Rule: The derivative
of a constant, Y = f(X) = a, is zero for all
values of a (the constant).

Y  f (X )  a

dY
0
dX

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 32
 Rules of Differentiation
Power Function Rule: The derivative of
a power function, where a and b are
constants, is defined as follows.

Y  f (X )  aX b

dY
 b  a X b 1
dX

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 33
 Rules of Differentiation
Sum-and-Differences Rule: The derivative
of the sum or difference of two functions,
U and V, is defined as follows.
U  g( X ) V  h( X ) Y  U V

dY dU dV
 
dX dX dX

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 34
 Rules of Differentiation
Product Rule: The derivative of the
product of two functions, U and V, is
defined as follows.
U  g( X ) V  h( X ) Y  U V

dY dV dU
U V
dX dX dX

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 35
 Rules of Differentiation
Quotient Rule: The derivative of the
ratio of two functions, U and V, is
defined as follows.
U
U  g( X ) V  h( X ) Y
V

dY

V dU  dX   U dV
dX 
2
dX V
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 36
 Rules of Differentiation
Chain Rule: The derivative of a function
that is a function of X is defined as follows.

Y  f (U ) U  g(X )

dY dY dU
 
dX dU dX

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 37
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 38
 Optimization with Calculus

Find X such that dY/dX = 0

Second derivative rules:
If d2Y/dX2 > 0, then X is a minimum.
If d2Y/dX2 < 0, then X is a maximum.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 39
 Univariate Optimization
Given objective function Y = f(X)
Find X such that dY/dX = 0
Second derivative rules:
If d2Y/dX2 > 0, then X is a minimum.
If d2Y/dX2 < 0, then X is a maximum.

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 40
 Example 1
• Given the following total revenue (TR)
function, determine the quantity of
output (Q) that will maximize total
revenue:
• TR = 100Q – 10Q2
• dTR/dQ = 100 – 20Q = 0
• Q* = 5 and d2TR/dQ2 = -20 < 0

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 41
 Example 2
• Given the following total revenue (TR)
function, determine the quantity of
output (Q) that will maximize total
revenue:
• TR = 45Q – 0.5Q2
• dTR/dQ = 45 – Q = 0
• Q* = 45 and d2TR/dQ2 = -1 < 0

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 42
 Example 3
• Given the following marginal cost
function (MC), determine the quantity of
output that will minimize MC:
• MC = 3Q2 – 16Q + 57
• dMC/dQ = 6Q - 16 = 0
• Q* = 2.67 and d2MC/dQ2 = 6 > 0

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 43
 Example 4
• Given
– TR = 45Q – 0.5Q2
– TC = Q3 – 8Q2 + 57Q + 2
• Determine Q that maximizes profit (π):
– π = 45Q – 0.5Q2 – (Q3 – 8Q2 + 57Q + 2)

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 44
 Example 4: Solution
• Method 1
– dπ/dQ = 45 – Q - 3Q2 + 16Q – 57 = 0
– -12 + 15Q - 3Q2 = 0
• Method 2
– MR = dTR/dQ = 45 – Q
– MC = dTC/dQ = 3Q2 - 16Q + 57
– Set MR = MC: 45 – Q = 3Q2 - 16Q + 57
• Use quadratic formula: Q* = 4
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 45
 Quadratic Formula
• Write the equation in the following form:
aX2 + bX + c = 0
• The solutions have the following form:
 b  b  4ac 2

2a

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 46
 Multivariate Optimization
• Objective function Y = f(X1, X2, ...,Xk)
• Find all Xi such that ∂Y/∂Xi = 0
• Partial derivative:
– ∂Y/∂Xi = dY/dXi while all Xj (where j ≠ i) are
held constant

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 47
 Example 5
• Determine the values of X and Y that
maximize the following profit function:
– π = 80X – 2X2 – XY – 3Y2 + 100Y
• Solution
– ∂π/∂X = 80 – 4X – Y = 0
– ∂π/∂Y = -X – 6Y + 100 = 0
– Solve simultaneously
– X = 16.52 and Y = 13.92
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 48
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 49
 Constrained Optimization
• Substitution Method
– Substitute constraints into the objective
function and then maximize the objective
function
• Lagrangian Method
– Form the Lagrangian function by adding
the Lagrangian variables and constraints to
the objective function and then maximize
the Lagrangian function
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 50
 Example 6
• Use the substitution method to
maximize the following profit function:
– π = 80X – 2X2 – XY – 3Y2 + 100Y
• Subject to the following constraint:
– X + Y = 12

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 51
 Example 6: Solution
• Substitute X = 12 – Y into profit:
– π = 80(12 – Y) – 2(12 – Y)2 – (12 – Y)Y – 3Y2 + 100Y
– π = – 4Y2 + 56Y + 672
• Solve as univariate function:
– dπ/dY = – 8Y + 56 = 0
– Y = 7 and X = 5

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 52
 Example 7
• Use the Lagrangian method to
maximize the following profit function:
– π = 80X – 2X2 – XY – 3Y2 + 100Y
• Subject to the following constraint:
– X + Y = 12

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 53
 Example 7: Solution
• Form the Lagrangian function
– L = 80X – 2X2 – XY – 3Y2 + 100Y + (X + Y – 12)
• Find the partial derivatives and solve
simultaneously
– dL/dX = 80 – 4X –Y +  = 0
– dL/dY = – X – 6Y + 100 +  = 0
– dL/d = X + Y – 12 = 0
• Solution: X = 5, Y = 7, and  = -53
PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 54
 Interpretation of the
Lagrangian Multiplier, 
• Lambda, , is the derivative of the
optimal value of the objective function
with respect to the constraint
– In Example 7,  = -53, so a one-unit
increase in the value of the constraint (from
-12 to -11) will cause profit to decrease by
approximately 53 units
– Actual decrease is 66.5 units

PowerPoint Slides Prepared by Robert F. Brooker, Ph.D. Copyright  2007 by Oxford University Press, Inc. Slide 55