Newsboy Problem

Consider the problem faced by a Newsboy who has to

decide everyday on the number of papers to stock in

the face of uncertainty in daily demand.
Daily demand is uncertain and given by the discrete
probability distribution
Demand

Probability

20

0.2

21

0.5

22

0.3

Price of newspaper = 6; cost = 3; salvage value = 1

Indian Institute of Management Calcutta, India

Problem Formulation and Solution

2

Demand = 20
Sales = Min (20, K)
0.2
Production = K

0.5

Demand = 21
Sales = Min (21, K)

0.3
Demand = 22
Sales = Min (22, K)

In each case, Profit = (Price)X(Sales) + (Salvage value)X(Unsold

quantity) (Cost)X(Production)
Indian Institute of Management Calcutta, India

Problem Formulation and Solution (Contd.)

3
Demand = 20; Sales = 20
Profit = 6X20 3X20 = 60

0.2

0.2
K = 20

Demand = 21; Sales = 20

Profit = 6X20 3x20 = 60

0.5

K = 21

0.5
0.3

0.3

Demand = 22; Sales = 20

Profit = 6X20 3x20 = 60

Expected Profit = 0.2X60 + 0.5X60 + 0.3X60 = 60

Demand = 20; Sales = 20

Profit = 6X20 + 1X(21-20)
3X21 = 58
Demand = 21; Sales = 21
Profit = 6X21 3X21 = 63
Demand = 22; Sales = 21
Profit = 6X21 3X21 = 63

Expected Profit = 0.2X58 + 0.5X63 + 0.3X63 = 62

Demand = 20; Sales = 20

Profit = 6X20 +1X(2220) 3X22 = 56
0.2
K = 22

0.5
0.3

Demand = 21; Sales = 21

Profit = 6X21 + 1X(22-21) 3X22 = 61
Demand = 22; Sales = 22
Profit = 6X22 3X22 = 66

Expected Profit = 0.2X56 + 0.5X61 + 0.3X66 = 61.5

Hence Optimal Capacity = 21; Corresponding Profit = 41

Indian Institute of Management Calcutta, India

Expected Profit Table

Demand

20 (.2)

21 (.5)

22 (.3)

Expected
Profit

Stock 20

60

60

60

60

Stock 21

58

63

63

62

Stock 22

56

61

66

61.5

Action

Maximum Expected Profit under uncertainty = 62. Hence decision : Stock 21

Note: Expected Profit under certainty = 60 x .2 + 63 x .5 + 66 x .3 = 63.3
Expected value of perfect information (EVPI) = 63.3 62 = 1.3

Expected Opportunity Loss (EOL) Table

Demand 20 (.2)

21 (.5)

22 (.3)

EOL

Action
Stock 20

3.3

Stock 21

1.3

Stock 22

1.8

Best decision implies minimum EOL, i.e. Stock 21

Note: EOL of the best decision is same as EVPI = 1.3