Contents

Linear Programming and Economic Analysis ................................................................................................ 1 Assumption ............................................................................................................................................... 2 Misconceptions ......................................................................................................................................... 2 Function .................................................................................................................................................... 2 Features .................................................................................................................................................... 2 Benefits ..................................................................................................................................................... 3 The Dual Problem and Shadow prices ...................................................................................................... 3 Applications of Linear Programming......................................................................................................... 3

Linear Programming and Economic Analysis

Linear Programming: is a mathematical technique for solving constrained maximization and minimization problems when there is more than one constraint and both the objective function to be optimized and constraints faced are linear. Linear programming is a method of economic and business analysis that relies on matrix algebra and other mathematics techniques to achieve the highest level of satisfaction -- maximum profits, for example -- subject to a set of known constraints. The challenge of maximizing satisfaction within a set of limits makes linear programming an ideal tool of analysis for economics, which studies the ways in which households, businesses and societies allocate limited resources to achieve needs and wants.

Assumption
A basic assumption of linear programming is that commodities can be produced with only a limited number of input combinations. Or the objective function that the organisation seeks to optimise (i.e. maximize or minimize) as well as the constraints that it faces, are linear and can be represented graphically by straight lines. This means that we assume that input and output prices are constant and that we have CRS.

Misconceptions
Although computers provide tremendous help with the complex mathematics used in linear programming, the word "programming" does not refer to a set of instructions to a computer. In this context, the word refers to operations planning.

Function
In economic analysis, linear programming has broad applications in industrial management and operations. Managers of industry want to maximize their companies' profits or minimize production costs, but recognize the existence of constraints. For example, managers of an automobile production plant want to produce the number of vehicles that will maximize factory profits, but they recognize that finite resources such as materials, labor and production equipment present constraints on the level of output the factory can achieve. Linear programming helps managers optimize output, subject to these and other constraints.

Features
Any linear programming problem in economic analysis contains the following three elements: an objective function, constraints and a set of variables. The objective function is a mathematical expression of the goal you want to achieve. For example, as a manager of a company, you want to maximize your company's profit. Your constraint is a mathematical expression of the limits that exist on achieving that goal of maximum profit. These might include a finite work force and limited materials for manufacturing your product. The variables represent factors that can be adjusted, such as the daily rate of output or costs of production. Linear programming involves combining the relevant variables that provide the highest value of the objective function, subject to existing constraints.

Benefits
In economic analysis, linear programming facilitates the search for an optimization solution involving large numbers of variables and constraints. Some large-scale optimization issues can involve hundreds of thousands of variables and thousands of constraints. Linear programming, combined with the power of computer programs, can solve these problems in practical amounts of time. Airline Operations Planning Output Planning with Resource and Process Capacity Constraints Distribution of Advertising Budget Routing of Long-Distance Phone Calls Investment Portfolio Selection Allocation of Personnel Among Activities

The Dual Problem and Shadow prices

Every linear programming problem, called the primal problem, has a corresponding or symmetrical problem called the dual problem. A profit-maximization primal problem has a cost-minimization dual problem, and vice versa. The solution of a dual problem yields the shadow prices. They give the change in the value of the objective function per unit change in each constraint in the primal problem. According to the duality theorem, the optimal value of the objective function is the same in the primal and in the corresponding dual problems.

Applications of Linear Programming

1. Optimal Process Selection: Given input prices and the quantity of the commodity that the firm wants to produce, linear programming can be used to determine the optimal combination of processes needed to produce the desired level and output at the lowest possible cost, subject to labor, capital and the other constraints that the firm may face.

2. Optimal Product Mix: Usually most firms produce a variety of products rather than a single one and must determine how to best use their plants, labor, and other inputs to produce the combination or mix of products that maximizes their total profits subject to the constraints they face i.e., the production of a particular commodity may lead to the highest profit per unit but may not use all the firms resources. The unused resources can be used to produce another commodity; however this product mix may not lead to overall profit maximization for the firm as a whole.

3. Satisfying Minimum Product Requirements: production often requires that certain minimum product requirements be met at minimum cost. i.e., the manager of a college dinning hall may be required to prepare meals that satisfy the minimum daily requirements of protein, minerals, and vitamins at a minimum cost. Due to the various nutrients and different prices, this problem can be complex and solved easily by linear programming by specifying the total cost function that manager seeks to minimize and the various constraints that he or she must meet or satisfy.

4. Long-Run Capacity Planning: An important question that firms seek to answer is how much contribution to profit each unit of the various inputs makes. If this exceeds the price that the firm must pay for the input, this is an indication that the firms total profit would increase by hiring more of the input. If the input is underused, this means that some units of the input need not be hired or can be sold to other firms without affecting the firms output. This can be very useful to the firm in its investment decisions and future profitability while determining the marginal contribution of an input.

5. Least Cost Shipping Route: Linear programming has also been applied to determine the least cost route for shipping commodities from plants in different locations to warehouses in other locations and from there to different markets ( so called Transportation Problems).