ISOM 2700: Operations Management
Session 20: Final Exam Review
Dongwook Shin
Dept. ISOM, HKUST Business School
About Final Exam
• Venue: S. H. Ho Sports Hall
• Time: Dec 13 (Monday), 12:30-2:30pm
• Please arrive at the venue at 12:15pm sharp
• Coverage: Lecture notes 12-20
• Format: Multiple choice (40 questions)
• Closed-book and closed-note
• No cheat sheet allowed, but a formula sheet will be
provided
• You can use a calculator
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More About Final Exam
• Coverage
• Inventory Management: 18-20 questions
• Revenue Management: 12-14 questions
• Supply Chain Management: 8-10 questions
• 30% Conceptual questions
• 70% Quantitative questions
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Topics
• Inventory Management
• EOQ / Probabilistic EOQ / EOQ with quantity discounts
• Newsvendor
• Demand & Revenue Management
• Forecasting methods (simple/weighted moving averages,
exponential smoothing, linear regression)
• Capacity-based revenue management (applications of
newsvendor model)
• Price-based revenue management (linear demand model)
• Supply Chain Management
• Double marginalization and coordination using contracts
(wholesale price/revenue sharing/returns)
• Bullwhip effect (causes and resolutions)
3
Round-Up Rule Explained
• Whenever you are looking up a target value in a table and the
target value falls between two entries, choose the entry that
leads to the larger order quantity
• Expected underage cost of n+1st unit
= underage cost × Pr(n+1st unit sells)
= Cu × Pr (Demand > n)
• Expected overage cost of n+1st unit
= overage cost × Pr(n+1st unit does not sell)
= Co × Pr (Demand ≤ n)
4
Round-Up Rule Explained
• Expected incremental profit from stocking the n+1st unit
• Profit(n → n+1)
= expected gain – expected loss
= Cu × Pr (Demand > n) – Co × Pr (Demand ≤ n)
= Cu – (Cu + Co ) × Pr (Demand ≤ n)
• Increase from n to n+1 when Profit(n → n+1) > 0
Cu
• Equivalently, Pr (Demand ≤ n) >
Cu+Co
• Hence the round-up rule
5
Practice Set 6 Q8
6
Practice Set 6 Q8
• Cost of underage Cu = Cost of reserving too few rooms
for high fare customers= 120 - 50 = $70.
• Cost of overage Co = Cost of reserving too many rooms
for high fare customers = 50 - 0 = $50
• The critical ratio=70/(70+50)=0.583
• P(number of high fare customers <= Q) = 0.583.
• The cumulative probability of 120 high fare customers =
0.6, which is just higher than the critical fractile. The
smallest such Q is 120. Hence, the optimal protection
level is 120 rooms and Double tree shall sell 150-120=30
rooms in advance to the agencies.
7
Practice Set 6 Q4
JetRed Airways flies several daily flights from Philadelphia to Chicago. Based
on historical data, the flight on Wednesday evening before Thanksgiving is
always sold-out. However, there are usually no-shows so the airline decides
to improve revenues by overbooking. The no-shows are Poisson-distributed
with mean 8 and the airline estimates that the cost of bumping a passenger is
about 10 times more than ticket price
Num. No Shows x Pr (Number of No show <= x)
1 0.00
2 0.01
3 0.04
4 0.10
5 0.19
6 0.31
7 0.45
8 0.59
9 0.72
10 0.82
11 0.89
12 0.94
13 0.97
14 0.98
15 0.99
16 1.00
(a) How many seats should JetRed overbook?
(b) JetRed management does not want to bump passengers more than 5% of
the time. What is the maximum number of seats that JetRed can overbook?
8
Probabilistic EOQ: Safety Stock
• Reduce demand variability ⟹ less safety stock
• Increase in underage cost ⟹ more safety stock
• Increase in overage cost ⟹ less safety stock
• Underage cost < overage cost ⟹ negative safety stock
• Underage cost > overage cost ⟹ positive safety stock
9
Practice Set 5 Q11 (a)
• Goop Inc needs to order a raw material to make a special polymer. The demand for
the polymer is forecasted to be normally distributed with a mean of 250 gallons and a
standard deviation of 125 gallons. Goop sells the polymer for $25 per gallon. Goop’s
purchases raw material for $10 per gallon and Goop must spend $5 per gallon to
dispose off all unused raw material due to government regulations. (One gallon of raw
material yields one gallon of polymer.) If demand is more than Goop can make, then
Goop sells only what they made and the rest of demand is lost.
• Suppose Good purchases 150 gallons of raw material. What is the probability that
they will run out of raw material?
• This question asks P Demand>150 =P(N 250,1252 >150)
• P(N(250,1252) > 150) = P(N(0,12) > (150-250)/125) = P(N(0,12) > -0.8)
• P(N(0,12) > -0.8) = P(N(0,12) <= 0.8)
• Now, use the standard normal distribution table!
10
The Standard Normal Distribution
z 0.00 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09
0.0 0.5000 0.5040 0.5080 0.5120 0.5160 0.5199 0.5239 0.5279 0.5319 0.5359
0.1 0.5398 0.5438 0.5478 0.5517 0.5557 0.5596 0.5636 0.5675 0.5714 0.5753
0.2 0.5793 0.5832 0.5871 0.5910 0.5948 0.5987 0.6026 0.6064 0.6103 0.6141
0.3 0.6179 0.6217 0.6255 0.6293 0.6331 0.6368 0.6406 0.6443 0.6480 0.6517
0.4 0.6554 0.6591 0.6628 0.6664 0.6700 0.6736 0.6772 0.6808 0.6844 0.6879
Φ(z) = Prob(N(0,1) < z) 0.5 0.6915 0.6950 0.6985 0.7019 0.7054 0.7088 0.7123 0.7157 0.7190 0.7224
0.6 0.7257 0.7291 0.7324 0.7357 0.7389 0.7422 0.7454 0.7486 0.7517 0.7549
0.7 0.7580 0.7611 0.7642 0.7673 0.7704 0.7734 0.7764 0.7794 0.7823 0.7852
0.8 0.7881 0.7910 0.7939 0.7967 0.7995 0.8023 0.8051 0.8078 0.8106 0.8133
0.9 0.8159 0.8186 0.8212 0.8238 0.8264 0.8289 0.8315 0.8340 0.8365 0.8389
1.0 0.8413 0.8438 0.8461 0.8485 0.8508 0.8531 0.8554 0.8577 0.8599 0.8621
1.1 0.8643 0.8665 0.8686 0.8708 0.8729 0.8749 0.8770 0.8790 0.8810 0.8830
1.2 0.8849 0.8869 0.8888 0.8907 0.8925 0.8944 0.8962 0.8980 0.8997 0.9015
1.3 0.9032 0.9049 0.9066 0.9082 0.9099 0.9115 0.9131 0.9147 0.9162 0.9177
1.4 0.9192 0.9207 0.9222 0.9236 0.9251 0.9265 0.9279 0.9292 0.9306 0.9319
1.5 0.9332 0.9345 0.9357 0.9370 0.9382 0.9394 0.9406 0.9418 0.9429 0.9441
Φ(z) 1.6 0.9452 0.9463 0.9474 0.9484 0.9495 0.9505 0.9515 0.9525 0.9535 0.9545
1.7 0.9554 0.9564 0.9573 0.9582 0.9591 0.9599 0.9608 0.9616 0.9625 0.9633
0 z 1.8
1.9
0.9641
0.9713
0.9649
0.9719
0.9656
0.9726
0.9664
0.9732
0.9671
0.9738
0.9678
0.9744
0.9686
0.9750
0.9693
0.9756
0.9699
0.9761
0.9706
0.9767
2.0 0.9772 0.9778 0.9783 0.9788 0.9793 0.9798 0.9803 0.9808 0.9812 0.9817
2.1 0.9821 0.9826 0.9830 0.9834 0.9838 0.9842 0.9846 0.9850 0.9854 0.9857
2.2 0.9861 0.9864 0.9868 0.9871 0.9875 0.9878 0.9881 0.9884 0.9887 0.9890
2.3 0.9893 0.9896 0.9898 0.9901 0.9904 0.9906 0.9909 0.9911 0.9913 0.9916
2.4 0.9918 0.9920 0.9922 0.9925 0.9927 0.9929 0.9931 0.9932 0.9934 0.9936
Φ(z) = 98.7% => z* = 2.23 2.5
2.6
0.9938
0.9953
0.9940
0.9955
0.9941
0.9956
0.9943
0.9957
0.9945
0.9959
0.9946
0.9960
0.9948
0.9961
0.9949
0.9962
0.9951
0.9963
0.9952
0.9964
2.7 0.9965 0.9966 0.9967 0.9968 0.9969 0.9970 0.9971 0.9972 0.9973 0.9974
2.8 0.9974 0.9975 0.9976 0.9977 0.9977 0.9978 0.9979 0.9979 0.9980 0.9981
2.9 0.9981 0.9982 0.9982 0.9983 0.9984 0.9984 0.9985 0.9985 0.9986 0.9986
3.0 0.9987 0.9987 0.9987 0.9988 0.9988 0.9989 0.9989 0.9989 0.9990 0.9990
3.1 0.9990 0.9991 0.9991 0.9991 0.9992 0.9992 0.9992 0.9992 0.9993 0.9993
3.2 0.9993 0.9993 0.9994 0.9994 0.9994 0.9994 0.9994 0.9995 0.9995 0.9995
3.3 0.9995 0.9995 0.9995 0.9996 0.9996 0.9996 0.9996 0.9996 0.9996 0.9997
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Practice Set 5, Question 3
The annual demand for a product is 15,600 units. The weekly demand
is 300 units with a standard deviation of 90 units. The cost to place an
order is $31.20, and the time from ordering to receipt is four weeks.
The annual inventory carrying cost is $0.10 per unit
a. Find the reorder point necessary to provide a 98% service probability
b. Suppose the production manager is asked to reduce the safety stock of
this item by 50%. If she does so, what will the new service probability be?
c. (New question) How much should the lead time be reduced to reduce the
safety stock by 50% without affecting the service probability of 98%?
The safety stock is 𝑧 ⋅ 𝜎 𝐿. All else being fixed, the lead time should be reduced by a
factor of four to reduce the safety stock by a factor of two
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Practice Set 5, Question 4
• Consider a retailer who plans to expand his business in a new city. He
can choose to build a flagship store to serve the entire city; or he can
build 2 regional branch stores, each serving its own region. Weekly
demand in region 1 is normally distributed with mean 2,000 and
standard deviation 400. Weekly demand in region 2 is normally
distributed with mean 800 and standard deviation 100. The lead time
for both regions is 2 weeks. Assume a target level CSL of 0.95
a. How much safety stock will the retailer have to hold if he
builds 2 regional stores?
b. How does the safety stock requirement change if the retailer
uses a central flagship store?
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Concept Checker: True/False
• Consider a firm facing a demand function
Da(p) = 100 – 2p
The firm can boost the demand by aggressive marketing efforts. The
marketing department estimates the aggressive marketing would shift
the demand function:
Db(p) = 200 – 2p
Assume that the firm always chooses a revenue-maximizing price.
With aggressive marketing:
a. The revenue-maximizing price would be doubled (T / F)
b. The demand will be doubled (T / F)
c. The revenue will be doubled (T / F)
14
Quiz 5 Q4
Consider a book retailer who sells a textbook. The seller would like to set
different price for regular and student editions of the book, where student
editions are available only for students. The average demand for regular
edition is
𝑑!"# 𝑝 = 𝑎 − 𝑏𝑝,
and the average demand for student edition is
𝑑 $%& (𝑝) = 𝑎 − 2𝑏𝑝.
In this case, find the value of Y+Z, where
(optimal price for the regular edition) = Y x (optimal price for the student
edition)
(optimal revenue for the regular edition) = Z x (optimal revenue for the student
edition).
15
Supply Chain Coordination
Wholesale price Retail price
w p=400
Supplier Retailer Consumers
Order quantity
Unit production cost q Demand D~N(1000,2002)
c=100
Revenue
Integrated Wholesale Returns
Sharing
Firm Price Contract Contract
Contract
Underage cost p-c p-w p(1-y)-w p-w
Overage cost c w w w-r
Yes, if w and y Yes, if w and r
First-best
Yes No are chosen are chosen
outcome?
appropriately appropriately
16
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Thank you!
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