Markov Analysis: To Accompany by Render, Stair, and Hanna Power Point Slides Created by Brian Peterson

Chapter 15

Markov Analysis

To accompany
Quantitative Analysis for Management, Eleventh Edition, Global Edition
by Render, Stair, and Hanna
Power Point slides created by Brian Peterson

Copyright © 2012 Pearson Education 15-1

Learning Objectives
After completing this chapter, students will be able to:
1. Determine future states or conditions by

using Markov analysis.
2. Compute long-term or steady-state
conditions by using only the matrix of
transition probabilities.
3. Understand the use of absorbing state
analysis in predicting future conditions.

Chapter Outline
15.1 Introduction
15.2 States and State Probabilities
15.3 Matrix of Transition Probabilities
15.4 Predicting Future Market Shares
15.5 Markov Analysis of Machine Operations
15.6 Equilibrium Conditions
15.7 Absorbing States and the Fundamental
Matrix: Accounts Receivable Application

Introduction
 Markov analysis is a technique that deals
with the probabilities of future occurrences
by analyzing presently known probabilities.
 It has numerous applications in business.
 Markov analysis makes the assumption that
the system starts in an initial state or
condition.
 The probabilities of changing from one state
to another are called a matrix of transition
probabilities.
 Solving Markov problems requires basic
matrix manipulation.

Introduction
 This discussion will be limited to Markov
problems that follow four assumptions:
1. There are a limited or finite number of
possible states.
2. The probability of changing states
remains the same over time.
3. We can predict any future state from the
previous state and the matrix of transition
probabilities.
4. The size and makeup of the system do
not change during the analysis.

States and State Probabilities
 States are used to identify all possible conditions
of a process or system.
 It is possible to identify specific states for many
processes or systems.
 In Markov analysis we assume that the states are
both collectively exhaustive and mutually
exclusive.
 After the states have been identified, the next
step is to determine the probability that the
system is in this state.

The information is placed into a vector of state
probabilities:
 (i) = vector of state probabilities
for period i
= (  1 ,  2 , 3 , … ,  n )
Where:
n = number of states
1 ,  2 , … ,  n = probability
of being in state 1, state 2, …,
state n
 In some cases it is possible to know with complete
certainty in which state an item is located:
 Vector states can then be represented as:
 (1) = (1, 0)
where
 (1) = vector of states for
the machine in period 1
1 = 1 = probability of
being in the first state
2 = 0 = probability of
being in the second state
The Vector of State Probabilities for
Three Grocery Stores Example
 States for people in a small town with three
grocery stores.
 A total of 100,000 people shop at the three
groceries during any given month:
 Forty thousand may be shopping at American Food
Store – state 1.
 Thirty thousand may be shopping at Food Mart – state 2.
 Thirty thousand may be shopping at Atlas Foods – state
3.

Probabilities are as follows:
State 1 – American Food Store: 40,000/100,000 = 0.40 = 40%
State 2 – Food Mart: 30,000/100,000 = 0.30 = 30%
State 3 – Atlas Foods: 30,000/100,000 = 0.30 = 30%
These probabilities can be placed in the following
vector of state probabilities
 (1) = (0.4, 0.3, 0.3)
where  (1) = vector of state probabilities for
the three grocery stores for period 1
1 = 0.4 = probability that person will
shop at American Food, state 1
shop at Food Mart, state 2
Copyright © 2012 Pearson Education shop at Atlas Foods, state 3 15-10
 The probabilities of the vector states represent
the market shares for the three groceries.
 Management will be interested in how their
market share changes over time.
 Figure 15.1 shows a tree diagram of how the
market shares in the next month.

Tree Diagram for the Three Grocery
Stores Example
0.8 #1 0.32 = 0.4(0.8)

American Food #1 0.1
#2 0.04 = 0.4(0.1)
0.4 0.1
#3 0.04 = 0.4(0.1)
0.1 #1 0.03
Food Mart #2 0.7
#2 0.21
0.3 0.2
#3 0.06
0.2 #1 0.06
Atlas Foods #3 0.2
#2 0.06
0.3 0.6
Figure 15.1 0.18
#3

Matrix of Transition Probabilities
The matrix of transition probabilities allows us to

get from a current state to a future state:
Let Pij = conditional probability of being in state j

in the future given the current state of i
For example, P12 is the probability of being in state 2

in the future given the event was in state 1 in the
period before:

Matrix of Transition Probabilities
Let P = the matrix of transition probabilities:
P11 P12 P13 … P1n

P= P21
… P22 P23 … P2n
…
…
Pm1 Pmn
 Individual Pij values are determined empirically

 The probabilities in each row will sum to 1

Transition Probabilities for the
Three Grocery Stores
We used historical data to develop the following matrix:
0.8 0.1 0.1

P = 0.1 0.7 0.2
0.2 0.2 0.6
Row 1
0.8 = P11 = probability of being in state 1 after being in state 1 in the
preceding period
preceding period
preceding period

Transition Probabilities for the
Three Grocery Stores
Row 2
preceding period
preceding period
preceding period
Row 3
preceding period
preceding period
preceding period

Predicting Future Market Shares
 One of the purposes of Markov analysis is to

predict the future.
 Given the vector of state probabilities and the
matrix of transitional probabilities, it is not very
difficult to determine the state probabilities at a
future date.
 This type of analysis allows the computation of
the probability that a person will be at one of the
grocery stores in the future.
 Since this probability is equal to market share, it
is possible to determine the future market shares
of the grocery stores.

When the current period is 0, the state probabilities
for the next period 1 are determined as follows:
 (1) =  (0)P
For any period n we can compute the state

probabilities for period n + 1:
 (n + 1) =  (n)P

The computations for the next period’s market share are:
 (1) =  (0)P
0.8 0.1 0.1

= (0.4, 0.3, 0.3) 0.1 0.7 0.2
0.2 0.2 0.6
= [(0.4)(0.8) + (0.3)(0.1) + (0.3)(0.2),
(0.4)(0.1) + (0.3)(0.7) + (0.3)(0.2),
(0.4)(0.1) + (0.3)(0.2) + (0.3)(0.6)]
= (0.41, 0.31, 0.28)

 The market share for American Food and Food

Mart have increased and the market share for
Atlas Foods has decreased.
 We can determine if this will continue by looking
at the state probabilities will be in the future.
 For two time periods from now:
 (2) =  (1)P

Since we know that:
 (1) =  (0)P
We have:
 (2) =  (1)P = [ (0)P]P =  (0)PP =  (0)P2
In general:
 (n) =  (0)Pn
The question of whether American and Food Mart

will continue to gain market share and Atlas will
continue to loose is best addressed in terms of
equilibrium or steady state conditions.
Markov Analysis of
Machine Operations
 The owner of Tolsky Works has recorded the
operation of his milling machine for several years.
 Over the past two years, 80% of the time the
milling machine functioned correctly for the
current month if it had functioned correctly during
the preceding month.
 90% of the time the machine remained incorrectly
adjusted if it had been incorrectly adjusted in the
preceding month.
 10% of the time the machine operated correctly in
a given month when it had been operating
incorrectly the previous month.

Tolsky Works
The matrix of transition probabilities for this machine is:
0.8 0.2
P=
0.1 0.9
where
P11 = 0.8 = probability that the machine will be correctly functioning
this month given it was correctly functioning last month
P12 = 0.2 = probability that the machine will not be correctly
functioning this month given it was correctly functioning
last month
P21 = 0.1 = probability that the machine will be correctly functioning
this month given it was not correctly functioning last
month
P22 = 0.9 = probability that the machine will not be correctly
functioning this month given it was not correctly
functioning last month
Tolsky Works
What is the probability that the machine will be

functioning correctly one and two months from now?
 (1) =  (0)P
0.8 0.2
= (1, 0)
0.1 0.9
= [(1)(0.8) + (0)(0.1), (1)(0.2) + (0)(0.9)]
= (0.8, 0.2)

Tolsky Works
What is the probability that the machine will be

functioning correctly one and two months from
now?
 (2) =  (1)P
0.8 0.2
= (0.8, 0.2)
0.1 0.9
= [(0.8)(0.8) + (0.2)(0.1), (0.8)(0.2) + (0.2)(0.9)]
= (0.66, 0.34)

Period State 1 State 2
State 1 1.000000 0.000000
Probabilities 2 0.800000 0.200000
for the 3 0.660000 0.340000
Machine 4 0.562000 0.438000
Example for 5 0.493400 0.506600
15 Periods 6 0.445380 0.554620
7 0.411766 0.588234
8 0.388236 0.611763
9 0.371765 0.628234
10 0.360235 0.639754
11 0.352165 0.647834
12 0.346515 0.653484
13 0.342560 0.657439
14 0.339792 0.660207
Table 15.1 15 0.337854 0.662145

Equilibrium Conditions
 It is easy to imagine that all market shares will
eventually be 0 or 1.
 But equilibrium share of the market values or
probabilities generally exist.
 An equilibrium condition exists if state
probabilities do not change after a large number
of periods.
 At equilibrium, state probabilities for the next
period equal the state probabilities for current
period.
 Equilibrium state probabilities can be computed
by repeating Markov analysis for a large number
of periods.
 It is always true that
 (next period) =  (this period)P
 Or
 (n + 1) =  (n)P
 At equilibrium
 (n + 1) =  (n)
 So at equilibrium
 (n + 1) =  (n)P =  (n)
 Or
 = P
 For Tolsky’s machine
=P
0.8 0.2
(1, 2) = (1, 2)
0.1 0.9
 Using matrix multiplication
(1, 2) = [(1)(0.8) + (2)(0.1), (1)(0.2) + (2)(0.9)]

 The first and second terms on the left side, 1 and
2, are equal to the first terms on the right side:
1 = 0.81 + 0.12
2 = 0.21 + 0.92
 The state probabilities sum to 1:
1 + 2 + … +  n = 1
 For Tolsky’s machine:
1 + 2 = 1

We arbitrarily decide to solve the following two equations:
2 = 0.21 + 0.92
 1 + 2 = 1
Through rearrangement and substitution we get
0.12 = 0.21
 2 = 21
1 + 2 = 1
 1 + 2 1 = 1
3 1 = 1
1 = 1/3 = 0.33333333
Copyright © 2012 Pearson Education
 = 2/ = 0.66666667 15-31
Absorbing States and the
Fundamental Matrix
 Accounts Receivable example
 The examples so far assume it is possible to go
from one state to another.
 This is not always possible.
 If you must remain in a state it is called an
absorbing state.
 An accounts receivable system normally places
accounts in three possible states:
State 1 (1): paid, all bills
State 2 (2): bad debt, overdue more than three months
State 3 (3): overdue less than one month
State 4 (4): overdue between one and three months

Fundamental Matrix
The matrix of transition probabilities of this problem is:
NEXT MONTH
BAD <1 1 TO 3
THIS MONTH PAID DEBT MONTH MONTHS
Paid 1 0 0 0
Bad debt 0 1 0 0
Less than 1 month 0.6 0 0.2 0.2
1 to 3 months 0.4 0.1 0.3 0.2
Thus:
1 0 0 0
0 1 0 0
P=
0.6 0 0.2 0.2
0.4 0.1 0.3 0.2
Fundamental Matrix
To obtain the fundamental matrix, it is necessary to
partition the matrix of transition probabilities as
follows:
I 0
1 0 0 0 1 0 0 0
I= 0=
0 1 0 0 0 1 0 0
P=
0.6 0 0.2 0.2 0.6 0 0.2 0.2
A= B=
0.4 0.1 0.3 0.2 0.4 0.1 0.3 0.2
A B
where
I = an identity matrix
0 = a matrix with all 0s
Fundamental Matrix
The fundamental matrix can be computed as:
F = (I – B)–1
–1
1 0 0.2 0.2
F= –
0 1 0.3 0.2
–1
0.8 –0.2
F=
–0.3 0.8
–1
d –b
The inverse a b a b r r
of the matrix c is =
d c d –c a
r r
where
r = ad – bc
Fundamental Matrix
To find the matrix F we compute:
r = ad – bc = (0.8)(0.8) – (–0.2)(–0.3) = 0.64 – 0.06 = 0.58
With this we have:
–1
0.8 –(–0.2)
0.8 –0.2 0.58 0.58 1.38 0.34
F= = =
–0.3 0.8 –(–0.3) 0.8 0.52 1.38
0.58 0.58

Fundamental Matrix
We can use the matrix FA to answer questions such
as how much of the debt in the less than one month
category will be paid back and how much will
become bad debt:
M = (M1, M2, M3, … , Mn)
where
n = number of nonabsorbing states
M1 = amount in the first state or category
M2 = amount in the second state or category
Mn = amount in the nth state or category

Fundamental Matrix
If we assume there is $2,000 in the less than one
month category and $5,000 in the one to three
month category, M would be:
M = (2,000, 5,000)
Amount paid and

amount in bad debts = MFA 0.97 0.03
= (2,000, 5,000)
0.86 0.14
= (6,240, 760)
Out of the total of $7,000, $6,240 will eventually be

paid and $760 will end up as bad debt.
Copyright
All rights reserved. No part of this publication may be

reproduced, stored in a retrieval system, or transmitted, in
any form or by any means, electronic, mechanical,
photocopying, recording, or otherwise, without the prior
written permission of the publisher. Printed in the United
States of America.

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Chapter 15

Copyright © 2012 Pearson Education 15-1

1. Determine future states or conditions by

Copyright © 2012 Pearson Education 15-2

Copyright © 2012 Pearson Education 15-3

Copyright © 2012 Pearson Education 15-4

Copyright © 2012 Pearson Education 15-5

Copyright © 2012 Pearson Education 15-6

Copyright © 2012 Pearson Education 15-9

Copyright © 2012 Pearson Education 15-11

0.8 #1 0.32 = 0.4(0.8)

Copyright © 2012 Pearson Education 15-12

The matrix of transition probabilities allows us to

Let Pij = conditional probability of being in state j

For example, P12 is the probability of being in state 2

Copyright © 2012 Pearson Education 15-13

Let P = the matrix of transition probabilities:

P11 P12 P13 … P1n

 Individual Pij values are determined empirically

Copyright © 2012 Pearson Education 15-14

0.8 0.1 0.1

Copyright © 2012 Pearson Education 15-15

Copyright © 2012 Pearson Education 15-16

 One of the purposes of Markov analysis is to

Copyright © 2012 Pearson Education 15-17

For any period n we can compute the state

Copyright © 2012 Pearson Education 15-18

The computations for the next period’s market share are:

0.8 0.1 0.1

Copyright © 2012 Pearson Education 15-19

 The market share for American Food and Food

Copyright © 2012 Pearson Education 15-20

 (2) =  (1)P = [ (0)P]P =  (0)PP =  (0)P2

The question of whether American and Food Mart

Copyright © 2012 Pearson Education 15-22

The matrix of transition probabilities for this machine is:

What is the probability that the machine will be

Copyright © 2012 Pearson Education 15-24

What is the probability that the machine will be

Copyright © 2012 Pearson Education 15-25

Copyright © 2012 Pearson Education 15-26

 Using matrix multiplication

(1, 2) = [(1)(0.8) + (2)(0.1), (1)(0.2) + (2)(0.9)]

Copyright © 2012 Pearson Education 15-29

 The state probabilities sum to 1:

 For Tolsky’s machine:

Copyright © 2012 Pearson Education 15-30

Copyright © 2012 Pearson Education 15-32

With this we have:

Copyright © 2012 Pearson Education 15-36

M = (M1, M2, M3, … , Mn)

Copyright © 2012 Pearson Education 15-37

Amount paid and

Out of the total of $7,000, $6,240 will eventually be

All rights reserved. No part of this publication may be

Copyright © 2012 Pearson Education 15-39

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