Output Decision to Maximize Profit under Monopoly: Genetic Algorithm Approach

Dipesh Karki MA (Economics) Patan Campus

Agenda
Introduction Problem Statement Methodology Result Economic Interpretation Limitation and Improvement

Introduction

Prelude to Computational Economics

Use of Genetic Algorithm in Monopoly Market

Finding solution to common profit maximization problem

Problem Statement (monopoly market)

Economics is science of optimization Profit maximization class of constrained optimization problem Cost function is polynomial of degree n
C(Q) = B0 +B1Q+ B2Q2+ B3 Q3++BN QN

Downward sloping demand function

Q=a-bP

Decision? Fix output or price

Marginal Revenue= Marginal Cost

Problem Statement (demonstration)

Cost Function: C(Q) = (1/3) Q3 7Q2 + 111Q +50 Price : P =100 Q Revenue: R(Q) = PQ=100Q- Q2 Marginal Revenue: R(Q)= 100 -2Q Marginal Cost: C(Q)= Q2 -14Q+111 From calculus: Minimum Q= 1 and Maximum Q= 11

Methodology

Genetic Algorithm: class of

stochastic beam search computational models that mimic natural evolution

Why GA? GA works with the coding of

set, not parameter themselves

a parameter

Fundamental Steps:
Search space contains encoded parameter. Fitness Function

Methodology (mechanism)

Random Number Generation: Subtractive

Random Number Generator Algorithm

Encoding
Binary Gray code Hamming distance: Number of bits to be flipped while converting from one digit to another. Gray code more preferred

Methodology (fitness function design)

Fitness Function:
If (MC'(Q) > MR' (Q)) f(z)= 1- 2* 0.5 sigmoid(z) Else f(z)= 2* 0.5 sigmoid(z) Where, sigmoid(z)= 1/(1+exp(-z)) z= MR(Q) MC(Q) * 0.001; 0.001 being the normalizing factor

Sigmoid function: has the property that can transform the Domain
[-,+] to Range of [-1, 1] where 0.5 is midpoint

Methodology (Implementation)

Results
Case I) Q=11 MR=MC=11; z=0; f(z)=1 . Fitness=100%
Case II) Q=12 MR=76; MC=87; z=0.011; f(z)=0.9945 . Fitness=99.45% Case III) Q =100 MR= -100; MC= 8711; z=8.611; f(z)=0.003 . Fitness= 0.036% Case IV) Q=1 (Minima) MR=98; MC=98; z=0; f(z)=0 . Fitness=0% (Chromosome is dropped from evolution)

Result ( Output Snapshot)

Economic Interpretation

Beginning monopolist unaware about quantity that yields maximum profit Later change in production based on previous decision which is evolution Profit maximizing decision are adopted those which are not are dropped

Limitation and Improvement

Simplified demand function

Non-encoding matrix approach ANOVA analysis

Thank You