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The OR Formalization Drive

Help us formalize the operations research literature in Lean.

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Convex OptimizationOperations ResearchOptimization·Captain: mikedeng1

Distributed Optimization and Statistical Learning via the Alternating Direction Method of Multipliers I: Under a Lagrangian Saddle Point, ADMM Residuals Vanish and Objective Values ConvergeTextbook

Why ADMM convergence matters

The alternating direction method of multipliers (ADMM) is one of the most widely used algorithms for large-scale convex optimization in statistics, machine learning and signal processing. Its appeal is decomposition: a problem whose objective splits into two parts, coupled only by a linear constraint, is solved by alternately minimizing over each part and updating a dual variable. Each subproblem is often a proximity operator, a projection or a small linear system, so ADMM turns problems such as the lasso, sparse inverse covariance selection and consensus fitting across many machines into sequences of simple steps. The survey of Boyd, Parikh, Chu, Peleato and Eckstein (DOI 10.1561/2200000016) made the method standard, and every algorithm in its later chapters is justified by one convergence result, stated in §3.2.1 and proved in Appendix A. This mission formalizes that result and the inequalities behind it.

The method goes back to Gabay and Mercier (1976). Eckstein and Bertsekas (1992) proved convergence through the theory of maximal monotone operators, by identifying ADMM with Douglas–Rachford splitting applied to the dual problem. The proof in Appendix A of the survey is different: it is a direct Lyapunov argument in finite dimensions that uses only convexity and elementary algebra.

Setting

Let f:Rn→R∪{+∞}f:\mathbb R^n\to\mathbb R\cup\{+\infty\}f:Rn→R∪{+∞} and g:Rm→R∪{+∞}g:\mathbb R^m\to\mathbb R\cup\{+\infty\}g:Rm→R∪{+∞}, let A∈Rp×nA\in\mathbb R^{p\times n}A∈Rp×n, B∈Rp×mB\in\mathbb R^{p\times m}B∈Rp×m and c∈Rpc\in\mathbb R^pc∈Rp. The problem is

minimize f(x)+g(z)subject to Ax+Bz=c,(3.1)\text{minimize } f(x)+g(z)\quad\text{subject to } Ax+Bz=c, \tag{3.1}minimize f(x)+g(z)subject to Ax+Bz=c,(3.1)

with optimal value p⋆=inf⁡{f(x)+g(z)∣Ax+Bz=c}p^\star=\inf\{f(x)+g(z)\mid Ax+Bz=c\}p⋆=inf{f(x)+g(z)∣Ax+Bz=c}. The augmented Lagrangian with parameter ρ≥0\rho\ge0ρ≥0 is

Lρ(x,z,y)=f(x)+g(z)+yT(Ax+Bz−c)+ρ2∥Ax+Bz−c∥22,L_\rho(x,z,y)=f(x)+g(z)+y^T(Ax+Bz-c)+\tfrac{\rho}{2}\|Ax+Bz-c\|_2^2,Lρ​(x,z,y)=f(x)+g(z)+yT(Ax+Bz−c)+2ρ​∥Ax+Bz−c∥22​,

and L0L_0L0​ is the ordinary Lagrangian. For ρ>0\rho>0ρ>0, ADMM generates iterates by

xk+1∈argmin⁡xLρ(x,zk,yk),zk+1∈argmin⁡zLρ(xk+1,z,yk),yk+1=yk+ρ(Axk+1+Bzk+1−c).x^{k+1}\in\operatorname*{argmin}_x L_\rho(x,z^k,y^k),\quad z^{k+1}\in\operatorname*{argmin}_z L_\rho(x^{k+1},z,y^k),\quad y^{k+1}=y^k+\rho(Ax^{k+1}+Bz^{k+1}-c).xk+1∈xargmin​Lρ​(x,zk,yk),zk+1∈zargmin​Lρ​(xk+1,z,yk),yk+1=yk+ρ(Axk+1+Bzk+1−c).

The state is (zk,yk)(z^k,y^k)(zk,yk); x0x^0x0 plays no role. The primal residual is rk=Axk+Bzk−cr^k=Ax^k+Bz^k-crk=Axk+Bzk−c, the dual residual is sk=ρATB(zk−zk−1)s^k=\rho A^TB(z^k-z^{k-1})sk=ρATB(zk−zk−1), and pk=f(xk)+g(zk)p^k=f(x^k)+g(z^k)pk=f(xk)+g(zk).

Two assumptions are made. Assumption 1: fff and ggg are closed, proper and convex. Assumption 2: L0L_0L0​ has a saddle point (x⋆,z⋆,y⋆)(x^\star,z^\star,y^\star)(x⋆,z⋆,y⋆), i.e. L0(x⋆,z⋆,y)≤L0(x⋆,z⋆,y⋆)≤L0(x,z,y⋆)L_0(x^\star,z^\star,y)\le L_0(x^\star,z^\star,y^\star)\le L_0(x,z,y^\star)L0​(x⋆,z⋆,y)≤L0​(x⋆,z⋆,y⋆)≤L0​(x,z,y⋆) for all x,z,yx,z,yx,z,y. Nothing is assumed about the ranks of AAA and BBB. The convergence proof uses the Lyapunov function

Vk=1ρ∥yk−y⋆∥22+ρ∥B(zk−z⋆)∥22.V^k=\tfrac1\rho\|y^k-y^\star\|_2^2+\rho\|B(z^k-z^\star)\|_2^2 .Vk=ρ1​∥yk−y⋆∥22​+ρ∥B(zk−z⋆)∥22​.

Formalization targets

Goal: residual and objective convergence (§3.2.1, p. 17; Appendix A, p. 106)

Under Assumptions 1 and 2 and for ρ>0\rho>0ρ>0, every ADMM run satisfies

rk→0,f(xk)+g(zk)→p⋆,sk→0(k→∞).r^k\to0,\qquad f(x^k)+g(z^k)\to p^\star,\qquad s^k\to0\qquad(k\to\infty).rk→0,f(xk)+g(zk)→p⋆,sk→0(k→∞).

The statement fixes no rate and no constant. It does not claim convergence of xkx^kxk or zkz^kzk, which fails in general (p. 17).

Milestones

In the order of Appendix A:

  1. (3.10) holds along the iteration: 0∈∂g(zk+1)+BTyk+10\in\partial g(z^{k+1})+B^Ty^{k+1}0∈∂g(zk+1)+BTyk+1 (§3.3, p. 18);
  2. the dual residual inclusion ρATB(zk+1−zk)∈∂f(xk+1)+ATyk+1\rho A^TB(z^{k+1}-z^k)\in\partial f(x^{k+1})+A^Ty^{k+1}ρATB(zk+1−zk)∈∂f(xk+1)+ATyk+1 (§3.3, p. 18);
  3. (A.3) p⋆−pk+1≤y⋆Trk+1p^\star-p^{k+1}\le y^{\star T}r^{k+1}p⋆−pk+1≤y⋆Trk+1;
  4. (A.2) pk+1−p⋆≤−(yk+1)Trk+1−ρ(B(zk+1−zk))T(−rk+1+B(zk+1−z⋆))p^{k+1}-p^\star\le-(y^{k+1})^Tr^{k+1}-\rho(B(z^{k+1}-z^k))^T(-r^{k+1}+B(z^{k+1}-z^\star))pk+1−p⋆≤−(yk+1)Trk+1−ρ(B(zk+1−zk))T(−rk+1+B(zk+1−z⋆));
  5. (3.11) pk−p⋆≤−(yk)Trk+(xk−x⋆)Tskp^k-p^\star\le-(y^k)^Tr^k+(x^k-x^\star)^Ts^kpk−p⋆≤−(yk)Trk+(xk−x⋆)Tsk;
  6. the monotonicity step (yk+1−yk)T(B(zk+1−zk))≤0(y^{k+1}-y^k)^T(B(z^{k+1}-z^k))\le0(yk+1−yk)T(B(zk+1−zk))≤0 for k≥1k\ge1k≥1 (p. 110);
  7. (A.6) Vk−Vk+1≥ρ∥rk+1−B(zk+1−zk)∥22V^k-V^{k+1}\ge\rho\|r^{k+1}-B(z^{k+1}-z^k)\|_2^2Vk−Vk+1≥ρ∥rk+1−B(zk+1−zk)∥22​;
  8. (A.1) Vk+1≤Vk−ρ∥rk+1∥22−ρ∥B(zk+1−zk)∥22V^{k+1}\le V^k-\rho\|r^{k+1}\|_2^2-\rho\|B(z^{k+1}-z^k)\|_2^2Vk+1≤Vk−ρ∥rk+1∥22​−ρ∥B(zk+1−zk)∥22​ for k≥1k\ge1k≥1;
  9. the summed bound ρ∑k≥1(∥rk+1∥22+∥B(zk+1−zk)∥22)≤V1\rho\sum_{k\ge1}(\|r^{k+1}\|_2^2+\|B(z^{k+1}-z^k)\|_2^2)\le V^1ρ∑k≥1​(∥rk+1∥22​+∥B(zk+1−zk)∥22​)≤V1, with rk→0r^k\to0rk→0 and B(zk+1−zk)→0B(z^{k+1}-z^k)\to0B(zk+1−zk)→0;
  10. the stopping-rule bound pk−p⋆≤−(yk)Trk+d∥sk∥2≤∥yk∥2∥rk∥2+d∥sk∥2p^k-p^\star\le-(y^k)^Tr^k+d\|s^k\|_2\le\|y^k\|_2\|r^k\|_2+d\|s^k\|_2pk−p⋆≤−(yk)Trk+d∥sk∥2​≤∥yk∥2​∥rk∥2​+d∥sk∥2​ when ∥xk−x⋆∥2≤d\|x^k-x^\star\|_2\le d∥xk−x⋆∥2​≤d (§3.3.1, p. 19).

Significance

The theorem is what licenses every specialized ADMM of the survey (lasso, basis pursuit, covariance selection, consensus and sharing, distributed model fitting): each of these chapters only computes the subproblem solutions, and correctness of the overall method is inherited from §3.2.1. Inequality (3.11) and its corollary in §3.3.1 justify the primal/dual residual stopping criterion (3.12) used in practice: small residuals certify small suboptimality.

The result itself is classical and proved; it is not open. To our knowledge no machine-checked proof of convex two-block ADMM convergence exists in Lean's Mathlib. Formalizing it produces a reusable development of the augmented Lagrangian method with explicit domain handling for extended-valued convex functions, and checks a proof whose index bookkeeping the printed text leaves loose (the monotonicity step and (A.1) need k≥1k\ge1k≥1, see below).

Difficulty

The obvious argument, "the subproblem optimality conditions plus the saddle point give a decreasing quantity", works only once the right Lyapunov function is found and the cross term −2ρ r(k+1)TB(zk+1−zk)-2\rho\, r^{(k+1)T}B(z^{k+1}-z^k)−2ρr(k+1)TB(zk+1−zk) is controlled. That term has no sign from the optimality conditions of a single iteration, and at the first iteration, where z0z^0z0 is an arbitrary starting point, the decrease (A.1) can genuinely fail. A second obstacle is that xkx^kxk and zkz^kzk need not converge or even be bounded when AAA or BBB is rank deficient, so objective convergence cannot pass through limits of the primal iterates; it has to come from the two-sided bounds (A.2) and (A.3). Finally, the subdifferential sum rule used to linearize each subproblem must be handled for functions taking the value +∞+\infty+∞.

Formalization scope

  • Vectors are EuclideanSpace ℝ (Fin n); matrices act through Matrix.toEuclideanLin; the problem data are bundled in a structure Problem n m p.
  • An extended-valued fff is encoded by its effective domain CfC_fCf​ and its real values on CfC_fCf​. Assumption 1 is: CfC_fCf​ nonempty, fff convex on CfC_fCf​, epigraph over CfC_fCf​ closed. All minimizations, and the saddle-point inequality in (x,z)(x,z)(x,z), range over the domains; this is equivalent to the book's formulation with +∞+\infty+∞.
  • p⋆p^\starp⋆ is the infimum over feasible points of the domains, not f(x⋆)+g(z⋆)f(x^\star)+g(z^\star)f(x⋆)+g(z⋆) by definition.
  • The run is a hypothesis. An ADMM run is any triple of sequences satisfying (3.2)–(3.4) exactly. The book asserts on p. 16 that Assumption 1 makes the subproblems solvable; this is false in general (f(x)=ex1f(x)=e^{x_1}f(x)=ex1​, A=[0 1]A=[0\ 1]A=[0 1]), so no statement constructs iterates. A formalization that defined the iterates by choice, or required Axk+Bzk=cAx^k+Bz^k=cAxk+Bzk=c of a run, would trivialize the residual claim and is ruled out.
  • Indices: k∈Nk\in\mathbb Nk∈N starts at the book's k=0k=0k=0. Statements about xkx^kxk, rkr^krk, sks^ksk, pkp^kpk are for k≥1k\ge1k≥1 (written with k+1k+1k+1). The monotonicity step and (A.1) are stated for k≥1k\ge1k≥1; the book states (A.1) without a range, and at k=0k=0k=0 with an arbitrary z0z^0z0 it can fail. The summed bound accordingly starts at k=1k=1k=1 and is bounded by V1V^1V1 instead of V0V^0V0; it is stated as a bound on every partial sum.
  • Subdifferentials (milestones 1–2) use the published ShorNonsmooth.Subdiff.subdifferential relative to the domain.
  • The dual-variable convergence yk→y⋆y^k\to y^\staryk→y⋆ listed in §3.2.1 is not proved in the book and is not a target.

A complete development needs the subdifferential of a convex function plus a differentiable quadratic, the first-order characterization of a constrained minimizer, and elementary limits; all of this is reusable for the later missions of the series, which take ADMM runs as given. Proofs of individual milestones are welcome independently.

Selected references

  • S. Boyd, N. Parikh, E. Chu, B. Peleato, J. Eckstein, Distributed Optimization and Statistical Learning via the Alternating Direction Method of Multipliers, Foundations and Trends in Machine Learning 3(1), 2011, pp. 1–122. https://doi.org/10.1561/2200000016
  • D. Gabay, B. Mercier, A dual algorithm for the solution of nonlinear variational problems via finite element approximation, Computers & Mathematics with Applications 2(1), 1976, pp. 17–40. https://doi.org/10.1016/0898-1221(76)90003-1
  • J. Eckstein, D. P. Bertsekas, On the Douglas–Rachford splitting method and the proximal point algorithm for maximal monotone operators, Mathematical Programming 55, 1992, pp. 293–318. https://doi.org/10.1007/BF01581204
  • R. T. Rockafellar, Convex Analysis, Princeton University Press, 1970. https://doi.org/10.1515/9781400873173
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Operations ResearchOptimizationProbability·Captain: mikedeng1

Scheduling Deteriorating Jobs on a Single Processor I: Under Linear Deterioration, Sequencing by Increasing E(X_i)/α_i Minimizes the Expected MakespanResearch Paper

Motivation

In classical single-machine stochastic scheduling, NNN jobs with independent random processing requirements XiX_iXi​ are processed one after another, and the makespan (the completion time of the last job) is the same for every schedule that never idles: it is X1+⋯+XNX_1+\dots+X_NX1​+⋯+XN​. Research therefore concentrated on weighted flow times and rewards. Browne and Yechiali (Operations Research 38(3), 1990, 495–498) studied jobs that deteriorate while they wait: the longer a job is delayed, the more processing it needs. Such models arose in the control of queueing and communication systems (Browne 1988; Browne and Yechiali 1989) and in inventory issuing, where stored items lose quality at item-specific rates. Under deterioration the actual processing times depend on the order, so the makespan, and its expectation, become functions of the schedule, and the basic question is which order minimizes the expected makespan.

Setting

There are NNN jobs, all available at time 000, and a single processor. Job iii has an initial processing requirement XiX_iXi​, a random variable on a probability space (Ω,F,P)(\Omega,\mathcal F,P)(Ω,F,P): the time needed to complete job iii if it is processed first. Under linear deterioration, a job whose processing is delayed until time ttt needs

Yi(t)=Xi+αit,Y_i(t) = X_i + \alpha_i t,Yi​(t)=Xi​+αi​t,

where αi>0\alpha_i>0αi​>0 is its deterministic growth rate. A job stops deteriorating once it is put on the processor.

Only nonpreemptive strategies without idling are allowed, so a policy is a permutation π\piπ of {1,…,N}\{1,\dots,N\}{1,…,N}, with π(i)=j\pi(i)=jπ(i)=j meaning that job jjj is the iii-th processed. The completion times follow the model: S0(π)=0S_0(\pi)=0S0​(π)=0, and the job in position kkk starts at Sk−1(π)S_{k-1}(\pi)Sk−1​(π) and takes Yπ(k)(Sk−1(π))Y_{\pi(k)}(S_{k-1}(\pi))Yπ(k)​(Sk−1​(π)), so

Sk(π)=Sk−1(π)+Xπ(k)+απ(k)Sk−1(π),k=1,…,N.S_k(\pi) = S_{k-1}(\pi) + X_{\pi(k)} + \alpha_{\pi(k)} S_{k-1}(\pi), \qquad k = 1,\dots,N.Sk​(π)=Sk−1​(π)+Xπ(k)​+απ(k)​Sk−1​(π),k=1,…,N.

The makespan is SN(π)S_N(\pi)SN​(π) and the expected makespan is E SN(π)\mathrm E\,S_N(\pi)ESN​(π). In Lean these are completionTime X α π k ω, makespan X α π ω and expectedMakespan P X α π in the namespace DeterioratingJobs.Makespan.

The paper's Lemma 1 concerns, for real numbers μi\mu_iμi​ and γi\gamma_iγi​, the sum (1)

Fμ,γ(π)=∑i=1Nμπ(i)∏r=i+1Nγπ(r),F_{\mu,\gamma}(\pi) = \sum_{i=1}^{N} \mu_{\pi(i)} \prod_{r=i+1}^{N} \gamma_{\pi(r)},Fμ,γ​(π)=i=1∑N​μπ(i)​r=i+1∏N​γπ(r)​,

the Lean lemma1Sum μ γ π (empty product =1=1=1).

Formalization targets

Goal: the expected-makespan index rule (§1, p. 496)

If the XiX_iXi​ are integrable, αi>0\alpha_i>0αi​>0, and π\piπ schedules the jobs by increasing values of E(Xi)/αi\mathrm E(X_i)/\alpha_iE(Xi​)/αi​, then

E SN(π)≤E SN(σ)for every permutation σ.\mathrm E\,S_N(\pi) \le \mathrm E\,S_N(\sigma) \qquad\text{for every permutation } \sigma .ESN​(π)≤ESN​(σ)for every permutation σ.

Milestones

  1. Lemma 1 (p. 495). If γi>1\gamma_i>1γi​>1 for all iii, the sum (1) is minimized over all permutations by any permutation ordered by increasing μi/[γi−1]\mu_i/[\gamma_i-1]μi​/[γi​−1], and maximized by any permutation ordered by decreasing values.
  2. Eq. (2) (p. 496). For every π\piπ and j≤Nj\le Nj≤N,
Sj(π)=∑i=1jXπ(i)∏r=i+1j(1+απ(r)).S_j(\pi) = \sum_{i=1}^{j} X_{\pi(i)} \prod_{r=i+1}^{j} \bigl(1+\alpha_{\pi(r)}\bigr).Sj​(π)=i=1∑j​Xπ(i)​r=i+1∏j​(1+απ(r)​).
  1. The expected makespan in the form (1) (p. 496, after (2)).
E SN(π)=∑i=1NE(Xπ(i))∏r=i+1N(1+απ(r))=FEX, 1+α(π).\mathrm E\,S_N(\pi) = \sum_{i=1}^{N} \mathrm E(X_{\pi(i)}) \prod_{r=i+1}^{N}\bigl(1+\alpha_{\pi(r)}\bigr) = F_{\mathrm E X,\,1+\alpha}(\pi).ESN​(π)=i=1∑N​E(Xπ(i)​)r=i+1∏N​(1+απ(r)​)=FEX,1+α​(π).

Significance

The result is an index rule: each job receives a number computed from its own data, E(Xi)/αi\mathrm E(X_i)/\alpha_iE(Xi​)/αi​, and sorting by that number is optimal. It needs only the means of the initial requirements, not their distributions, and it holds without independence. The same reduction to Lemma 1 gives the paper's other index rules: the variance of the makespan under independent requirements, the Poisson-shock model (5), Lévy-type growth (6) and setup/detach times (7). In inventory issuing, it says which stored item to issue first when items lose value at item-specific linear rates. Lemma 1 itself, which the paper attributes to Rau (1971) and relates to optimal search, is a general statement about ordering products of factors along a sequence.

The result is proved in the paper by an appeal to Lemma 1, whose proof is given there as one sentence ("direct upon an interchange argument"). None of these statements has a machine-checked proof on Prove2Me or in Mathlib. This mission produces a formal model of linear deterioration on a single machine, a formal proof of the interchange lemma with ties handled, and the formal index rule.

Difficulty

The algebra of one adjacent interchange is short. The work is in passing from that local comparison to optimality over all N!N!N! permutations, with ties allowed: the paper speaks of "the permutation ordered by increasing values", but with equal indices several permutations qualify, and each of them must be shown optimal. The natural route, "an optimal permutation exists and must be sorted", needs care, because a sorted permutation is not unique and the swap that improves an unsorted permutation may only weakly improve it. On the probabilistic side, the expectation of the makespan must be reduced to the expectations of the XiX_iXi​; the makespan is a polynomial in the XiX_iXi​ with deterministic coefficients, so this is linearity of the integral, but integrability has to be carried through the recursion.

Formalization scope

  • Jobs are Fin N (0-based: Lean job i is the paper's job i+1i+1i+1); a policy is π : Equiv.Perm (Fin N) with π k the job in position k, as in the paper's π(i)=j\pi(i)=jπ(i)=j. N=0N=0N=0 is allowed.
  • The probability space is (Ω, P) with [IsProbabilityMeasure P]; XiX_iXi​ is Ω → ℝ; expectations are Bochner integrals, and every theorem about them assumes each XiX_iXi​ integrable. The growth rates are deterministic reals.
  • Completion times are defined by the model recursion Sk=Sk−1+Yπ(k)(Sk−1)S_{k}=S_{k-1}+Y_{\pi(k)}(S_{k-1})Sk​=Sk−1​+Yπ(k)​(Sk−1​), never by the closed form (2), so that (2) is a theorem about the model.
  • Explicit readings of loose phrases: "the permutation ordered by increasing values of viv_ivi​" means any permutation with k↦vπ(k)k\mapsto v_{\pi(k)}k↦vπ(k)​ non-strictly increasing (Monotone), and "decreasing" means Antitone; "is minimized" means ≤\le≤ against every permutation; "expected" means the integral of an integrable random variable.
  • Added hypotheses: αi>0\alpha_i>0αi​>0 in the goal (the paper divides by αi\alpha_iαi​ without stating it) and γi>1\gamma_i>1γi​>1 in Lemma 1 (the paper applies it only with γi=1+αi\gamma_i = 1+\alpha_iγi​=1+αi​ or (1+αi)2(1+\alpha_i)^2(1+αi​)2; for γi<1\gamma_i<1γi​<1 the ordering reverses).
  • Omitted assumptions: positivity of the XiX_iXi​ and their independence. The goal holds without them, so the formal statement is slightly more general than the paper's.
  • Trivializing formalizations are excluded: defining SSS by formula (2) would make milestone 2 a definition unfolding; a strictly increasing ordering would make the goal vacuous whenever two indices tie; ordering π−1\pi^{-1}π−1 instead of π\piπ states a different theorem; dropping integrability makes all expectations 000; allowing αi=0\alpha_i=0αi​=0 makes E(Xi)/αi=0\mathrm E(X_i)/\alpha_i=0E(Xi​)/αi​=0 a meaningless index.
  • Not formalized here: the variance result (3), the Poisson model (5), the Lévy model (6), Proposition 1, setup times (7), exponential growth (9), and the NP-hardness conjecture. Proposition 2 (weighted expected completion time) is the companion mission Scheduling Deteriorating Jobs on a Single Processor II.
  • Related platform items, none of which states these results: PalmQueueing.Ordering.interchange_permutations (interchange permutations of a GI/GI/1 queue) and the additive, non-deteriorating completion-time models MooreLateJobs.Shared.completionTime and NumStochOpt.ListScheduling.Makespan.

Contributions welcome: proofs of the milestones, a reusable "sorted permutation minimizes a sum of products" lemma, and the variance index (3) as an extension.

Selected references

  • S. Browne, U. Yechiali, Scheduling Deteriorating Jobs on a Single Processor, Operations Research 38(3), 1990, 495–498. https://doi.org/10.1287/opre.38.3.495
  • J. G. Rau, Minimizing a Function of Permutations of n Integers, Operations Research 19(1), 1971, 237–240. https://doi.org/10.1287/opre.19.1.237
  • F. P. Kelly, A Remark on Search and Sequencing Problems, Mathematics of Operations Research 7(1), 1982, 154–157. https://doi.org/10.1287/moor.7.1.154
  • R. W. Conway, W. L. Maxwell, L. W. Miller, Theory of Scheduling, Addison-Wesley, 1967.
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Operations ResearchOptimal TransportOptimization+1·Captain: mikedeng1

Quantifying Distributional Model Risk via Optimal Transport 2: The Worst-Case Probability of a Closed Set A Equals the Baseline Probability of Its Inflation {x : c(x, A) ≤ 1/λ*}Research Paper

Motivation

A probability model μ\muμ for a risk quantity, such as the reserve process of an insurer or the path of a queue, is usually chosen for tractability or fitted to limited data, and the true law of the system is unknown. Distributional model risk asks how large a probability of interest could be if the true law were any model "close" to μ\muμ. When closeness is measured by an optimal transport cost rather than a likelihood ratio, the competing models may put mass where μ\muμ puts none, which is the situation for rare events such as ruin or buffer overflow: the event of interest often lies outside the support of the baseline.

Blanchet and Murthy (arXiv:1604.01446, Mathematics of Operations Research 44(2), 2019) prove strong duality for worst-case expectations over an optimal-transport ball on a general Polish space, with a lower semicontinuous cost. Their §2.4 specializes the duality to worst-case probabilities of a closed set and obtains a closed-form answer: the worst-case probability of AAA is the baseline probability of an inflated version of AAA. This mission formalizes that result, Theorem 3 of the paper, together with the numbered statements its proof uses.

Setting

Let SSS be a Polish space with its Borel σ\sigmaσ-algebra, P(S)P(S)P(S) its probability measures, and μ∈P(S)\mu \in P(S)μ∈P(S) the baseline. A cost c:S×S→R+c : S \times S \to \mathbb R_+c:S×S→R+​ satisfies Assumption (A1): it is nonnegative, lower semicontinuous, and c(x,y)=0c(x,y) = 0c(x,y)=0 if and only if x=yx = yx=y.

For μ1,μ2∈P(S)\mu_1, \mu_2 \in P(S)μ1​,μ2​∈P(S), a coupling of μ1\mu_1μ1​ and μ2\mu_2μ2​ is a probability measure π\piπ on S×SS \times SS×S with marginals μ1\mu_1μ1​ and μ2\mu_2μ2​; Π(μ1,μ2)\Pi(\mu_1,\mu_2)Π(μ1​,μ2​) is the set of couplings, and the optimal transport cost is

dc(μ1,μ2)=inf⁡{∫c dπ:π∈Π(μ1,μ2)}.d_c(\mu_1,\mu_2) = \inf\Big\{\int c\,d\pi : \pi \in \Pi(\mu_1,\mu_2)\Big\}.dc​(μ1​,μ2​)=inf{∫cdπ:π∈Π(μ1​,μ2​)}.

For a budget δ>0\delta > 0δ>0, the primal feasible set Φμ,δ\Phi_{\mu,\delta}Φμ,δ​ consists of the probability measures π\piπ on S×SS \times SS×S with first marginal μ\muμ and ∫c dπ≤δ\int c\,d\pi \le \delta∫cdπ≤δ.

Fix a nonempty closed set A⊆SA \subseteq SA⊆S and let c(x,A)=inf⁡{c(x,y):y∈A}c(x,A) = \inf\{c(x,y) : y \in A\}c(x,A)=inf{c(x,y):y∈A} be the cheapest cost of moving unit mass from xxx into AAA. The worst-case probability is

I=sup⁡{P(A):dc(μ,P)≤δ}.(12)I = \sup\{P(A) : d_c(\mu,P) \le \delta\}. \tag{12}I=sup{P(A):dc​(μ,P)≤δ}.(12)

Its dual is the univariate problem

inf⁡λ≥0{λδ+Eμ[(1−λc(X,A))+]},(13)\inf_{\lambda \ge 0}\Big\{\lambda\delta + E_\mu\big[(1 - \lambda c(X,A))^+\big]\Big\}, \tag{13}λ≥0inf​{λδ+Eμ​[(1−λc(X,A))+]},(13)

and for a minimizer λ∗∈[0,∞)\lambda^* \in [0,\infty)λ∗∈[0,∞) of (13) the paper defines

c‾=∫{c(x,A)<1/λ∗}c(x,A) dμ(x),c‾=∫{c(x,A)≤1/λ∗}c(x,A) dμ(x).(14)\underline c = \int_{\{c(x,A) < 1/\lambda^*\}} c(x,A)\,d\mu(x), \qquad \overline c = \int_{\{c(x,A) \le 1/\lambda^*\}} c(x,A)\,d\mu(x). \tag{14}c​=∫{c(x,A)<1/λ∗}​c(x,A)dμ(x),c=∫{c(x,A)≤1/λ∗}​c(x,A)dμ(x).(14)

Formalization targets

Goal: Theorem 3 (p. 10)

If λ∗∈[0,∞)\lambda^* \in [0,\infty)λ∗∈[0,∞) attains the infimum in (13) and c‾=c‾\underline c = \overline cc​=c, then

sup⁡{P(A):dc(μ,P)≤δ}=μ{x:c(x,A)≤1/λ∗}.(15)\sup\{P(A) : d_c(\mu,P) \le \delta\} = \mu\{x : c(x,A) \le 1/\lambda^*\}. \tag{15}sup{P(A):dc​(μ,P)≤δ}=μ{x:c(x,A)≤1/λ∗}.(15)

Milestones, in the order the proof uses them

  1. Coupling form (§2.2, p. 5, for f=1Af = 1_Af=1A​): I=sup⁡{π(S×A):π∈Φμ,δ}I = \sup\{\pi(S \times A) : \pi \in \Phi_{\mu,\delta}\}I=sup{π(S×A):π∈Φμ,δ​}.
  2. Indicator supremum (pp. 8–9): sup⁡y{1A(y)−λc(x,y)}=(1−λc(x,A))+\sup_{y}\{1_A(y) - \lambda c(x,y)\} = (1 - \lambda c(x,A))^+supy​{1A​(y)−λc(x,y)}=(1−λc(x,A))+ for λ≥0\lambda \ge 0λ≥0.
  3. (13) (p. 9): III equals the infimum in (13).
  4. Remark 4, (11) for f=1Af = 1_Af=1A​ (p. 8): an ε\varepsilonε-optimal plan πε\pi_\varepsilonπε​ satisfies ∫(φλ∗(x)−(1A(y)−λ∗c(x,y))) dπε≤ε\int(\varphi_{\lambda^*}(x) - (1_A(y) - \lambda^* c(x,y)))\,d\pi_\varepsilon \le \varepsilon∫(φλ∗​(x)−(1A​(y)−λ∗c(x,y)))dπε​≤ε and, for λ∗>0\lambda^* > 0λ∗>0, (δ−ε/λ∗)+≤∫c dπε≤δ(\delta - \varepsilon/\lambda^*)^+ \le \int c\,d\pi_\varepsilon \le \delta(δ−ε/λ∗)+≤∫cdπε​≤δ.
  5. Lemma 4 (p. 11): plans πn∈Φμ,δ\pi_n \in \Phi_{\mu,\delta}πn​∈Φμ,δ​, n>1n > 1n>1, with πn(Cn)≥1−1/n\pi_n(C_n) \ge 1 - 1/nπn​(Cn​)≥1−1/n, no cost outside the set CnC_nCn​ of §2.4.1, and πn(S×A)≥I−2/n\pi_n(S \times A) \ge I - 2/nπn​(S×A)≥I−2/n.
  6. Lemma 2 (p. 10): c‾≤δ≤c‾\underline c \le \delta \le \overline cc​≤δ≤c if λ∗>0\lambda^* > 0λ∗>0 attains (13); δ≥c‾=c‾\delta \ge \overline c = \underline cδ≥c=c​ if λ∗=0\lambda^* = 0λ∗=0 does.

Significance

Theorem 3 converts a supremum over an infinite-dimensional ball of probability measures into a single probability under the baseline: μ\muμ of the set of points that can reach AAA at cost at most 1/λ∗1/\lambda^*1/λ∗, where 1/λ∗1/\lambda^*1/λ∗ is determined by δ\deltaδ through the one-dimensional function u↦∫{c(x,A)≤u}c(x,A) dμu \mapsto \int_{\{c(x,A) \le u\}} c(x,A)\,d\muu↦∫{c(x,A)≤u}​c(x,A)dμ. For the cost c=dc = dc=d of a metric this is the baseline probability of the 1/λ∗1/\lambda^*1/λ∗-neighbourhood of AAA. The paper uses it to compute worst-case ruin probabilities for the Cramér–Lundberg model around a Brownian approximation (§3, §6.1), where SSS is a path space; the result applies there because nothing in it uses local compactness of SSS.

The result is proved in the paper. As far as the platform's corpus shows, neither it nor the strong duality behind it has been formalized. A formal development produces, beyond Theorem 3: a reusable definition of optimal transport costs with lower semicontinuous costs on Polish spaces; the coupling reformulation of the transport ball, which rests on the existence of optimal transport plans (Villani, Optimal Transport, Theorem 4.1), not in Mathlib; and an ε\varepsilonε-optimal-plan argument that avoids assuming a primal optimizer exists.

Difficulty

The heuristic derivation on pp. 9–10 constructs an optimal transport plan that moves each xxx with c(x,A)≤1/λ∗c(x,A) \le 1/\lambda^*c(x,A)≤1/λ∗ to a nearest point of AAA and leaves the others in place. It needs a nearest point to exist and to be selectable measurably, which fails for general closed AAA in a non-locally-compact space, and it needs a primal optimizer, which need not exist. Theorem 3 assumes neither, so the construction is not a proof. A second point is the boundary level c(x,A)=1/λ∗c(x,A) = 1/\lambda^*c(x,A)=1/λ∗: when μ\muμ charges it, as for atomic baselines, the identity (15) can fail (for μ\muμ a point mass at distance 111 from AAA and δ<1\delta < 1δ<1, the worst case is δ\deltaδ, not 111), and the hypothesis c‾=c‾\underline c = \overline cc​=c is exactly what excludes this. Measurability is a second obstacle: x↦c(x,A)x \mapsto c(x,A)x↦c(x,A) is an infimum of a lower semicontinuous function over AAA and in general only universally measurable, so integrals of it are taken against the completion of μ\muμ.

Formalization scope

All objects live in the namespace ModelRiskOT.WorstProb. SSS carries [TopologicalSpace S] [PolishSpace S] [MeasurableSpace S] [BorelSpace S]; μ\muμ is a Measure S with IsProbabilityMeasure; the cost is a real-valued c : S → S → ℝ with (A1) bundled as a structure (nonnegativity, lower semicontinuity on S×SS \times SS×S, and c(x,y)=0  ⟺  x=yc(x,y) = 0 \iff x = yc(x,y)=0⟺x=y). Committed conventions:

  • Values in [0,∞][0,\infty][0,∞]. dcd_cdc​, III, the objective of (13), c‾\underline cc​ and c‾\overline cc are ℝ≥0∞; integrals are lower Lebesgue integrals and the positive part (⋅)+(\cdot)^+(⋅)+ is ENNReal.ofReal. For the universally measurable functions and sets that occur, lower integrals and outer measures agree with the completion of μ\muμ, which is the paper's reading (p. 4). No Bochner integral is used.
  • The threshold 1/λ∗1/\lambda^*1/λ∗ is written in multiplied form: c(x,A)≤1/λ∗c(x,A) \le 1/\lambda^*c(x,A)≤1/λ∗ is λ∗c(x,A)≤1\lambda^* c(x,A) \le 1λ∗c(x,A)≤1, and likewise for the strict inequality and for the sets CnC_nCn​. For λ∗>0\lambda^* > 0λ∗>0 this is the printed condition; at λ∗=0\lambda^* = 0λ∗=0 it is the whole space, the paper's convention 1/0=∞1/0 = \infty1/0=∞.
  • dcd_cdc​ fixes both marginals; Φμ,δ\Phi_{\mu,\delta}Φμ,δ​ fixes only the first.
  • c(x,A)c(x,A)c(x,A) is a real infimum over the subtype AAA; every statement assumes AAA nonempty.
  • "λ∗\lambda^*λ∗ attains the infimum in (13)" is λ∗≥0\lambda^* \ge 0λ∗≥0 and g(λ∗)≤g(λ)g(\lambda^*) \le g(\lambda)g(λ∗)≤g(λ) for all λ≥0\lambda \ge 0λ≥0.
  • Inequalities X≥I−tX \ge I - tX≥I−t are written I≤X+tI \le X + tI≤X+t in [0,∞][0,\infty][0,∞]; sequences "n>1n > 1n>1" are indexed by n∈Nn \in \mathbb Nn∈N with 1<n1 < n1<n.

A formalization in which the transport ball fixes only the first marginal would contain every probability measure and give I=1I = 1I=1 for every nonempty AAA; the definitions here fix both marginals of the couplings in dcd_cdc​, and the hypothesis c‾=c‾\underline c = \overline cc​=c is kept as stated rather than replaced by continuity of u↦∫{c(x,A)≤u}c(x,A) dμu \mapsto \int_{\{c(x,A) \le u\}} c(x,A)\,d\muu↦∫{c(x,A)≤u}​c(x,A)dμ.

A complete development needs the existence of optimal couplings for lower semicontinuous costs (tightness and Prokhorov's theorem, available in Mathlib), the strong duality of the paper's Theorem 1 specialized to indicators (milestone 3; a separate mission in this series formalizes Theorem 1 in general), and universal measurability of c(⋅,A)c(\cdot,A)c(⋅,A) through projections of Borel sets. The transport-cost definitions and the coupling reformulation are reusable beyond this mission. Proofs of any milestone are welcome, as are proofs that derive (13) from the general strong duality once that is published.

Selected references

  • J. Blanchet, K. Murthy, Quantifying Distributional Model Risk via Optimal Transport, arXiv:1604.01446v2, 2017; Mathematics of Operations Research 44(2):565–600, 2019. https://arxiv.org/abs/1604.01446, https://doi.org/10.1287/moor.2018.0936
  • C. Villani, Optimal Transport: Old and New, Grundlehren der mathematischen Wissenschaften 338, Springer, 2009. https://doi.org/10.1007/978-3-540-71050-9
  • R. Gao, A. Kleywegt, Distributionally Robust Stochastic Optimization with Wasserstein Distance, arXiv:1604.02199, 2016. https://arxiv.org/abs/1604.02199
  • P. Mohajerin Esfahani, D. Kuhn, Data-driven distributionally robust optimization using the Wasserstein metric, Mathematical Programming 171:115–166, 2018. https://doi.org/10.1007/s10107-017-1172-1
  • D. P. Bertsekas, S. E. Shreve, Stochastic Optimal Control: The Discrete-Time Case, Academic Press, 1978 (universal measurability, Ch. 7).
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Operations ResearchOptimal TransportOptimization+1·Captain: mikedeng1

Quantifying Distributional Model Risk via Optimal Transport 3: A Worst-Case Transport Plan Exists in a Locally Compact Normed Space under Growth Conditions on c and fResearch Paper

Motivation

In distributionally robust modelling, a baseline probability model μ\muμ on a space SSS is distrusted, and the analyst reports the largest expected loss over every model within a budget of μ\muμ. Blanchet and Murthy (arXiv:1604.01446; Math. Oper. Res. 44(2), 2019, doi:10.1287/moor.2018.0936) measure the budget with an optimal transport cost and prove strong duality for the resulting worst-case expectation on an arbitrary Polish space, with a lower semicontinuous cost and an upper semicontinuous performance function. Duality computes the worst-case value. A risk manager also wants the worst-case model: a distribution that attains the value, whose structure explains which perturbation of μ\muμ is most harmful.

Such a model need not exist. Unlike the Kantorovich problem, where the set of couplings with two fixed marginals is weakly compact, the feasible set here fixes only one marginal and is not compact in general. Section 5 of the paper gives an example on R\mathbb RR where the supremum is not attained, then gives abstract conditions under which it is (Proposition 9), and growth conditions on a locally compact normed space that imply them (Corollary 1). Related existence results in Rd\mathbb R^dRd were obtained by Gao and Kleywegt (arXiv:1604.02199, 2016) and, for empirical baselines and norm costs, by Mohajerin Esfahani and Kuhn (arXiv:1505.05116, 2018).

Setting

Let SSS be a Polish space with its Borel σ\sigmaσ-algebra, μ\muμ a probability measure on SSS, δ>0\delta>0δ>0 a budget, c:S×S→[0,∞)c:S\times S\to[0,\infty)c:S×S→[0,∞) a cost and f:S→Rf:S\to\mathbb Rf:S→R a performance function. The standing assumptions are:

  • (A1) ccc is lower semicontinuous and c(x,y)=0c(x,y)=0c(x,y)=0 iff x=yx=yx=y;
  • (A2) fff is upper semicontinuous and μ\muμ-integrable.

The primal feasible set Φμ,δ\Phi_{\mu,\delta}Φμ,δ​ consists of the probability measures π\piπ on S×SS\times SS×S with first marginal μ\muμ and ∫c dπ≤δ\int c\,d\pi\le\delta∫cdπ≤δ (transport plans out of μ\muμ of cost at most δ\deltaδ). The primal objective is I(π)=∫f(y) dπ(x,y)I(\pi)=\int f(y)\,d\pi(x,y)I(π)=∫f(y)dπ(x,y) and the primal value is I=sup⁡{I(π):π∈Φμ,δ}I=\sup\{I(\pi):\pi\in\Phi_{\mu,\delta}\}I=sup{I(π):π∈Φμ,δ​}. The dual feasible set Λc,f\Lambda_{c,f}Λc,f​ consists of pairs (λ,φ)(\lambda,\varphi)(λ,φ) with λ≥0\lambda\ge0λ≥0, φ:S→[−∞,∞]\varphi:S\to[-\infty,\infty]φ:S→[−∞,∞] universally measurable and φ(x)+λc(x,y)≥f(y)\varphi(x)+\lambda c(x,y)\ge f(y)φ(x)+λc(x,y)≥f(y) for all x,yx,yx,y. The dual objective is J(λ,φ)=λδ+∫φ dμJ(\lambda,\varphi)=\lambda\delta+\int\varphi\,d\muJ(λ,φ)=λδ+∫φdμ and the dual value is J=inf⁡J(λ,φ)J=\inf J(\lambda,\varphi)J=infJ(λ,φ). For λ≥0\lambda\ge0λ≥0 put φλ(x)=sup⁡y{f(y)−λc(x,y)}\varphi_\lambda(x)=\sup_y\{f(y)-\lambda c(x,y)\}φλ​(x)=supy​{f(y)−λc(x,y)}.

Section 5 assumes throughout that (λ∗,φλ∗)∈Λc,f(\lambda^*,\varphi_{\lambda^*})\in\Lambda_{c,f}(λ∗,φλ∗​)∈Λc,f​ is a dual optimal pair with I=J=J(λ∗,φλ∗)<∞I=J=J(\lambda^*,\varphi_{\lambda^*})<\inftyI=J=J(λ∗,φλ∗​)<∞. Write Φμ,δ′\Phi'_{\mu,\delta}Φμ,δ′​ for the plans in Φμ,δ\Phi_{\mu,\delta}Φμ,δ​ concentrated on {f(x)≤f(y)}\{f(x)\le f(y)\}{f(x)≤f(y)}.

(P-Compactness): for every ε>0\varepsilon>0ε>0 there are a compact KεK_\varepsilonKε​ with μ(Kε)>1−ε\mu(K_\varepsilon)>1-\varepsilonμ(Kε​)>1−ε and γ>0\gamma>0γ>0 such that {(x,y)∈Kε×S:f(y)−λ∗c(x,y)≥φλ∗(x)−γ}\{(x,y)\in K_\varepsilon\times S: f(y)-\lambda^*c(x,y)\ge\varphi_{\lambda^*}(x)-\gamma\}{(x,y)∈Kε​×S:f(y)−λ∗c(x,y)≥φλ∗​(x)−γ} has compact closure. (P-USC): lim sup⁡nI(πn)≤I(π∗)\limsup_n I(\pi_n)\le I(\pi^*)limsupn​I(πn​)≤I(π∗) whenever πn∈Φμ,δ′\pi_n\in\Phi'_{\mu,\delta}πn​∈Φμ,δ′​ converge weakly to π∗∈Φμ,δ\pi^*\in\Phi_{\mu,\delta}π∗∈Φμ,δ​.

On a normed space EEE: (A3) c(x,y)≥g(∥x−y∥)c(x,y)\ge g(\|x-y\|)c(x,y)≥g(∥x−y∥) for ∥x−y∥>C\|x-y\|>C∥x−y∥>C, with ggg nondecreasing and g(t)↑∞g(t)\uparrow\inftyg(t)↑∞. (A4) (f(y)−f(x))/(1+h(∥x−y∥))≤K(f(y)-f(x))/(1+h(\|x-y\|))\le K(f(y)−f(x))/(1+h(∥x−y∥))≤K for an increasing hhh with h(t)↑∞h(t)\uparrow\inftyh(t)↑∞; and for every ε>0\varepsilon>0ε>0, f(y)−f(x)≤ε(1+c(x,y))f(y)-f(x)\le\varepsilon(1+c(x,y))f(y)−f(x)≤ε(1+c(x,y)) once ∥x−y∥>Cε\|x-y\|>C_\varepsilon∥x−y∥>Cε​.

Formalization targets

Goal: Corollary 1 (p. 27)

Let EEE be a real normed space that is locally compact, and let c,fc,fc,f satisfy (A1)–(A4). Under the standing assumption, if λ∗>0\lambda^*>0λ∗>0 there is π∗∈Φμ,δ\pi^*\in\Phi_{\mu,\delta}π∗∈Φμ,δ​ with

I(π∗)=I=J=J(λ∗,φλ∗).I(\pi^*)=I=J=J(\lambda^*,\varphi_{\lambda^*}).I(π∗)=I=J=J(λ∗,φλ∗​).

Milestones

  1. Remark 4, (10)–(11) (p. 8): for π∈Φμ,δ\pi\in\Phi_{\mu,\delta}π∈Φμ,δ​, I−I(π)I-I(\pi)I−I(π) is the sum of two nonnegative gaps, ∫(φλ∗(x)−f(y)+λ∗c(x,y)) dπ\int(\varphi_{\lambda^*}(x)-f(y)+\lambda^*c(x,y))\,d\pi∫(φλ∗​(x)−f(y)+λ∗c(x,y))dπ and λ∗(δ−∫c dπ)\lambda^*(\delta-\int c\,d\pi)λ∗(δ−∫cdπ); so an ε\varepsilonε-optimal plan has both gaps at most ε\varepsilonε.
  2. Lemma 17 (p. 43): every plan in Φμ,δ\Phi_{\mu,\delta}Φμ,δ​ can be replaced by one in Φμ,δ′\Phi'_{\mu,\delta}Φμ,δ′​ with at least the same value.
  3. §5 display (p. 26): I=sup⁡{I(π):π∈Φμ,δ′}I=\sup\{I(\pi):\pi\in\Phi'_{\mu,\delta}\}I=sup{I(π):π∈Φμ,δ′​}.
  4. Proposition 9 (p. 26): on a Polish space, (P-Compactness) and (P-USC) give a primal optimizer.
  5. Corollary 1, Step 1 (p. 28): (A1)–(A4) and λ∗>0\lambda^*>0λ∗>0 give (P-Compactness).
  6. Corollary 1, Step 2 (pp. 28–29): (A1), (A2), (A4) and I<∞I<\inftyI<∞ give (P-USC):
lim sup⁡n∫f(y) dπn≤∫f(y) dπ∗.\limsup_n\int f(y)\,d\pi_n\le\int f(y)\,d\pi^*.nlimsup​∫f(y)dπn​≤∫f(y)dπ∗.

Significance

The result. An attained worst case turns duality into a structural statement. By Theorem 1(b) of the paper, an optimizer moves mass from xxx only to maximizers of f(y)−λ∗c(x,y)f(y)-\lambda^*c(x,y)f(y)−λ∗c(x,y) and, when λ∗>0\lambda^*>0λ∗>0, uses the full budget. When those maximizers are unique (Remark 8: ccc convex in yyy, fff concave) the worst-case model is unique and is the image of μ\muμ under a transport map. That map is what stress tests and robust estimators are built from. Without existence, these statements describe an object that may not be there.

Formalizing it. The paper's proofs are complete; nothing here is open. No machine-checked version of this result is known: the worst-case optimal transport literature, including the strong duality of this paper, is unformalized. The mission produces the transport objects of §2 in a form that keeps the paper's generality (Polish space, lower semicontinuous real cost, universally measurable dual variables, the ∞−∞\infty-\infty∞−∞ convention), a tightness argument for nearly optimal one-marginal plans, and an upper semicontinuity argument for unbounded upper semicontinuous integrands under uniform integrability.

Difficulty

The obvious argument takes a maximizing sequence and extracts a weak limit. Both steps fail without more structure. First, Φμ,δ\Phi_{\mu,\delta}Φμ,δ​ is not tight: only the first marginal is fixed, and a sequence may push mass to infinity at bounded cost. That is exactly what happens in Example 2 (p. 26), where λ∗=0\lambda^*=0λ∗=0 and the value 111 is approached but never reached. Tightness has to come from the dual: nearly optimal plans concentrate near maximizers of f(y)−λ∗c(x,y)f(y)-\lambda^*c(x,y)f(y)−λ∗c(x,y), and (A3)–(A4) with λ∗>0\lambda^*>0λ∗>0 confine those maximizers. Second, fff is only upper semicontinuous and unbounded, so weak convergence alone does not give lim sup⁡∫f dπn≤∫f dπ∗\limsup\int f\,d\pi_n\le\int f\,d\pi^*limsup∫fdπn​≤∫fdπ∗. A uniform integrability bound is needed, and it uses the restriction to Φμ,δ′\Phi'_{\mu,\delta}Φμ,δ′​ in an essential way. A third, Lean-specific difficulty is measure-theoretic: φλ∗\varphi_{\lambda^*}φλ∗​ is only universally measurable, and the gaps of Remark 4 are integrals against completions.

Formalization scope

All declarations sit in the namespace ModelRiskOT.PrimalOpt. Values of I(π)I(\pi)I(π), III, J(λ,φ)J(\lambda,\varphi)J(λ,φ), JJJ and φλ\varphi_\lambdaφλ​ are in EReal. I(π)I(\pi)I(π) is ∫f+(y) dπ−∫f−(y) dπ\int f^+(y)\,d\pi-\int f^-(y)\,d\pi∫f+(y)dπ−∫f−(y)dπ with lower integrals, and Mathlib's ⊤−⊤=⊥\top-\top=\bot⊤−⊤=⊥ realises the paper's reading of the supremum (footnote 2, p. 5). Integrals of nonnegative or extended-real functions are lower integrals (lintegral), never Bochner integrals. Universal measurability is the published BertsekasShreve.AnalyticSelection.IsUniversallyMeasurable. Weak convergence is the topology of ProbabilityMeasure (S × S). Measures on S×SS\times SS×S use the product σ\sigmaσ-algebra.

The following readings are fixed:

  • The standing assumption of §5 ((λ∗,φλ∗)∈Λc,f(\lambda^*,\varphi_{\lambda^*})\in\Lambda_{c,f}(λ∗,φλ∗​)∈Λc,f​, I=JI=JI=J, J=J(λ∗,φλ∗)J=J(\lambda^*,\varphi_{\lambda^*})J=J(λ∗,φλ∗​), finiteness) consists of hypotheses of Proposition 9 and Corollary 1. I=JI=JI=J is Theorem 1(a), the goal of the companion mission on strong duality, and is not assumed proved here.
  • In (P-Compactness) the constant γ\gammaγ may depend on ε\varepsilonε.
  • "Increasing" in (A4) is strict.
  • Remark 4's second conclusion in (11) is also stated as λ∗(δ−∫c dπ)≤ε\lambda^*(\delta-\int c\,d\pi)\le\varepsilonλ∗(δ−∫cdπ)≤ε, which covers λ∗=0\lambda^*=0λ∗=0.
  • Lemma 17's last inequality is stated for every plan, which is equivalent under the EReal convention.
  • Corollary 1's space is a real normed space with LocallyCompactSpace. It also carries PolishSpace, which is redundant, since a locally compact real normed space is finite-dimensional.

The goal cannot be satisfied by a junk value: III and JJJ are EReal suprema and infima, not real sSup, and the hypothesis λ∗>0\lambda^*>0λ∗>0 is kept because Example 2 shows the conclusion fails without it. A sorry-free check that c(x,y)=(x−y)2c(x,y)=(x-y)^2c(x,y)=(x−y)2, f(y)=yf(y)=yf(y)=y on R\mathbb RR satisfy (A1), (A3) and (A4) accompanies the drafts.

A complete development needs Prokhorov's theorem (in Mathlib), a Fatou lemma for weakly converging measures with a lower semicontinuous integrand, an upper semicontinuity theorem for uniformly integrable upper semicontinuous integrands, and the change of variables ∫φ(x) dπ=∫φ dμ\int\varphi(x)\,d\pi=\int\varphi\,d\mu∫φ(x)dπ=∫φdμ for universally measurable φ\varphiφ. The last three are reusable well beyond this mission. Proofs of any milestone, and these general lemmas as separate contributions, are welcome.

Selected references

  • J. Blanchet and K. Murthy, Quantifying Distributional Model Risk via Optimal Transport, Math. Oper. Res. 44(2):565–600, 2019. arXiv:1604.01446v2, doi:10.1287/moor.2018.0936
  • R. Gao and A. Kleywegt, Distributionally Robust Stochastic Optimization with Wasserstein Distance, 2016. arXiv:1604.02199
  • P. Mohajerin Esfahani and D. Kuhn, Data-driven distributionally robust optimization using the Wasserstein metric, Math. Program. 171:115–166, 2018. arXiv:1505.05116
  • A. M. Zapała, Unbounded mappings and weak convergence of measures, Statist. Probab. Lett. 78(6):698–706, 2008. doi:10.1016/j.spl.2007.09.033
  • C. Villani, Optimal Transport: Old and New, Springer, 2009. doi:10.1007/978-3-540-71050-9
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CombinatoricsLinear OptimizationOperations Research·Captain: mikedeng1

Solving Large-Scale Zero-One Linear Programming Problems: A Minimal Cover Inequality Cuts Off x̄ iff the Knapsack Problem (2.12) Has Optimal Value Less Than OneResearch Paper

Motivation

Large zero–one linear programs can contain constraints involving only a small fraction of their variables. Crowder, Johnson and Padberg study how to extract useful inequalities from one such row while solving the larger program. Their computational method identifies a violated inequality at a current linear programming solution, adds it, and resolves the relaxation. The mathematical question behind that step is whether a minimal cover inequality can be found by a separate optimization problem. The authors answer it in Section 2.3 of their 1983 paper, after developing cover and configuration inequalities in Section 2.2. Crowder, Johnson and Padberg (1983)

The target is a known result from that paper. It is a precise statement about a finite knapsack row and a point in the unit cube, independent of the paper's implementation and numerical experiments. The paper also discusses (1,k)(1,k)(1,k)-configurations and lifting, which turn the identified inequalities into valid cuts involving additional row variables. Those statements supply the mission's milestones and make the separation result useful in its original setting. Crowder, Johnson and Padberg (1983), Sections 2.2–2.4

Setting

Fix a finite index set KKK, positive rational coefficients aja_jaj​ for j∈Kj\in Kj∈K, and a rational right-hand side a0a_0a0​. A zero–one solution is a vector with each xj∈{0,1}x_j\in\{0,1\}xj​∈{0,1} satisfying the single row

∑j∈Kajxj≤a0.(2.5)\sum_{j\in K}a_jx_j\le a_0. \tag{2.5}j∈K∑​aj​xj​≤a0​.(2.5)

The model uses the support set x={j:xj=1}x=\{j:x_j=1\}x={j:xj​=1} for such a vector. A set S⊆KS\subseteq KS⊆K is a minimal cover when its total coefficient exceeds a0a_0a0​, but removing any one member makes the total at most a0a_0a0​:

∑j∈Saj>a0,∑j∈Saj−ak≤a0(k∈S).(2.6)\sum_{j\in S}a_j>a_0, \qquad \sum_{j\in S}a_j-a_k\le a_0\quad(k\in S). \tag{2.6}j∈S∑​aj​>a0​,j∈S∑​aj​−ak​≤a0​(k∈S).(2.6)

It yields the cover inequality ∑j∈Sxj≤∣S∣−1\sum_{j\in S}x_j\le |S|-1∑j∈S​xj​≤∣S∣−1 for every feasible zero–one vector. The right-hand side is interpreted as a real number, so the expression also has its usual meaning when SSS is empty.

A (1,k)(1,k)(1,k)-configuration consists of S∗⊆KS^*\subseteq KS∗⊆K, t∉S∗t\notin S^*t∈/S∗ and an integer 2≤k≤∣S∗∣2\le k\le |S^*|2≤k≤∣S∗∣. The set S∗S^*S∗ itself fits the row, while Q∪{t}Q\cup\{t\}Q∪{t} is a minimal cover for every kkk-element subset QQQ of S∗S^*S∗. For any k≤r≤∣S∗∣k\le r\le |S^*|k≤r≤∣S∗∣ and rrr-element T⊆S∗T\subseteq S^*T⊆S∗, its inequality is (r−k+1)xt+∑j∈Txj≤r(r-k+1)x_t+\sum_{j\in T}x_j\le r(r−k+1)xt​+∑j∈T​xj​≤r. Crowder, Johnson and Padberg (1983), pp. 810–811

For a point xˉ∈[0,1]K\bar x\in[0,1]^Kxˉ∈[0,1]K, the separation problem asks for a cover s⊆Ks\subseteq Ks⊆K minimizing ∑j∈s(1−xˉj)\sum_{j\in s}(1-\bar x_j)∑j∈s​(1−xˉj​), subject to the strict condition ∑j∈saj>a0\sum_{j\in s}a_j>a_0∑j∈s​aj​>a0​. This is problem (2.12). The set of attainable values is finite, but it is empty if the row has no cover. An optimal value zzz is therefore asserted only when a least attainable value exists.

Formalization targets

Cover separation

The goal is the paper's Section 2.3 equivalence:

(∃S⊆K minimal:∑j∈Sxˉj>∣S∣−1)⟺z<1,\left(\exists S\subseteq K\text{ minimal}: \sum_{j\in S}\bar x_j>|S|-1\right) \quad\Longleftrightarrow\quad z<1,​∃S⊆K minimal:j∈S∑​xˉj​>∣S∣−1​⟺z<1,

where zzz is the attained optimum of (2.12). A cover inequality cuts off xˉ\bar xxˉ precisely when its left-hand side exceeds ∣S∣−1|S|-1∣S∣−1. If there is no cover, (2.12) has no optimal value; the theorem does not assign it an artificial value. Crowder, Johnson and Padberg (1983), pp. 812–813

Valid inequalities and lifting

The milestones state the validity of (2.7) and every inequality in (2.9), the two assertions used in the separation equivalence, and the relaxed lifting claims of Section 2.4. For lifting, zkz_kzk​ is the maximum integer objective value in (2.10), zˉk\bar z_kzˉk​ is the maximum in its linear relaxation, and zk∗=⌊zˉk⌋z_k^*=\lfloor\bar z_k\rfloorzk∗​=⌊zˉk​⌋. The claims are zk≤zk∗z_k\le z_k^*zk​≤zk∗​ and validity after adding variable kkk with coefficient fk=f0−zk∗f_k=f_0-z_k^*fk​=f0​−zk∗​. They concern attained optima, as the paper's “maximum” language requires. Crowder, Johnson and Padberg (1983), pp. 811, 814

Significance

The equivalence turns a geometric question about which cover inequality excludes xˉ\bar xxˉ into a finite optimization test with a numerical threshold of one. It identifies when a minimal cover cut exists for a row, while the validity milestones certify that the inequalities can be added without removing zero–one feasible points. The lifting claims explain how an inequality first written on a subset of variables remains valid as further variables enter it. These are the mathematical guarantees used by the paper's cutting plane procedure. Crowder, Johnson and Padberg (1983), Sections 2.2–2.4

The paper proves the separation equivalence and states the surrounding validity claims. This mission records their exact statements in Lean; its theorem proofs remain open. A complete development would add machine-checked proofs for the finite cover argument, configuration inequalities, and lifting validity. The resulting definitions of feasible supports, attained optimization values and intermediate inequality validity can also be reused in other finite knapsack formalizations.

Difficulty

Checking all subsets of KKK directly grows rapidly with the row size. A separation result must relate a minimum over all covers to an inequality indexed by a minimal cover, while accounting for objective coefficients that may be zero when xˉj=1\bar x_j=1xˉj​=1. The same boundary matters for lifting: the zero–one maximum is compared with a continuous relaxation, and rounding is justified by the integer coefficients of the current inequality. If the lifting problem is infeasible, neither maximum exists. Crowder, Johnson and Padberg (1983), pp. 812–814

Formalization scope

Lean uses an arbitrary finite index type for KKK, replacing the paper's indices 1,…,n1,\ldots,n1,…,n. A zero–one vector is a finite support set. Row coefficients and a0a_0a0​ are rational, as on p. 810; the point xˉ\bar xxˉ and separation values are real. The target asks only that xˉ\bar xxˉ lie in the unit cube. Although the paper obtains it as an optimum of the full LP relaxation (2.11), that additional property is not used in the row-level equivalence. No sign condition is imposed on a0a_0a0​.

The strict knapsack condition in (2.12) is retained. “Chops off” means strict violation of (2.7). “Optimal value” means membership and leastness in the attainable value set; for lifting it means membership and greatestness. Thus rows with no cover or infeasible lifting subproblem do not acquire a default zero optimum. The size expressions ∣S∣−1|S|-1∣S∣−1 and r−k+1r-k+1r−k+1 are evaluated in the reals, so natural-number truncation cannot change them. Integer lifting coefficients and the floor of the relaxed optimum express the paper's “truncating to its integer part”; the feasible relaxed problem includes the zero vector, so this agrees with truncation toward zero there.

Validity during an intermediate lifting step ranges over feasible zero–one vectors supported in the current set SSS. After adding kkk, it ranges over support in S∪{k}S\cup\{k\}S∪{k}. The final inequality covers the whole row when that set is KKK. The development must preserve the full quantifier over every kkk-subset in (2.8) and every rrr and TTT in (2.9); restricting these would weaken the paper's claim. Contributions proving the named milestones, adding concrete examples, or developing general finite optimization lemmas are in scope. The facet assertions attributed to Padberg are outside the target. A related lifted-cover facet statement already appears on the platform as NemhauserWolsey.partitioned_cover_lifting_defines_facet; its conventions and claim differ from this mission's validity results.

Selected references

  • H. Crowder, E. L. Johnson and M. Padberg, Solving Large-Scale Zero-One Linear Programming Problems, Operations Research 31(5), 803–834, 1983. DOI: 10.1287/opre.31.5.803
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Operations ResearchOptimizationTheoretical Computer Science·Captain: mikedeng1

Assortment Optimisation Under a General Discrete Choice Model: A Tight Analysis of Revenue-Ordered Assortments II: Revenue-Ordered Assortments Earn OPT/(1 + ln ν), ν the Optimum's Purchase RatioResearch Paper

Motivation

A retailer that can display only some of its products must choose an assortment: the set of products offered to an arriving customer. Customers substitute: whether a given product is bought depends on what else is on the shelf. The assortment problem asks for the offer set that maximises expected revenue under a model of this substitution behaviour. It is a core problem of revenue management (Talluri and van Ryzin, Management Science 2004), and it is NP-hard already for a mixture of two multinomial logit models (Rusmevichientong, Shmoys, Tong and Topaloglu, POMS 2014).

The heuristic used most widely in practice is revenue-ordered assortments: sort the products by price and offer, for some threshold, every product priced at least that threshold. It is optimal under the multinomial logit model (Talluri and van Ryzin 2004) but not in general. Berbeglia and Joret (arXiv:1606.01371v3, 2019; Algorithmica 2020) give a tight analysis of its approximation ratio for every regular discrete choice model, a class that includes all random utility models. They prove three incomparable guarantees. This mission formalizes the third, Theorem 3.3, whose ratio depends on the purchase behaviour of an optimal assortment rather than on the prices. Companion missions in this series cover the price-ratio bound (Theorem 3.2) and the tightness of all three bounds (Theorem 3.4).

Setting

Let C\mathcal CC be a finite nonempty set of products. A system of choice probabilities gives, for every offer set S⊆CS\subseteq\mathcal CS⊆C and product xxx, the probability P(x,S)\mathcal P(x,S)P(x,S) that a customer offered SSS buys xxx. Buying nothing is the option 000, with P(0,S)=1−∑x∈SP(x,S)\mathcal P(0,S)=1-\sum_{x\in S}\mathcal P(x,S)P(0,S)=1−∑x∈S​P(x,S). The model is regular when

  1. P(x,S)≥0\mathcal P(x,S)\ge0P(x,S)≥0 for products and for x=0x=0x=0;
  2. P(x,S)=0\mathcal P(x,S)=0P(x,S)=0 for x∉Sx\notin Sx∈/S;
  3. ∑x∈SP(x,S)≤1\sum_{x\in S}\mathcal P(x,S)\le1∑x∈S​P(x,S)≤1;
  4. P(x,S)≥P(x,S′)\mathcal P(x,S)\ge\mathcal P(x,S')P(x,S)≥P(x,S′) whenever S⊆S′S\subseteq S'S⊆S′ and x∈S∪{0}x\in S\cup\{0\}x∈S∪{0}.

Axiom 4 at x=0x=0x=0 says that enlarging the offer set never makes buying nothing more likely.

Prices are a function r:C→R>0r:\mathcal C\to\mathbb R_{>0}r:C→R>0​. Offering SSS earns rev(S)=∑x∈SP(x,S) r(x)\mathrm{rev}(S)=\sum_{x\in S}\mathcal P(x,S)\,r(x)rev(S)=∑x∈S​P(x,S)r(x), and OPT=max⁡S⊆Crev(S)\mathrm{OPT}=\max_{S\subseteq\mathcal C}\mathrm{rev}(S)OPT=maxS⊆C​rev(S). Let r1<⋯<rkr_1<\dots<r_kr1​<⋯<rk​ be the distinct values of rrr, and let Si={x:r(x)≥ri}S_i=\{x:r(x)\ge r_i\}Si​={x:r(x)≥ri​} for i∈[k]i\in[k]i∈[k]. The revenue-ordered strategy earns

RO=max⁡1≤i≤krev(Si).\mathrm{RO}=\max_{1\le i\le k}\mathrm{rev}(S_i).RO=1≤i≤kmax​rev(Si​).

For an assortment S∗S^*S∗, the purchase profile is

Ni=∑x∈S∗, r(x)≥riP(x,S∗)(i∈[k]),Nk+1:=0,N_i=\sum_{x\in S^*,\ r(x)\ge r_i}\mathcal P(x,S^*)\qquad(i\in[k]),\qquad N_{k+1}:=0,Ni​=x∈S∗, r(x)≥ri​∑​P(x,S∗)(i∈[k]),Nk+1​:=0,

the probability that a customer offered S∗S^*S∗ buys something priced at least rir_iri​. It is non-increasing in iii.

Formalization targets

Goal: Theorem 3.3 (p. 9)

Let S∗S^*S∗ be optimal, rev(S∗)=OPT\mathrm{rev}(S^*)=\mathrm{OPT}rev(S∗)=OPT, suppose N1>0N_1>0N1​>0, and let ℓ∈[k]\ell\in[k]ℓ∈[k] be maximum with Nℓ>0N_\ell>0Nℓ​>0. Then

OPT≤(∑i=1ℓNi−Ni+1Ni)ROand∑i=1ℓNi−Ni+1Ni≤1+ln⁡ν,ν=N1Nℓ.\mathrm{OPT}\le\Big(\sum_{i=1}^{\ell}\frac{N_i-N_{i+1}}{N_i}\Big)\mathrm{RO} \qquad\text{and}\qquad \sum_{i=1}^{\ell}\frac{N_i-N_{i+1}}{N_i}\le1+\ln\nu,\quad\nu=\frac{N_1}{N_\ell}.OPT≤(i=1∑ℓ​Ni​Ni​−Ni+1​​)ROandi=1∑ℓ​Ni​Ni​−Ni+1​​≤1+lnν,ν=Nℓ​N1​​.

The first inequality is the paper's sum-form factor, the bound that Theorem 3.4 shows to be tight. The second is the closed form 1/(1+ln⁡ν)1/(1+\ln\nu)1/(1+lnν).

Milestones (in proof order)

  • Lemma 2.1 (p. 6): ∑x∈SP(x,S)≤∑x∈S′P(x,S′)\sum_{x\in S}\mathcal P(x,S)\le\sum_{x\in S'}\mathcal P(x,S')∑x∈S​P(x,S)≤∑x∈S′​P(x,S′) for S⊆S′S\subseteq S'S⊆S′.
  • First observation of the proof (p. 9): Ni≤∑x∈SiP(x,Si)N_i\le\sum_{x\in S_i}\mathcal P(x,S_i)Ni​≤∑x∈Si​​P(x,Si​) and Niri≤∑x∈SiP(x,Si)riN_ir_i\le\sum_{x\in S_i}\mathcal P(x,S_i)r_iNi​ri​≤∑x∈Si​​P(x,Si​)ri​.
  • Inequality (6) (p. 9): Niri≤RON_ir_i\le\mathrm{RO}Ni​ri​≤RO for every i∈[k]i\in[k]i∈[k].
  • Revenue identity (p. 9): rev(S∗)=∑i=1ℓ(Ni−Ni+1)ri=∑i=1ℓNi−Ni+1NiNiri\mathrm{rev}(S^*)=\sum_{i=1}^{\ell}(N_i-N_{i+1})r_i=\sum_{i=1}^{\ell}\frac{N_i-N_{i+1}}{N_i}N_ir_irev(S∗)=∑i=1ℓ​(Ni​−Ni+1​)ri​=∑i=1ℓ​Ni​Ni​−Ni+1​​Ni​ri​.
  • Logarithmic step (p. 9, the comparison 1/∑≥1/(1+ln⁡ν)1/\sum\ge1/(1+\ln\nu)1/∑≥1/(1+lnν) in Theorem 3.3, used in the last inequality of the proof): for N1≥⋯≥Nℓ>0N_1\ge\dots\ge N_\ell>0N1​≥⋯≥Nℓ​>0 and Nℓ+1=0N_{\ell+1}=0Nℓ+1​=0, ∑i=1ℓ(Ni−Ni+1)/Ni≤1+ln⁡(N1/Nℓ)\sum_{i=1}^{\ell}(N_i-N_{i+1})/N_i\le1+\ln(N_1/N_\ell)∑i=1ℓ​(Ni​−Ni+1​)/Ni​≤1+ln(N1​/Nℓ​). The paper states this step without proof.

Significance

Theorem 3.3 gives a guarantee that is independent of prices. The bound 1+ln⁡(rk/r1)1+\ln(r_k/r_1)1+ln(rk​/r1​) of Theorem 3.2 grows when prices are spread out. The bound 1+ln⁡ν1+\ln\nu1+lnν is small whenever an optimal assortment sells its expensive products with probability comparable to its overall purchase probability. In §4 the paper combines it with a reduction from unit-demand pricing to derive, for example, the 1/(1+ln⁡m)1/(1+\ln m)1/(1+lnm) guarantee of uniform pricing for the unit-demand min-pricing problem (Corollary 4.8, originally due to Aggarwal et al.). Together with Theorems 3.1 and 3.2, it describes the performance of the most common assortment heuristic over the whole class of regular models, with no parametric assumption on customer behaviour.

The theorem is proved on paper. To our knowledge it has no machine-checked proof, and no regular choice model has been formalized on the platform. This mission produces the regular model as a reusable definition, a statement of Theorem 3.3 in which every hypothesis is explicit, and formal versions of the proof's identities and inequalities. The logarithmic step is asserted without proof in the source, so a formal proof of it completes the paper's argument.

Difficulty

Each step is elementary. The difficulty is bookkeeping. The revenue of S∗S^*S∗ has to be regrouped by distinct price levels rather than by products: several products may share a price, and kkk counts values. The regrouping uses an Abel-type rearrangement with the boundary convention Nk+1=0N_{k+1}=0Nk+1​=0. Comparing NiN_iNi​ with the purchase probability of SiS_iSi​ needs regularity twice. First, axiom 4 for products passes from S∗S^*S∗ to S∗∩SiS^*\cap S_iS∗∩Si​. Then the no-purchase case passes from S∗∩SiS^*\cap S_iS∗∩Si​ to SiS_iSi​. A proof that uses axiom 4 only for products fails at the second step, and the claim is false without it.

Formalization scope

  • Products form a finite type C with [Fintype C] [DecidableEq C]. The goal adds [Nonempty C], the paper's k≥1k\ge1k≥1. Offer sets are Finset C, and P\mathcal PP is P : C → Finset C → ℝ. The no-purchase option is not a product: P(0,S)\mathcal P(0,S)P(0,S) is the derived quantity noPurchase P S. IsRegular P carries axioms 1–4, including both no-purchase cases.
  • OPT\mathrm{OPT}OPT is Finset.sup' over all subsets. RO\mathrm{RO}RO is Finset.sup' over the indices 1,…,k1,\dots,k1,…,k of the threshold sets only.
  • Indices are 1-based natural numbers. level r i is rir_iri​ for 1≤i≤k1\le i\le k1≤i≤k. purchaseProfile P r S i is NiN_iNi​ for 1≤i≤k1\le i\le k1≤i≤k and 000 otherwise, which builds in Nk+1=0N_{k+1}=0Nk+1​=0.
  • Optimality is the hypothesis rev(S∗)=OPT\mathrm{rev}(S^*)=\mathrm{OPT}rev(S∗)=OPT. The index ℓ\ellℓ is a variable with hypotheses 1≤ℓ≤k1\le\ell\le k1≤ℓ≤k, Nℓ>0N_\ell>0Nℓ​>0, and Ni≯0N_i\not>0Ni​>0 for ℓ<i≤k\ell<i\le kℓ<i≤k. N1>0N_1>0N1​>0 is kept as in the paper.
  • The approximation factor is stated in product form, OPT≤D⋅RO\mathrm{OPT}\le D\cdot\mathrm{RO}OPT≤D⋅RO, never as a ratio. Both the sum form and the logarithmic form are stated. ln⁡\lnln is Real.log, applied to ν≥1\nu\ge1ν≥1.
  • The milestones other than the goal are stated for an arbitrary S∗S^*S∗, because the proof does not use optimality there.

The following statements are trivial or false and are not this mission: a maximum over all subsets in place of RO\mathrm{RO}RO; regularity without its no-purchase case; a purchase profile taken from a non-optimal set while rev(S∗)\mathrm{rev}(S^*)rev(S∗) is still called the optimum; the logarithmic form alone; a specific choice model (MNL, Markov chain) in place of an arbitrary regular P\mathcal PP.

A complete development needs finite sums regrouped by the values of a function and an elementary logarithm inequality. The regular choice model and the revenue-ordered sets are shared with the other missions of this series and are reusable for any analysis of assortment heuristics. Proofs of any milestone are welcome. So are alternative arguments for the logarithmic step and a proof that NNN is non-increasing.

Selected references

  • G. Berbeglia and G. Joret, Assortment Optimisation Under a General Discrete Choice Model: A Tight Analysis of Revenue-Ordered Assortments, arXiv:1606.01371v3, 2019; Algorithmica 82, 2020. https://arxiv.org/abs/1606.01371v3
  • K. Talluri and G. van Ryzin, Revenue Management Under a General Discrete Choice Model of Consumer Behavior, Management Science 50(1), 2004. https://doi.org/10.1287/mnsc.1030.0147
  • P. Rusmevichientong, D. Shmoys, C. Tong and H. Topaloglu, Assortment Optimization under the Multinomial Logit Model with Random Choice Parameters, Production and Operations Management 23(11), 2014. https://doi.org/10.1111/poms.12191
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Graph TheoryLinear OptimizationOperations Research+1·Captain: mikedeng1

Finding Minimum-Cost Circulations by Successive Approximation II: For Real Costs, the Strongly Polynomial Loop Reaches a Minimum-Cost Circulation After at Most m⌈log₂(2n)⌉ RefinementsResearch Paper

Why minimum-cost circulation needs a real-cost iteration bound

A minimum-cost circulation is a way to send flow around a directed network while respecting capacities and paying a cost per unit on each arc. It is a basic form of network optimization: a minimum-cost flow with prescribed supplies and demands can be reduced to a circulation problem, and the circulation formulation exposes the residual arcs on which a flow can be improved. Goldberg and Tarjan's successive-approximation method relaxes exact optimality by an error parameter and repeatedly reduces that error. Its ordinary stopping rule for integer costs depends on the largest cost. For arbitrary real costs, including irrational costs, a decreasing positive error need never cross a fixed numerical cutoff. The strongly polynomial loop in their 1987 technical report, later published in Mathematics of Operations Research instead tests the smallest error parameter appropriate to the current circulation and stops when it is zero.

This mission formalizes the number of refinement calls made by that loop. It builds on the related Goldberg–Tarjan 1988 max-flow and 1989 minimum-mean cycle-canceling series: those develop different algorithms for network flow, while the published 1989 circulation and approximate-optimality definitions provide this mission's common network model. The result here concerns successive approximation and its fixed-arc progress measure.

Network and approximate optimality

The vertex set VVV is finite, with n=∣V∣n=|V|n=∣V∣, and EEE is a symmetric set of directed arcs, with m=∣E∣m=|E|m=∣E∣. Symmetry means that (v,w)∈E(v,w)\in E(v,w)∈E brings (w,v)∈E(w,v)\in E(w,v)∈E too. Each arc has a real capacity u(v,w)u(v,w)u(v,w) and a real cost c(v,w)c(v,w)c(v,w); costs obey c(v,w)=−c(w,v)c(v,w)=-c(w,v)c(v,w)=−c(w,v). A circulation fff obeys f(v,w)≤u(v,w)f(v,w)\le u(v,w)f(v,w)≤u(v,w), f(v,w)=−f(w,v)f(v,w)=-f(w,v)f(v,w)=−f(w,v), and conservation of flow at every vertex. Its total cost is half the sum of c(v,w)f(v,w)c(v,w)f(v,w)c(v,w)f(v,w) over directed arcs, since each unordered edge appears twice. A minimum-cost circulation costs no more than any other circulation of the network.

The residual capacity is uf(v,w)=u(v,w)−f(v,w)u_f(v,w)=u(v,w)-f(v,w)uf​(v,w)=u(v,w)−f(v,w). For a price function p:V→Rp:V\to\mathbb Rp:V→R, the report writes the reduced cost as cp(v,w)=c(v,w)−p(v)+p(w)c_p(v,w)=c(v,w)-p(v)+p(w)cp​(v,w)=c(v,w)−p(v)+p(w). A circulation is ε\varepsilonε-optimal with respect to ppp when every residual arc has reduced cost at least −ε-\varepsilon−ε. It is ε\varepsilonε-optimal if some price function works, where ε≥0\varepsilon\ge0ε≥0. The tight error ε(f)\varepsilon(f)ε(f) is the least such error. A circulation is ε\varepsilonε-tight when it is ε\varepsilonε-optimal but fails to be ε′\varepsilon'ε′-optimal at every ε′<ε\varepsilon'<\varepsilonε′<ε. This includes attainment at ε\varepsilonε.

An arc is ε\varepsilonε-fixed if all ε\varepsilonε-optimal circulations carry the same flow through it. Write FεF_\varepsilonFε​ for the set of these arcs. Theorem 4.2 supplies an arc-fixing criterion from a large absolute reduced cost. Lemma 4.4 says that when a positive tight error falls by a factor of 2n2n2n, FεF_\varepsilonFε​ becomes strictly larger. Both are numbered results on printed pages 16–17 of the source report's journal counterpart.

Formalization targets

The goal is the circulation-level form of Theorem 4.5. Begin with a circulation f0f_0f0​ and a sequence f0,f1,…f_0,f_1,\ldotsf0​,f1​,… whose positive-error steps satisfy the contract of Figure 3: if ε(fk)>0\varepsilon(f_k)>0ε(fk​)>0, the next circulation is ε(fk)/2\varepsilon(f_k)/2ε(fk​)/2-optimal. With the report's standing n≥2n\ge2n≥2 and m≥n−1m\ge n-1m≥n−1, the target is

∃k≤m⌈log⁡2(2n)⌉:ε(fk)=0andfk is minimum-cost.\exists k\le m\left\lceil\log_2(2n)\right\rceil:\quad \varepsilon(f_k)=0\quad\text{and}\quad f_k\text{ is minimum-cost}.∃k≤m⌈log2​(2n)⌉:ε(fk​)=0andfk​ is minimum-cost.

The milestone list contains the already proved complementary-slackness characterization of minimum cost (Theorem 2.2), the cross-parameter arc-fixing result (Theorem 4.2), and strict growth of fixed arcs (Lemma 4.4). The report states Theorem 4.5 as O(mlog⁡n)O(m\log n)O(mlogn) iterations when each refinement decreases error by a constant factor. The target makes explicit the factor two used by the paper's refinements and the resulting finite count.

What the result establishes

The theorem gives a bound on the number of refinement calls that depends on the number of vertices and arcs, not on the magnitude, precision, or integrality of the costs. It gives an exact minimum-cost circulation rather than an arbitrary small-error approximation. This distinguishes the real-cost loop from an integer-cost stopping rule based on 1/n1/n1/n. The bound counts refinement calls only; the report analyzes the work within particular implementations separately.

The published 1989 definitions and the complementary-slackness theorem already have machine-checked status on the platform. Theorem 4.2, Lemma 4.4, and this iteration theorem are the open formalization targets. A complete development will connect the tight error to residual-cycle structure, establish that its infimum is attained for circulations, and prove that zero tight error implies minimum cost. The mission thereby makes the fixed-arc argument reusable for other circulation algorithms that lower an approximate-optimality parameter.

Why the bound needs more than repeated halving

Repeatedly dividing a positive real error by two gives errors approaching zero, but it does not by itself produce a finite step with zero error. The missing finite progress is structural: an arc must become fixed after enough reductions, and only finitely many arcs exist. Proving that fixedness is strict is delicate because it compares all circulations at two different error levels, not just two consecutive flows. Theorem 4.2 is the quantitative bridge between a price certificate for one flow and agreement of an arc across every sufficiently accurate flow. At the boundary ε=0\varepsilon=0ε=0, the printed wording of Lemma 4.4 would require F0F_0F0​ to be a proper subset of itself, so its positive-error regime must be made explicit.

Formalization scope

The Lean network uses CycleCanceling.MinMean.CircNetwork with a finite vertex type, a finite symmetric arc set, and real-valued capacities, costs, and flows. Off-arc values of these functions are irrelevant. The report assumes m≥n−1≥1m\ge n-1\ge1m≥n−1≥1 on printed page 5; the theorem binders express it as n≥2n\ge2n≥2 and m≥n−1m\ge n-1m≥n−1. The arc count is for ordered arcs, exactly as the report defines mmm. No integrality, rounding, or bounded-cost hypothesis is imposed. A feasible initial circulation is required because Figure 3 starts from one; infeasibility detection is outside this target.

The reused 1989 definitions write reduced cost as c(v,w)+p(v)−p(w)c(v,w)+p(v)-p(w)c(v,w)+p(v)−p(w). Substituting −p-p−p for ppp gives the report's c(v,w)−p(v)+p(w)c(v,w)-p(v)+p(w)c(v,w)−p(v)+p(w), so existential price certificates, ε\varepsilonε-optimality, and absolute reduced-cost conditions agree. The tight error is represented by a real infimum; proving that it is attained is part of the work. The set FεF_\varepsilonFε​ is filtered from EEE and includes only arcs whose flow is shared by all ε\varepsilonε-optimal circulations. The halving run computes its error from the current circulation; it does not take an unrelated error sequence. Once that error is zero, the loop has returned and later sequence entries are unconstrained. These choices exclude a vacuous or artificially fixed error parameter and a preselected optimal flow.

The explicit reading of the report's asymptotic count is t=⌈log⁡2(2n)⌉t=\lceil\log_2(2n)\rceilt=⌈log2​(2n)⌉ halvings per factor-2n2n2n reduction and at most mmm such blocks, giving mtm tmt refinements. This is a statement about refinement count, not a RAM-operation bound. Contributions on Theorem 4.2, the residual-cycle characterization of positive tight error, the fixed-arc strictness lemma, and the final finite counting argument all support the goal. The circulation, price, and fixed-arc infrastructure can be reused beyond this particular implementation.

Selected references

  • A. V. Goldberg and R. E. Tarjan, Finding Minimum-Cost Circulations by Successive Approximation, MIT/LCS/TM-333, July 1987; journal version in Mathematics of Operations Research 15(3), 1990, pp. 430–466. DOI: 10.1287/moor.15.3.430. The mission's page and theorem indices refer to the 1987 report.
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Algorithmic Game TheoryAnalysisOperations Research+1·Captain: mikedeng1

A Generalization of Brouwer's Fixed Point Theorem: An Upper Semi-Continuous Map with Nonempty Closed Convex Values on a Bounded Closed Convex Set in Euclidean Space Has a Fixed PointResearch Paper

Motivation

Brouwer's fixed point theorem says that a continuous map of a closed simplex into itself has a fixed point. Many existence questions in game theory and mathematical economics produce instead a point-to-set mapping: to each point xxx it assigns a whole set Φ(x)\Phi(x)Φ(x) of admissible responses, for instance the set of best replies of a player to the others' strategies. Such a set need not be a single point, and no continuous single-valued selection need exist. Kakutani's 1941 note, A generalization of Brouwer's fixed point theorem, gives the fixed point theorem for this setting, and shows on the same three pages that it implies two results of J. von Neumann: an intersection theorem for two closed subsets of a product of convex sets, and the minimax theorem.

Timeline, as the paper records it:

  • 1912–1929: Brouwer's theorem; the paper cites the proof of Knaster, Kuratowski and Mazurkiewicz (Fund. Math. 14, 1929).
  • 1928: von Neumann proves the minimax theorem for matrix games (Math. Ann. 100).
  • 1937: von Neumann proves the intersection theorem (Kakutani's Theorem 2) in his paper on an economic equilibrium system, "by using a notion of integral in Euclidean spaces".
  • 1941: Kakutani proves Theorem 1 (simplex), the Corollary (bounded closed convex sets), and derives Theorems 2 and 3 from it.
  • 1950: Nash's existence proof for equilibrium points of nnn-person games applies Kakutani's theorem (PNAS 36).

Setting

Let E=RmE=\mathbb R^mE=Rm with its Euclidean norm, and let S⊆ES\subseteq ES⊆E. Kakutani writes R(S)\mathfrak R(S)R(S) for the family of all closed convex subsets of SSS; as printed, it contains the empty set. A point-to-set mapping of SSS into R(S)\mathfrak R(S)R(S) assigns to each x∈Sx\in Sx∈S a closed convex set Φ(x)⊆S\Phi(x)\subseteq SΦ(x)⊆S.

Φ\PhiΦ is upper semi-continuous (in the paper's sense) when

xn∈S,xn→x0∈S,yn∈Φ(xn),yn→y0⟹y0∈Φ(x0).x_n\in S,\quad x_n\to x_0\in S,\quad y_n\in\Phi(x_n),\quad y_n\to y_0\quad\Longrightarrow\quad y_0\in\Phi(x_0).xn​∈S,xn​→x0​∈S,yn​∈Φ(xn​),yn​→y0​⟹y0​∈Φ(x0​).

This is a sequential closed-graph condition. The paper remarks that for a closed SSS it is equivalent to the graph {(x,y):x∈S, y∈Φ(x)}\{(x,y):x\in S,\ y\in\Phi(x)\}{(x,y):x∈S, y∈Φ(x)} being closed in S×SS\times SS×S.

An rrr-dimensional closed simplex is the convex hull of r+1r+1r+1 affinely independent points of EEE. A fixed point of Φ\PhiΦ is a point x0∈Sx_0\in Sx0​∈S with x0∈Φ(x0)x_0\in\Phi(x_0)x0​∈Φ(x0​).

Formalization targets

Goal: the Corollary (p. 458)

Let S⊆RmS\subseteq\mathbb R^mS⊆Rm be nonempty, bounded, closed and convex, and let Φ\PhiΦ be upper semi-continuous on SSS with every value Φ(x)\Phi(x)Φ(x), x∈Sx\in Sx∈S, a nonempty closed convex subset of SSS. Then

∃ x0∈S:x0∈Φ(x0).\exists\,x_0\in S:\qquad x_0\in\Phi(x_0).∃x0​∈S:x0​∈Φ(x0​).

Milestones

  1. Brouwer's fixed point theorem (§1, p. 457) — a published, proved platform theorem, referenced.
  2. Approximation step of the proof of Theorem 1 (pp. 457–458): for every ε>0\varepsilon>0ε>0 there are a point xxx of the simplex, points x0,…,xrx_0,\dots,x_rx0​,…,xr​ within ε\varepsilonε of xxx, selections yi∈Φ(xi)y_i\in\Phi(x_i)yi​∈Φ(xi​) and weights λ∈Δr\lambda\in\Delta_rλ∈Δr​ with x=∑iλixi=∑iλiyix=\sum_i\lambda_ix_i=\sum_i\lambda_iy_ix=∑i​λi​xi​=∑i​λi​yi​.
  3. Limit step of the proof of Theorem 1 (p. 458): such data for every ε>0\varepsilon>0ε>0, on a compact SSS, force a fixed point.
  4. Theorem 1 (p. 457): the fixed point statement for an rrr-dimensional closed simplex.
  5. Enclosing simplex (proof of the Corollary, p. 458): every bounded subset of Rm\mathbb R^mRm lies in an mmm-dimensional closed simplex S′S'S′.
  6. Retraction (proof of the Corollary, p. 458): a continuous map of S′S'S′ into SSS fixing SSS.
  7. Composition (proof of the Corollary, p. 458): x↦Φ(ψ(x))x\mapsto\Phi(\psi(x))x↦Φ(ψ(x)) is upper semi-continuous on S′S'S′ with values in R(S)⊆R(S′)\mathfrak R(S)\subseteq\mathfrak R(S')R(S)⊆R(S′).
  8. Closed-graph equivalence (§1, p. 457), for closed SSS and Φ(x)⊆S\Phi(x)\subseteq SΦ(x)⊆S.
  9. Theorem 2 (p. 458, von Neumann's intersection theorem): if K⊆RmK\subseteq\mathbb R^mK⊆Rm, L⊆RnL\subseteq\mathbb R^nL⊆Rn are bounded closed convex, K≠∅K\neq\emptysetK=∅, and U,V⊆K×LU,V\subseteq K\times LU,V⊆K×L are closed with all sections Ux0⊆LU_{x_0}\subseteq LUx0​​⊆L, Vy0⊆KV_{y_0}\subseteq KVy0​​⊆K nonempty, closed and convex, then U∩V≠∅U\cap V\neq\emptysetU∩V=∅.

Milestones 8 and 9 stand off the goal's proof path: the paper proves Theorem 2 from the Corollary, using milestone 8 to check upper semi-continuity.

Significance

The Corollary is the form in which Kakutani's theorem is used: existence of equilibrium points in nnn-person games (Nash), of competitive equilibria (Arrow–Debreu), and of solutions of generalized games and variational inequalities all reduce to a fixed point of a point-to-set mapping with nonempty closed convex values on a compact convex set. Theorem 2 in turn gives the minimax theorem (the paper's Theorem 3) in a few lines.

The results are classical and their proofs are known; what is missing is a machine-checked version. Mathlib does not contain Kakutani's theorem, and on Prove2Me the theorem is not posed. Brouwer's theorem is proved on the platform (AGT.brouwer_fixed_point) and enters as a reference milestone. Theorem 3 is already proved on the platform as a special case of Sion's minimax theorem (FamousTheorems.sion_minimax_theorem, Mathlib's Sion.minimax) and is therefore not posed here. A related open platform statement, Debreu's 1952 fixed point lemma for a contractible polyhedron with contractible values and a closed graph (SocialEquilibrium.Existence.fixed_point_of_contractible_polyhedron), generalizes Theorem 1 on polyhedra but not the Corollary, since a bounded closed convex set need not be a polyhedron. Once proved, the goal is the standard entry point for formalized equilibrium existence results.

Difficulty

Brouwer's theorem needs a continuous single-valued map, and a point-to-set mapping with closed convex values need not admit a continuous selection: the mapping on [−1,1][-1,1][−1,1] equal to {1}\{1\}{1} for x<0x<0x<0, [−1,1][-1,1][−1,1] at 000 and {−1}\{-1\}{−1} for x>0x>0x>0 is upper semi-continuous and has none. So the obvious route, select and apply Brouwer, fails; any proof must pass through approximations and a limit in which the graph condition and the convexity of the limiting value both enter. The approximation step needs a family of triangulations of the simplex with mesh tending to zero, which Mathlib does not provide. The transfer from a simplex to a general convex set needs a continuous retraction, which uses convexity and closedness of SSS in Euclidean space.

Formalization scope

  • The ambient space is EuclideanSpace ℝ (Fin m), m=0m=0m=0 included. A point-to-set mapping is a total function Φ : E → Set E; only its values on SSS are constrained.
  • IsClosedConvexSubset S A is the paper's A∈R(S)A\in\mathfrak R(S)A∈R(S) (A⊆SA\subseteq SA⊆S, closed, convex) and admits A=∅A=\emptysetA=∅ as printed. Nonemptiness of the values (and of SSS, and of KKK in Theorem 2) is a separate, labelled hypothesis: with Φ≡∅\Phi\equiv\emptysetΦ≡∅, or S=∅S=\emptysetS=∅, the printed hypotheses hold and there is no fixed point, while the paper's proof picks "an arbitrary point yny^nyn from Φ(xn)\Phi(x^n)Φ(xn)".
  • IsUpperSemicontinuous S Φ is the paper's sequential condition, with sequences in SSS and limit x0∈Sx_0\in Sx0​∈S. It is not Berge's open-neighbourhood upper hemicontinuity.
  • Explicit readings of loose phrases: "the nnn-th barycentric simplicial subdivision" becomes "for every ε>0\varepsilon>0ε>0" with the selected vertices within ε\varepsilonε of the point (no subdivision is built into the statement); "it is clear that … converges" becomes compactness of SSS in the limit step; "take a closed simplex S′S'S′ which contains SSS" becomes an mmm-dimensional affinely independent hull; "a continuous retracting point-to-point mapping" becomes ContinuousOn ψ S', MapsTo ψ S' S and ψ x = x on SSS; "clearly an upper semi-continuous point-to-set mapping of S′S'S′ into R(S)⊆R(S′)\mathfrak R(S)\subseteq\mathfrak R(S')R(S)⊆R(S′)" is stated as three conclusions; "closed subset of S×SS\times SS×S" is closedness in E×EE\times EE×E (the same for closed SSS); U⋅VU\cdot VU⋅V is U∩VU\cap VU∩V; "K×LK\times LK×L in Rm+nR^{m+n}Rm+n" is the product Rm×Rn\mathbb R^m\times\mathbb R^nRm×Rn.
  • A trivializing formalization would allow empty values, an empty domain, a degenerate simplex, or approximation data for a single coarse ε\varepsilonε; each is excluded by the statements as written.
  • Infrastructure a complete development needs: barycentric subdivisions or another construction of approximate fixed points; nearest-point projection onto closed convex sets in Euclidean space; transport of the Corollary to Rm×Rn\mathbb R^m\times\mathbb R^nRm×Rn for Theorem 2. The two definitions are generic and reusable for any later set-valued existence result. Proofs by any faithful route are welcome, including a route through Brouwer's theorem and a continuous approximate selection.

Selected references

  • S. Kakutani, A generalization of Brouwer's fixed point theorem, Duke Math. J. 8 (1941), 457–459. https://doi.org/10.1215/s0012-7094-41-00838-4
  • B. Knaster, C. Kuratowski, S. Mazurkiewicz, Ein Beweis des Fixpunktsatzes für n-dimensionale Simplexe, Fund. Math. 14 (1929), 132–137. https://doi.org/10.4064/fm-14-1-132-137
  • J. von Neumann, Zur Theorie der Gesellschaftsspiele, Math. Ann. 100 (1928), 295–320. https://doi.org/10.1007/BF01448847
  • J. von Neumann, Über ein ökonomisches Gleichungssystem und eine Verallgemeinerung des Brouwerschen Fixpunktsatzes, Ergebnisse eines Math. Kolloquiums 8 (1937), 73–83.
  • J. F. Nash, Equilibrium points in n-person games, Proc. Natl. Acad. Sci. USA 36 (1950), 48–49. https://doi.org/10.1073/pnas.36.1.48
  • M. Sion, On general minimax theorems, Pacific J. Math. 8 (1958), 171–176. https://doi.org/10.2140/pjm.1958.8.171
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Operations ResearchOptimizationProbability·Captain: mikedeng1

Supply Chain Coordination with Contracts I: The Newsvendor Quantity-Flexibility Contract (w_q(δ), δ) Gives the Retailer at Least Π(q°) at δ = 0, the Supplier at Least Π(q°) at δ = 1Textbook

Why contracts in a newsvendor supply chain

A supplier sells to a retailer who must order before a single selling season with random demand. Each firm maximizes its own expected profit, and with the simplest contract, a fixed wholesale price per unit, the retailer orders too little: he bears all the risk of unsold stock but earns only part of the margin on each sale. The supply chain as a whole then earns less than it could. A contract is said to coordinate the supply chain if the chain-optimal actions are an equilibrium of the two firms' game. Which contracts coordinate, and how they divide the chain's profit, is the subject of a large literature in operations management. G. P. Cachon's survey chapter in the Handbooks in Operations Research and Management Science (Cachon 2003) gives its standard account. This mission formalizes §6.2 of that chapter, Coordinating the newsvendor, read in the author's 3rd draft (January 2003).

Timeline of the contracts treated in §6.2:

  • Pasternack (1985) shows that buy-back (returns) contracts coordinate the newsvendor.
  • Tsay (1999) and Tsay and Lovejoy (1999) study quantity flexibility contracts, in which the supplier refunds unsold units up to a fraction δ of the order.
  • Cachon and Lariviere (2005, working paper 2000) analyze revenue sharing and show it is equivalent to buy back in the newsvendor.
  • Taylor (2002) studies sales rebates. Moorthy (1987) and Kolay and Shaffer (2002) treat quantity discounts.

Setting

Demand D≥0D \ge 0D≥0 has distribution function FFF, with Fˉ=1−F\bar F = 1 - FFˉ=1−F and mean μ=E[D]\mu = E[D]μ=E[D]. The retail price is ppp. The supplier's unit production cost is csc_scs​ and the retailer's unit cost is crc_rcr​, with c=cs+cr<pc = c_s + c_r < pc=cs​+cr​<p. Unmet demand costs the retailer a goodwill penalty grg_rgr​ per unit and the supplier gsg_sgs​, with g=gs+grg = g_s + g_rg=gs​+gr​. Each unsold unit is worth v<cv < cv<c to the retailer.

Expected sales are S(q)=E[min⁡(q,D)]S(q) = E[\min(q, D)]S(q)=E[min(q,D)], leftover inventory is I(q)=E[(q−D)+]I(q) = E[(q - D)^+]I(q)=E[(q−D)+] and lost sales are L(q)=E[(D−q)+]L(q) = E[(D - q)^+]L(q)=E[(D−q)+]. If TTT is the expected payment from the retailer to the supplier, the firms earn

πr(q)=(p−v+gr)S(q)−(cr−v)q−grμ−T,πs(q)=gsS(q)−csq−gsμ+T,\pi_r(q) = (p - v + g_r)S(q) - (c_r - v)q - g_r\mu - T, \qquad \pi_s(q) = g_sS(q) - c_sq - g_s\mu + T,πr​(q)=(p−v+gr​)S(q)−(cr​−v)q−gr​μ−T,πs​(q)=gs​S(q)−cs​q−gs​μ+T,

and the chain earns Π(q)=(p−v+g)S(q)−(c−v)q−gμ\Pi(q) = (p - v + g)S(q) - (c - v)q - g\muΠ(q)=(p−v+g)S(q)−(c−v)q−gμ. Let qoq^oqo be a maximizer of Π\PiΠ, with Π(qo)>0\Pi(q^o) > 0Π(qo)>0.

Under the quantity flexibility contract (wq,δ)(w_q, \delta)(wq​,δ) the retailer pays wqw_qwq​ per unit ordered and is refunded wq+cr−vw_q + c_r - vwq​+cr​−v for each unsold unit, up to δq\delta qδq units:

Tq(q,wq,δ)=wqq−(wq+cr−v)∫(1−δ)qqF(y) dy.T_q(q, w_q, \delta) = w_qq - (w_q + c_r - v)\int_{(1-\delta)q}^q F(y)\,dy.Tq​(q,wq​,δ)=wq​q−(wq​+cr​−v)∫(1−δ)qq​F(y)dy.

The wholesale price that makes qoq^oqo satisfy the retailer's first-order condition is

wq(δ)=(p−v+gr) Fˉ(qo)Fˉ(qo)+(1−δ)F((1−δ)qo)−cr+v.w_q(\delta) = \frac{(p - v + g_r)\,\bar F(q^o)}{\bar F(q^o) + (1-\delta)F((1-\delta)q^o)} - c_r + v.wq​(δ)=Fˉ(qo)+(1−δ)F((1−δ)qo)(p−v+gr​)Fˉ(qo)​−cr​+v.

Formalization targets

Goal: the quantity flexibility contract can split the profit in any way

With πr(q,wq(δ),δ)\pi_r(q, w_q(\delta), \delta)πr​(q,wq​(δ),δ) and πs(q,wq(δ),δ)\pi_s(q, w_q(\delta), \delta)πs​(q,wq​(δ),δ) the firms' profits under (wq(δ),δ)(w_q(\delta), \delta)(wq​(δ),δ):

πr(qo,wq(0),0)=Π(qo)+gs(μ−S(qo)+Fˉ(qo)qo)≥Π(qo),\pi_r(q^o, w_q(0), 0) = \Pi(q^o) + g_s\big(\mu - S(q^o) + \bar F(q^o)q^o\big) \ge \Pi(q^o),πr​(qo,wq​(0),0)=Π(qo)+gs​(μ−S(qo)+Fˉ(qo)qo)≥Π(qo), πs(qo,wq(1),1)=Π(qo)+μgr≥Π(qo),\pi_s(q^o, w_q(1), 1) = \Pi(q^o) + \mu g_r \ge \Pi(q^o),πs​(qo,wq​(1),1)=Π(qo)+μgr​≥Π(qo),

and for every a∈[0,Π(qo)]a \in [0, \Pi(q^o)]a∈[0,Π(qo)] some δ∈[0,1]\delta \in [0,1]δ∈[0,1] gives the retailer aaa and the supplier Π(qo)−a\Pi(q^o) - aΠ(qo)−a (§6.2.5, p. 25).

Milestones, in attack order

  1. S(q)=q−∫0qFS(q) = q - \int_0^q FS(q)=q−∫0q​F, I(q)=q−S(q)I(q) = q - S(q)I(q)=q−S(q), L(q)=μ−S(q)L(q) = \mu - S(q)L(q)=μ−S(q) (p. 10).
  2. The unique maximizer qoq^oqo of Π\PiΠ satisfies Fˉ(qo)=(c−v)/(p−v+g)\bar F(q^o) = (c - v)/(p - v + g)Fˉ(qo)=(c−v)/(p−v+g) (Eq. (2), p. 11).
  3. wq(0)=(p−v+gr)Fˉ(qo)+v−crw_q(0) = (p - v + g_r)\bar F(q^o) + v - c_rwq​(0)=(p−v+gr​)Fˉ(qo)+v−cr​ and wq(1)=p+gr−crw_q(1) = p + g_r - c_rwq​(1)=p+gr​−cr​. Also, wqw_qwq​ is increasing on [0,1][0,1][0,1], which gives v−cr≤wq(δ)≤p+gr−crv - c_r \le w_q(\delta) \le p + g_r - c_rv−cr​≤wq​(δ)≤p+gr​−cr​ (p. 24).
  4. qoq^oqo maximizes the retailer's profit under (wq(δ),δ)(w_q(\delta), \delta)(wq​(δ),δ) (Eq. (11), p. 24).
  5. The supplier's first-order condition holds at qoq^oqo (p. 25).
  6. The δ = 0 identity and the δ = 1 identity (p. 25).

Companion results of §6.2

  • Revenue sharing {wr,ϕ}\{w_r,\phi\}{wr​,ϕ} equals the buy back wb=wr+(1−ϕ)pw_b = w_r + (1-\phi)pwb​=wr​+(1−ϕ)p, b=(1−ϕ)(p−v)b = (1-\phi)(p - v)b=(1−ϕ)(p−v) for every demand realization (p. 22).
  • The sales rebate contract: first-order condition (12), price (13), the retailer's profit and its monotonicity in the threshold (p. 27), and failure under voluntary compliance (p. 28).
  • The quantity discount gives the retailer πr=λ(Π(q)+gμ)−grμ\pi_r = \lambda(\Pi(q) + g\mu) - g_r\muπr​=λ(Π(q)+gμ)−gr​μ, so qoq^oqo is optimal for both firms (p. 29).
  • Under the wholesale price contract, the retailer's profit increases in the induced quantity (p. 14).

Significance

The goal is what makes quantity flexibility a complete coordinating family. Retailer optimality (milestone 4) says qoq^oqo can be implemented. The allocation statement says that bargaining power can then be expressed through the single parameter δ without losing efficiency. Together with the supplier's first-order condition, these are the facts that matter in practice: forced compliance suffices for coordination, and the choice of δ is purely distributional. The companions put §6.2's other contracts on the same footing. Revenue sharing and buy back are equivalent. Sales rebates coordinate only with forced compliance. Quantity discounts coordinate with a bounded retailer share.

All of these results are stated in the source. Related results are Proved on the platform in Snyder and Shen's chapter (SupplyChainTheory.*), including the chain-optimal fractile and retailer optimality under quantity flexibility. This mission states them locally because Snyder and Shen's contract data impose stronger restrictions on salvage value than Cachon's model. The efficiency formula (k+1)−(1+1/k)(k+2)(k+1)^{-(1+1/k)}(k+2)(k+1)−(1+1/k)(k+2) for the power distribution on p. 14 is already posed as the Open item RevShareCoord.Wholesale.alpha_family_efficiency and is not posed again.

Difficulty

Each identity is elementary algebra once SSS, its derivative and the integrals of FFF are under control. That is where the work lies. Expected sales are defined as an expectation, so S(q)=q−∫0qFS(q) = q - \int_0^q FS(q)=q−∫0q​F is a theorem to prove, not a definition to unfold.

Differentiating ∫(1−δ)qqF\int_{(1-\delta)q}^q F∫(1−δ)qq​F needs continuity of FFF at two points. The sales rebate transfer is piecewise and has a kink at the threshold, so derivatives must be taken on the right side of it.

The allocation clause rests on continuity of δ ↦ π_r(q^o, w_q(δ), δ). The obvious argument, "the profits are continuous in δ", hides two facts. First, the denominator of wq(δ)w_q(\delta)wq​(δ) stays positive on [0,1][0,1][0,1]. Second, F((1−δ)qo)F((1-\delta)q^o)F((1−δ)qo) moves continuously, which fails for a demand law with atoms. Both must be derived from the model, not assumed.

Formalization scope

The local ContractData follows Cachon's v<cs+crv<c_s+c_rv<cs​+cr​ and cs+cr<pc_s+c_r<pcs​+cr​<p. Its rrr is Cachon's price ppp, and its ps,prp_s,p_rps​,pr​ are the goodwill penalties gs,grg_s,g_rgs​,gr​. The penalties are nonnegative costs. Net salvage may be negative and may exceed crc_rcr​; both possibilities were excluded by the related published model.

A demand law is a probability measure on ℝ with no mass on (−∞,0)(-\infty, 0)(−∞,0), finite mean and no atoms (so FFF is continuous). FFF is strictly increasing on [0,∞)[0, \infty)[0,∞) as long as F<1F < 1F<1. Its derivative is specified on the positive interior of that active support. This reading admits the bounded-support power law the chapter itself uses on p. 14, whose cdf has a corner at the support endpoint. Derivative conclusions use HasDerivAt.

Optimality is IsMaxOn … Set.univ over real quantities; the optimum is positive under the model assumptions. Π(qo)>0\Pi(q^o) > 0Π(qo)>0 is a hypothesis wherever an optimum is named, following p. 11.

Cachon's sales rebate rrr is rebate in Lean.

Three printed slips are corrected, and the milestone quotes keep the print:

  • p. 24 writes www for wqw_qwq​ in TqT_qTq​.
  • p. 25 mixes qqq and qoq^oqo in the δ = 0 and δ = 1 displays.
  • p. 28 has a spurious −v-v−v in ws(r)−rw_s(r) - rws​(r)−r.

Two encodings are ruled out. wq(δ)w_q(\delta)wq​(δ) is the explicit formula, never "the solution of (11)". The supplier's profit is the model's own function, not Π\PiΠ minus the retailer's profit, so no clause holds by definition.

The local definition file CachonCoord.Newsvendor.Contracts contains the model, its expected profits, the contract transfers, the sales rebate price ws(r)w_s(r)ws​(r), the quantity discount schedule, and realized profits and payments. Lemmas about SSS, ∫F\int F∫F and continuity of contract prices are reusable across the series. The sales rebate existence-of-threshold argument and the normal-distribution counterexample of p. 25 are outside this mission.

Selected references

  • G. P. Cachon, Supply Chain Coordination with Contracts, in S. Graves, T. de Kok (eds.), Handbooks in OR & MS Vol. 11, North-Holland, 2003 (3rd draft, Jan. 2003). https://doi.org/10.1016/S0927-0507(03)11006-7
  • B. A. Pasternack, Optimal pricing and return policies for perishable commodities, Marketing Science 4(2), 1985. https://doi.org/10.1287/mksc.4.2.166
  • A. A. Tsay, The quantity flexibility contract and supplier–customer incentives, Management Science 45(10), 1999. https://doi.org/10.1287/mnsc.45.10.1339
  • G. P. Cachon, M. A. Lariviere, Supply chain coordination with revenue-sharing contracts: strengths and limitations, Management Science 51(1), 2005. https://doi.org/10.1287/mnsc.1040.0215
  • T. A. Taylor, Supply chain coordination under channel rebates with sales effort effects, Management Science 48(8), 2002. https://doi.org/10.1287/mnsc.48.8.992.168
  • L. V. Snyder, Z.-J. M. Shen, Fundamentals of Supply Chain Theory, 2nd ed., Wiley, 2019, Ch. 14. https://doi.org/10.1002/9781119584445
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Graph TheoryLinear OptimizationOperations Research+1·Captain: mikedeng1

Finding Minimum-Cost Circulations by Successive Approximation I: The Generic Refine Subroutine Stops Within 3n(n − 1) + 3nm + 3n²(m + n) Update Operations at an ε-Optimal CirculationResearch Paper

Motivation

Minimum-cost circulation asks how to route flow around a directed network without accumulating flow at any vertex, while minimizing the total cost of the routed units. It is a basic network optimization problem: lower-bound and demand constraints in many flow models can be converted into circulation form. Goldberg and Tarjan's 1987 technical report develops a successive-approximation approach in which a local repair subroutine, refine, improves an approximately optimal circulation. The report was followed by a 1990 journal article; all theorem numbers and page citations in this mission refer to the 1987 report.

The mission isolates the generic form of refine, where an implementation may choose any applicable update at each step. Its question is whether every such choice sequence finishes after a controlled number of operations and returns a circulation with a stronger optimality certificate. The related Goldberg–Tarjan maximum-flow algorithm uses push and relabel operations with distance labels; here the labels are real-valued prices tied to arc costs. The authors' cycle-canceling work uses the same circulation network model and supplies published definitions reused in this development.

Setting

A circulation network has a finite vertex set VVV and a symmetric set EEE of directed arcs: whenever (v,w)(v,w)(v,w) is an arc, so is (w,v)(w,v)(w,v). Let n=∣V∣n=|V|n=∣V∣ and m=∣E∣m=|E|m=∣E∣, counting both orientations. Each arc has a real capacity u(v,w)u(v,w)u(v,w) and cost c(v,w)c(v,w)c(v,w), with c(v,w)=−c(w,v)c(v,w)=-c(w,v)c(v,w)=−c(w,v). A pseudoflow fff respects capacities and the paired-arc relation f(v,w)=−f(w,v)f(v,w)=-f(w,v)f(v,w)=−f(w,v). Its excess ef(v)e_f(v)ef​(v) is the sum of flow entering vvv. A circulation is a pseudoflow with zero excess everywhere. The already published CycleCanceling.MinMean.Network supplies this network, its circulation predicate, and residual capacity uf(v,w)=u(v,w)−f(v,w)u_f(v,w)=u(v,w)-f(v,w)uf​(v,w)=u(v,w)−f(v,w). An arc is residual when this capacity is positive.

A price function p:V→Rp:V\to\mathbb Rp:V→R changes an arc's reduced cost to cp(v,w)=c(v,w)−p(v)+p(w)c_p(v,w)=c(v,w)-p(v)+p(w)cp​(v,w)=c(v,w)−p(v)+p(w). A pseudoflow is ε\varepsilonε-optimal with respect to ppp when every residual arc has reduced cost at least −ε-\varepsilon−ε. A vertex is active when its excess is positive. An admissible arc is a residual arc of negative reduced cost. Refine takes an input circulation that is 2ε2\varepsilon2ε-optimal, saturates every arc whose reduced cost is negative, and then repeatedly applies an available update. A push sends flow from an active vertex along an admissible arc. A relabel raises the price of an active vertex with no outgoing admissible arc to the largest value permitted by ε\varepsilonε-optimality. These rules are Figures 4 and 5, printed pages 18–19.

Formalization targets

The supporting targets are the paper's progress and correctness results, its price bound, and the three operation counts. For any generic refine run from a 2ε2\varepsilon2ε-optimal circulation, Lemma 5.8 bounds each vertex's price increase by 3nε3n\varepsilon3nε. Lemmas 5.9–5.11 bound the numbers R,S,TR,S,TR,S,T of relabelings, saturating pushes, and nonsaturating pushes:

R≤3n(n−1),S≤3nm,T≤3n2(m+n).R\leq 3n(n-1),\qquad S\leq 3nm,\qquad T\leq 3n^2(m+n).R≤3n(n−1),S≤3nm,T≤3n2(m+n).

The goal combines the resulting bound on the number KKK of updates with progress and correctness:

K≤3n(n−1)+3nm+3n2(m+n).K\leq 3n(n-1)+3nm+3n^2(m+n).K≤3n(n−1)+3nm+3n2(m+n).

If the final state has an active vertex, another update exists. If no update applies, the final pseudoflow is a circulation and is ε\varepsilonε-optimal with respect to its final prices. This is the explicit operation-count content behind the generic subroutine's analysis in Section 5. It does not claim a bound for a particular data structure or a complete minimum-cost algorithm.

Significance

The theorem gives an order-independent finite bound: the choice of which applicable push or relabel to perform cannot cause generic refine to run forever or stop with an active vertex. Its output is a circulation whose approximate-optimality tolerance has been halved. That output can serve as the next input in the successive-approximation framework. For integral costs, the report's Theorem 2.3 later turns a sufficiently small tolerance into exact minimum cost; that outer-loop result is outside this mission.

This mission specifies the generic cost-scaling state machine in Lean and poses its quantitative analysis as open formalization targets. The shared network and circulation definitions from the published Goldberg–Tarjan 1989 series are available, and a related generic maximum-flow theorem in the 1988 series has a machine-checked proof. Those results do not prove refine's price-based bounds. Contributions that establish the paper's progress, price, or counting statements for this state machine, and reusable facts about finite residual networks, advance the open goal.

Difficulty

A push respects a capacity, but it can create activity at another vertex; a relabel changes which arcs are admissible. Thus checking a single update does not bound an arbitrary sequence. The price bound also depends on the circulation and prices supplied at entry, not merely on the current pseudoflow being ε\varepsilonε-optimal. Finally, a vertex with no admissible outgoing arc may appear to be stuck when the relabel minimum is over an empty set. Feasibility of the original circulation network is needed to establish that an active vertex still has a genuine next update. The operation bound requires accounting for the three update types across every possible choice sequence.

Formalization scope

Vertices form a finite type, and capacities, costs, flows, and prices are real-valued functions. The network has symmetric ordered arcs and antisymmetric costs. There is no separate nonnegativity assumption on capacities; feasibility is supplied by the input circulation. The new ε\varepsilonε is positive, so the entry circulation is 2ε2\varepsilon2ε-optimal before Figure 4 halves the error parameter. The run starts from the resulting saturated pseudoflow and records one applicable push or relabel per index k<Kk<Kk<K. Counts classify those actual steps by the selected arc's residual capacity after a push. Termination is the negation of the paper's loop guard, not a definition that assumes zero excess.

The reduced-cost sign is c−p(v)+p(w)c-p(v)+p(w)c−p(v)+p(w), and relabel raises p(v)p(v)p(v). This differs from the published 1989 epsilon-optimality definition, so only its network model is imported. The relabel relation requires an attained minimum over a nonempty set of outgoing residual arcs; it assigns no default value to an empty minimum. Loops may occur in the reused network model, but cost antisymmetry makes their reduced cost zero, so they cannot be push arcs. The explicit constants are the report's 3nε3n\varepsilon3nε, 3n(n−1)3n(n-1)3n(n−1), 3nm3nm3nm, and 3n2(m+n)3n^2(m+n)3n2(m+n); the goal sums the last three. The report's RAM-model O(⋅)O(\cdot)O(⋅) running times are outside the formal statements. A definition that makes termination equivalent to conservation or assigns an arbitrary relabel price at an empty set would miss the target.

Selected references

  • Andrew V. Goldberg and Robert E. Tarjan, Finding Minimum-Cost Circulations by Successive Approximation, MIT/LCS/TM-333, July 1987. Technical report.
  • Andrew V. Goldberg and Robert E. Tarjan, Finding Minimum-Cost Circulations by Successive Approximation, Mathematics of Operations Research 15(3), 1990, pp. 430–466. DOI. The report above supplies this mission's numbering.
  • Andrew V. Goldberg and Robert E. Tarjan, A New Approach to the Maximum-Flow Problem, Journal of the ACM 35(4), 1988. DOI.
  • Andrew V. Goldberg and Robert E. Tarjan, Finding Minimum-Cost Circulations by Canceling Negative Cycles, Journal of the ACM 36(4), 1989. DOI.
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Operations ResearchOptimizationProbability·Captain: mikedeng1

Supply Chain Coordination with Contracts II: With Price-Dependent Demand the Price-Contingent Buy-Back Gives the Retailer λΠ(q, p), as Revenue Sharing Does, and Coordinates Price and QuantityTextbook

Motivation

A retailer who controls both inventory and price can respond to a supply contract in two ways. A contract that induces the right order quantity at a fixed price may change the retailer's incentive to raise or lower that price. For a one-season supply chain, Cachon's chapter compares familiar contracts under price-dependent demand and identifies a price-contingent buy-back, also called a price-discount contract, that aligns both decisions. The mission concerns §6.3 of the author's January 2003 third draft, on printed pages 33–38. Those page and equation numbers belong to the draft and may differ from the typeset chapter.

Setting

One risk-neutral supplier and one risk-neutral retailer have full information before a single selling season. The retailer chooses a nonnegative stocking quantity qqq and a retail price ppp from an admissible price set PPP; the price stays fixed during the season. Demand has a probability law DpD_pDp​ that depends on ppp. Write F(y∣p)F(y\mid p)F(y∣p) for its distribution function, S(q,p)=Ep[min⁡(q,D)]S(q,p)=\mathbb E_p[\min(q,D)]S(q,p)=Ep​[min(q,D)] for expected sales, and μ(p)=Ep[D]\mu(p)=\mathbb E_p[D]μ(p)=Ep​[D] for mean demand. Demand is nonnegative, has a finite mean and, in the chapter's regular setting, its distribution function increases with demand level and has a positive price derivative at positive demand levels. Higher prices thus lower demand in the stochastic order used by the chapter. The price set is nonempty and open so an admissible price optimum has an interior first-order condition.

The supplier's unit cost is csc_scs​, the retailer's unit procurement cost is crc_rcr​, and c=cs+crc=c_s+c_rc=cs​+cr​ is total unit cost. Their goodwill penalties for unmet demand are gsg_sgs​ and grg_rgr​, with g=gs+grg=g_s+g_rg=gs​+gr​. An unsold unit has salvage value vvv at the retailer. The integrated channel's expected profit is

Π(q,p)=(p−v+g)S(q,p)−(c−v)q−gμ(p).\Pi(q,p)=(p-v+g)S(q,p)-(c-v)q-g\mu(p).Π(q,p)=(p−v+g)S(q,p)−(c−v)q−gμ(p).

A buy-back contract charges a wholesale price wbw_bwb​ for each ordered unit and pays the retailer bbb for each unsold unit. A revenue-sharing contract charges a wholesale price wrw_rwr​ and gives the retailer a fraction ϕ\phiϕ of sales and salvage revenue. In this section the supplier offers the terms and the retailer chooses (q,p)(q,p)(q,p). The profit formulas use the chapter's convention that a positive transfer goes from retailer to supplier.

Formalization targets

The goal is the price-contingent buy-back on p. 35, with λ∈[0,1]\lambda\in[0,1]λ∈[0,1]:

b(p)=(1−λ)(p−v+g)−gs,wb(p)=λcs+(1−λ)(p+g−cr)−gs.b(p)=(1-\lambda)(p-v+g)-g_s,\qquad w_b(p)=\lambda c_s+(1-\lambda)(p+g-c_r)-g_s.b(p)=(1−λ)(p−v+g)−gs​,wb​(p)=λcs​+(1−λ)(p+g−cr​)−gs​.

In the chapter's zero-goodwill case, gr=gs=0g_r=g_s=0gr​=gs​=0, every feasible (q,p)(q,p)(q,p) then gives the retailer λΠ(q,p)\lambda\Pi(q,p)λΠ(q,p) and the supplier (1−λ)Π(q,p)(1-\lambda)\Pi(q,p)(1−λ)Π(q,p). The same retailer profit is obtained from revenue sharing with ϕ=λ\phi=\lambdaϕ=λ and wr=λ(c−v)−cr+λvw_r=\lambda(c-v)-c_r+\lambda vwr​=λ(c−v)−cr​+λv. Thus every existing maximizer (q∘,p∘)(q^\circ,p^\circ)(q∘,p∘) of the integrated profit maximizes each firm's profit under the contingent buy-back. At λ=0\lambda=0λ=0 the retailer is indifferent; at λ=1\lambda=1λ=1 the supplier is indifferent.

The milestones follow the chapter's printed claims in attack order:

  1. the integrated price condition (14), p. 34;
  2. the quantity-flexibility condition (15), p. 34: price coordination forces wq=v−crw_q=v-c_rwq​=v−cr​ or δ=0\delta=0δ=0;
  3. the fixed buy-back condition (16), p. 35: price coordination forces b=−gsb=-g_sb=−gs​ and then wb=cs−gsw_b=c_s-g_swb​=cs​−gs​;
  4. the linear price-contingent terms derived from (5)–(6), p. 35;
  5. the p. 36 profit split πr=λ(Π+gμ)−grμ\pi_r=\lambda(\Pi+g\mu)-g_r\muπr​=λ(Π+gμ)−gr​μ, πs=(1−λ)Π−(λg−gr)μ\pi_s=(1-\lambda)\Pi-(\lambda g-g_r)\muπs​=(1−λ)Π−(λg−gr​)μ, valid for all goodwill penalties as an identity;
  6. the zero-goodwill revenue-sharing price claim following (17), p. 36 (the milestone quotes its restatement in §6.3.2, p. 38);
  7. the price-contingent revenue-sharing parameters, p. 37;
  8. the quantity discount wd(q)w_d(q)wd​(q), pp. 37–38: with gs=0g_s=0gs​=0 it does not distort the price, and given p∘p^\circp∘ it makes q∘q^\circq∘ optimal for both firms.

Significance

The result identifies a contract schedule under which the same quantity-price pair is best for the integrated channel and for the two firms' reported profit functions. It also explains the relation between a buy-back whose terms vary with the chosen price and a revenue-sharing arrangement. In the zero-goodwill setting, both allocate every realized choice's expected channel profit in fixed shares. The general-goodwill identity shows the additional mean-demand terms that matter when the retailer controls price.

The source presents these results analytically; this mission asks for Lean proofs of the stated price and profit relationships. A published Prove2Me definition already supplies expected sales and mean demand for a single demand law, and the model here applies those functions to each price's law. The earlier open theorem RevShareCoord.Single.price_quantity_coordination (from Cachon and Lariviere's revenue-sharing paper) treats deterministic revenue and a simpler cost convention. It is an overlap in theme, but its statement does not include price-indexed demand, salvage value, retailer cost or the contingent buy-back terms, so it is not posed again here. The new model can support further price-dependent contract comparisons in the chapter.

Difficulty

The obstacle is that matching the retailer's quantity incentive at a fixed price can change the retailer's price incentive. The buy-back rate required by the fixed-price coordination equations depends on ppp; a fixed buy-back contract therefore does not generally align both choices. Revenue sharing with goodwill penalties has a similar price dependence. The integrated profit need not be concave or unimodal in (q,p)(q,p)(q,p), so a price first-order condition by itself does not establish coordination. The chapter assumes a finite integrated optimum exists and treats the price condition as necessary, not sufficient.

Formalization scope

Lean represents price-dependent demand as a family of probability measures on R\mathbb RR, one for each price in PPP. Each admissible law is supported on nonnegative demand, has no atom at zero and has an integrable identity function, so μ(p)\mu(p)μ(p) is a genuine finite expectation. Sales are defined by Ep[min⁡(q,D)]\mathbb E_p[\min(q,D)]Ep​[min(q,D)], using the published SupplyChainTheory_contracts definition; they are not defined by the equivalent CDF integral. The admissible decisions are exactly q≥0q\ge0q≥0 and p∈Pp\in Pp∈P. Unit costs and goodwill penalties are nonnegative, each admissible price exceeds c=cs+crc=c_s+c_rc=cs​+cr​, and v<cv<cv<c, as in the model of §6.2. The chapter's standing risk-neutrality and full-information conventions appear in the use of expected profit with the same demand laws available to both firms.

There is a material qualification. With price-dependent demand, μ(p)\mu(p)μ(p) may change with ppp. The printed first-order condition (14) and the p. 36 inference from πr=λ(Π+gμ)−grμ\pi_r=\lambda(\Pi+g\mu)-g_r\muπr​=λ(Π+gμ)−gr​μ to a joint optimum omit that effect when goodwill penalties are positive. Price first-order and optimality statements here therefore use gr=gs=0g_r=g_s=0gr​=gs​=0, a case explicitly discussed in the chapter; general-goodwill claims are limited to algebraic identities. The printed p. 36 equality of price derivatives under revenue sharing also misses its factor ϕ\phiϕ, which the formal statement restores. The contingent buy-back terms are defined by the chapter's linear formulas, not by a property that hard-codes coordination. The algebraic statement permits parameter values that may violate economic buy-back bounds such as 0≤b≤wb0\le b\le w_b0≤b≤wb​; those bounds need separate checks when selecting a contract.

Two first-order statements, (15) and (16), compare price derivatives; they take the derivative of expected sales in price as a hypothesis, and (15) also takes differentiation under the integral sign of ∫(1−δ)qqF(y∣p) dy\int_{(1-\delta)q}^{q}F(y\mid p)\,dy∫(1−δ)qq​F(y∣p)dy as a disclosed regularity hypothesis. For the quantity discount, the statement claims what the page shows, undistorted prices for each qqq and optimality of q∘q^\circq∘ given p∘p^\circp∘, not joint optimality of (q∘,p∘)(q^\circ,p^\circ)(q∘,p∘) for the retailer. The page's claim that revenue sharing with goodwill coordinates only with ϕ=gr/g\phi=g_r/gϕ=gr​/g is not stated, for the mean-demand reason above.

A trivializing formalization is ruled out: no contract term is defined by the profit identity it should satisfy, the demand family cannot be replaced by a single law, and the optimal pair is a hypothesis about the integrated profit, not a chosen witness.

Reusable contributions include the price-indexed demand family, the expected-profit model with five contract types, and the price-maximizer statements. Proofs of the first-order milestones need Fermat's interior-extremum theorem on the open price set and, for (15), positivity of an interval integral; the identities need the expectation algebra of SSS and μ\muμ, including S(0,p)=0S(0,p)=0S(0,p)=0.

Selected references

  • Gérard P. Cachon, “Supply Chain Coordination with Contracts,” in Handbooks in Operations Research and Management Science, vol. 11, Supply Chain Management, North-Holland, 2003. DOI 10.1016/S0927-0507(03)11006-7. Formalization source: author's third draft, January 2003, §6.3, pp. 33–38.
  • Fernando Bernstein and Awi Federgruen, “Decentralized supply chains with competing retailers under demand uncertainty,” Management Science 51(1), 2005 (the price-discount sharing contract; cited in the draft as a 2000 working paper). DOI 10.1287/mnsc.1040.0230
  • Nicholas C. Petruzzi and Maqbool Dada, “Pricing and the newsvendor problem: a review with extensions,” Operations Research 47(2), 1999, 183–194. DOI 10.1287/opre.47.2.183
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Operations ResearchOptimization·Captain: mikedeng1

Assortment Optimisation Under a General Discrete Choice Model: A Tight Analysis of Revenue-Ordered Assortments VI: Revenue-Ordered Offer Sets Grow with Capacity Left and Shrink with Time LeftResearch Paper

Motivation

In airline and hotel revenue management a firm sells a fixed stock of a perishable resource (seats on a flight leg, rooms on a night) over a finite selling horizon, and in each period decides which fare classes to open. Customers do not buy a fixed fare: they choose among the fares on offer, or leave. Talluri and van Ryzin (Management Science, 2004) formulated this single-leg, choice-based problem as a dynamic program over the time remaining and the units remaining.

Practical revenue management systems rarely offer arbitrary sets of fares. They use nested controls: fares are opened from the most expensive downwards, so the open set is always "every fare above some threshold". Whether restricting to such revenue-ordered offer sets is natural depends on how the optimal threshold moves as the state changes. For mixtures of multinomial logit models, Rusmevichientong, Shmoys, Tong and Topaloglu (Production and Operations Management, 2014, Theorem 6) showed that the best revenue-ordered threshold moves monotonically in both the remaining capacity and the remaining time.

Berbeglia and Joret (arXiv:1606.01371v3, §5, Theorem 5.1) extend these two monotonicity properties to every regular discrete choice model, the class that contains essentially every model used in revenue management, including all random utility models. This mission formalizes that result.

Setting

A finite nonempty set C\mathcal CC of products is sold. For a choice set S⊆CS\subseteq\mathcal CS⊆C and a product xxx, P(x,S)\mathcal P(x,S)P(x,S) is the probability that a customer offered SSS buys xxx; the no-purchase probability is P(0,S)=1−∑x∈SP(x,S)\mathcal P(0,S)=1-\sum_{x\in S}\mathcal P(x,S)P(0,S)=1−∑x∈S​P(x,S). The system P\mathcal PP is regular when (i) all these probabilities are nonnegative, (ii) P(x,S)=0\mathcal P(x,S)=0P(x,S)=0 for x∉Sx\notin Sx∈/S, (iii) ∑x∈SP(x,S)≤1\sum_{x\in S}\mathcal P(x,S)\le 1∑x∈S​P(x,S)≤1, and (iv) P(x,S)≥P(x,S′)\mathcal P(x,S)\ge\mathcal P(x,S')P(x,S)≥P(x,S′) whenever S⊆S′S\subseteq S'S⊆S′, for every x∈Sx\in Sx∈S and for the no-purchase option x=0x=0x=0.

Each product xxx has a revenue r(x)>0r(x)>0r(x)>0. Let r1<r2<⋯<rkr_1<r_2<\cdots<r_kr1​<r2​<⋯<rk​ be the distinct revenues. For ℓ∈[k]={1,…,k}\ell\in[k]=\{1,\dots,k\}ℓ∈[k]={1,…,k} the revenue-ordered assortment is Sℓ={x∈C:r(x)≥rℓ}S_\ell=\{x\in\mathcal C:r(x)\ge r_\ell\}Sℓ​={x∈C:r(x)≥rℓ​}; a larger index ℓ\ellℓ gives a smaller set, S1=CS_1=\mathcal CS1​=C.

In the multi-period model one customer arrives per period. With ttt periods remaining and qqq units left, the firm offers some SℓS_\ellSℓ​. The values of the revenue-ordered dynamic program are

Jt(q,ℓ)=∑x∈SℓP(x,Sℓ)(r(x)+Jt−1(q−1))+P(0,Sℓ) Jt−1(q)(t,q>0),\mathcal J_t(q,\ell)=\sum_{x\in S_\ell}\mathcal P(x,S_\ell)\bigl(r(x)+\mathcal J_{t-1}(q-1)\bigr)+\mathcal P(0,S_\ell)\,\mathcal J_{t-1}(q)\qquad(t,q>0),Jt​(q,ℓ)=x∈Sℓ​∑​P(x,Sℓ​)(r(x)+Jt−1​(q−1))+P(0,Sℓ​)Jt−1​(q)(t,q>0),

Jt(q,ℓ)=0\mathcal J_t(q,\ell)=0Jt​(q,ℓ)=0 when t=0t=0t=0 or q=0q=0q=0, and Jt(q)=max⁡ℓ∈[k]Jt(q,ℓ)\mathcal J_t(q)=\max_{\ell\in[k]}\mathcal J_t(q,\ell)Jt​(q)=maxℓ∈[k]​Jt​(q,ℓ). The optimal revenue-ordered index is the smallest maximiser,

ℓt∗(q)=min⁡{ℓ∈[k]:Jt(q,ℓ)=Jt(q)},\ell^*_t(q)=\min\{\ell\in[k]:\mathcal J_t(q,\ell)=\mathcal J_t(q)\},ℓt∗​(q)=min{ℓ∈[k]:Jt​(q,ℓ)=Jt​(q)},

and ΔJt(q)=Jt(q)−Jt(q−1)\Delta\mathcal J_t(q)=\mathcal J_t(q)-\mathcal J_t(q-1)ΔJt​(q)=Jt​(q)−Jt​(q−1) is the marginal value of capacity.

Formalization targets

Goal: Theorem 5.1

For every t≥1t\ge 1t≥1 and q≥1q\ge 1q≥1,

ℓt∗(q)≤ℓt∗(q−1)  if q≥2,ℓt∗(q)≥ℓt−1∗(q)  if t≥2.\ell^*_t(q)\le\ell^*_t(q-1)\ \text{ if } q\ge 2,\qquad \ell^*_t(q)\ge\ell^*_{t-1}(q)\ \text{ if } t\ge 2 .ℓt∗​(q)≤ℓt∗​(q−1)  if q≥2,ℓt∗​(q)≥ℓt−1∗​(q)  if t≥2.

More units left give a weakly larger optimal offer set; more periods left give a weakly smaller one. The paper states the theorem for t∈[T]t\in[T]t∈[T], q∈[Q]q\in[Q]q∈[Q]; the horizon and the capacity only bound ttt and qqq, so the goal is stated for all t,q≥1t,q\ge 1t,q≥1.

Milestones

  1. Lemma 2.1 (p. 6): ∑x∈SP(x,S)≤∑x∈S′P(x,S′)\sum_{x\in S}\mathcal P(x,S)\le\sum_{x\in S'}\mathcal P(x,S')∑x∈S​P(x,S)≤∑x∈S′​P(x,S′) for S⊆S′S\subseteq S'S⊆S′.
  2. Lemma .1 (p. 35): with L∗(δ)\mathcal L^*(\delta)L∗(δ) the set of indices ℓ\ellℓ maximising ∑x∈SℓP(x,Sℓ)(r(x)+δ)\sum_{x\in S_\ell}\mathcal P(x,S_\ell)(r(x)+\delta)∑x∈Sℓ​​P(x,Sℓ​)(r(x)+δ), if δ1+rk≥0\delta_1+r_k\ge 0δ1​+rk​≥0 and δ1≤δ2\delta_1\le\delta_2δ1​≤δ2​ then min⁡L∗(δ2)≤min⁡L∗(δ1)\min\mathcal L^*(\delta_2)\le\min\mathcal L^*(\delta_1)minL∗(δ2​)≤minL∗(δ1​).
  3. Equation (16) (p. 36): Jt(q)=max⁡ℓ∑x∈SℓP(x,Sℓ)(r(x)−ΔJt−1(q))+Jt−1(q)\mathcal J_t(q)=\max_{\ell}\sum_{x\in S_\ell}\mathcal P(x,S_\ell)(r(x)-\Delta\mathcal J_{t-1}(q))+\mathcal J_{t-1}(q)Jt​(q)=maxℓ​∑x∈Sℓ​​P(x,Sℓ​)(r(x)−ΔJt−1​(q))+Jt−1​(q).
  4. Equations (17)–(18) (p. 36): ℓt∗(q)=min⁡L∗(−ΔJt−1(q))\ell^*_t(q)=\min\mathcal L^*(-\Delta\mathcal J_{t-1}(q))ℓt∗​(q)=minL∗(−ΔJt−1​(q)).
  5. Marginal value at most rkr_krk​ (p. 36): ΔJt(q)≤rk\Delta\mathcal J_t(q)\le r_kΔJt​(q)≤rk​.
  6. Marginal value non-increasing in capacity (p. 36, citing Talluri–van Ryzin, Lemma 4): ΔJt(q+1)≤ΔJt(q)\Delta\mathcal J_t(q+1)\le\Delta\mathcal J_t(q)ΔJt​(q+1)≤ΔJt​(q).
  7. Marginal value non-decreasing in time (p. 37, citing Talluri–van Ryzin, Lemma 5): ΔJt(q)≤ΔJt+1(q)\Delta\mathcal J_t(q)\le\Delta\mathcal J_{t+1}(q)ΔJt​(q)≤ΔJt+1​(q).

Milestones 5–7 are asserted or cited in the paper, not proved there; milestones 6–7 are stated for this restricted dynamic program, which is the one the paper applies them to.

Significance

The theorem says that a firm restricted to revenue-ordered offer sets can implement its policy as a nested booking control: as seats sell out, the threshold fare can only rise, and as departure approaches with seats in hand, it can only fall. This is the structure that standard revenue management systems already assume, and Rusmevichientong et al. point out that such monotonicity can be used to implement them. The paper's contribution is that the property depends only on regularity of the choice model, not on its multinomial-logit form.

Formalizing it adds a machine-checked statement of the single-leg choice-based dynamic program over a general choice model, a precise account of the tie-breaking rule (the smallest maximiser), and machine-checked versions of the two marginal-value monotonicity facts that the paper cites from Talluri and van Ryzin rather than proves. To our knowledge none of these statements has been formalized in any proof assistant; the paper's proofs are informal.

Difficulty

The paper's proof is short, but two of its steps are not proved there. The marginal-value inequalities are imported from Talluri and van Ryzin, whose dynamic program optimises over all offer sets; here only the kkk revenue-ordered sets are available and the empty set is not, so those proofs have to be redone for this program, and the bound ΔJ≤rk\Delta\mathcal J\le r_kΔJ≤rk​ is needed to keep each stage's shifted problem well behaved. The claim ΔJ≤rk\Delta\mathcal J\le r_kΔJ≤rk​ itself is justified on the page only by an informal sentence.

The second subtlety is tie-breaking. The monotonicity is about the smallest optimal index. Several indices can be optimal at once, and the comparison of Lemma .1 transfers optimality of one index from one shift to another only through Lemma 2.1, that is, through the no-purchase case of the regularity axiom. Without that case the statement fails.

Formalization scope

  • Products form a finite nonempty type C; choice probabilities are P : C → Finset C → ℝ, defined on all pairs. The no-purchase option is not a product: its probability is the derived quantity noPurchase P S = 1 − ∑_{x∈S} P x S.
  • IsChoiceSystem P is axioms (i)–(iii); IsRegular P adds axiom (iv) for products and for the no-purchase option. Milestones 5–7 assume only axioms (i)–(iii), as the paper says suffices; Lemma .1, (16), (18) and the goal assume regularity and r>0r>0r>0.
  • Revenue levels use the paper's 1-based index: level r ℓ is rℓr_\ellrℓ​ for 1≤ℓ≤k1\le\ell\le k1≤ℓ≤k, topRevenue r is rkr_krk​, and roSet r ℓ is SℓS_\ellSℓ​ as a Finset. The paper's sorting of products (Sℓ={1,…,j(ℓ)}S_\ell=\{1,\dots,j(\ell)\}Sℓ​={1,…,j(ℓ)}) is notation only and is not used.
  • The dynamic program is defined by structural recursion on ttt; there is no stochastic process. Maxima over [k][k][k] are Finset.sup', and the minima defining ℓt∗(q)\ell^*_t(q)ℓt∗​(q) and min⁡L∗(δ)\min\mathcal L^*(\delta)minL∗(δ) are Finset.min' over sets proved nonempty.
  • ΔJt(q)\Delta\mathcal J_t(q)ΔJt​(q) is used only for q≥1q\ge 1q≥1; milestones are stated with t+1t+1t+1, q+1q+1q+1 in place of the paper's t−1t-1t−1, q−1q-1q−1 to avoid natural-number subtraction, which the goal keeps under its hypotheses q≥2q\ge 2q≥2, t≥2t\ge 2t≥2.

Formalizations that would trivialize the statement are ruled out: the dynamic program maximises over the kkk revenue-ordered sets only, never over all subsets (that is Talluri and van Ryzin's program); ℓ∗\ell^*ℓ∗ is the smallest maximiser, never the largest; and TTT, QQQ, kkk and the choice model are arbitrary, never fixed.

The definitions (regular choice model, revenue-ordered assortments, the restricted dynamic program) are reusable for other results on nested policies. Proofs of the cited Talluri–van Ryzin lemmas for this program are especially welcome, as they are the part the paper leaves to the literature.

Selected references

  • G. Berbeglia and G. Joret, Assortment Optimisation Under a General Discrete Choice Model: A Tight Analysis of Revenue-Ordered Assortments, arXiv:1606.01371v3, 2019; Algorithmica 82, 2020. https://arxiv.org/abs/1606.01371
  • K. Talluri and G. van Ryzin, Revenue Management Under a General Discrete Choice Model of Consumer Behavior, Management Science 50(1), 2004. https://doi.org/10.1287/mnsc.1030.0147
  • P. Rusmevichientong, D. Shmoys, C. Tong and H. Topaloglu, Assortment Optimization under the Multinomial Logit Model with Random Choice Parameters, Production and Operations Management 23(11), 2014. https://doi.org/10.1111/poms.12191
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Supply Chain Coordination with Contracts III: With Effort-Dependent Demand, Buy-Backs, Quantity Flexibility and Revenue Sharing Under-Reward Effort, While a Quantity Discount Gives λΠ(q, e°)Textbook

Why effort breaks the standard coordinating contracts

A supplier selling through a retailer earns more when the retailer works harder at selling. Examples are a better shelf position, more knowledgeable sales staff, local advertising and keeping the display in order. These activities cost the retailer, raise demand, and usually cannot be observed or verified by the supplier, so no contract can be written on them directly. Chapter 6 of the Handbook of Operations Research and Management Science, Vol. 11: Supply Chain Management (G. P. Cachon, Supply Chain Coordination with Contracts, 2003) surveys contracts that align a retailer's decisions with the interest of the whole supply chain. Its §6.4 asks which of these contracts survive when the retailer also chooses such an unverifiable effort level.

The question goes back to the marketing literature on retail effort (Chu and Desai 1995, Desai and Srinivasan 1995, Desiraju and Moorthy 1997, Lal 1990, Lariviere and Padmanabhan 1997). It was taken up for newsvendor contracts by Taylor (2000), who showed that a sales rebate combined with a buy back restores coordination, and by Krishnan, Kapuscinski and Butz (2001), who let effort be chosen after demand is observed. This mission is the third in a series that formalizes the chapter's section capstones. It covers §6.4.1.

The newsvendor with effort-dependent demand

One supplier sells to one retailer for a single selling season. Before the season the retailer chooses an order quantity q≥0q \ge 0q≥0 and an effort level e≥0e \ge 0e≥0. Effort costs him g(e)g(e)g(e), where g(0)=0g(0) = 0g(0)=0, g′>0g' > 0g′>0 and g′′>0g'' > 0g′′>0. Demand DDD given effort eee has distribution function F(⋅∣e)F(\cdot \mid e)F(⋅∣e) on [0,∞)[0, \infty)[0,∞), with F(0∣e)=0F(0 \mid e) = 0F(0∣e)=0 and F(⋅∣e)F(\cdot \mid e)F(⋅∣e) strictly increasing. Demand is stochastically increasing in effort: ∂F(y∣e)/∂e<0\partial F(y \mid e)/\partial e < 0∂F(y∣e)/∂e<0 for y>0y > 0y>0. Units sell at the retail price ppp and cost c<pc < pc<p to produce. Goodwill costs, the salvage value and the retailer's own unit cost are zero. Expected sales and the integrated channel's profit are

S(q,e)=E[min⁡(q,D)]=q−∫0qF(y∣e) dy,Π(q,e)=pS(q,e)−cq−g(e).S(q, e) = \mathbb E[\min(q, D)] = q - \int_0^q F(y \mid e)\,dy, \qquad \Pi(q, e) = pS(q, e) - cq - g(e).S(q,e)=E[min(q,D)]=q−∫0q​F(y∣e)dy,Π(q,e)=pS(q,e)−cq−g(e).

Let (qo,eo)(q^o, e^o)(qo,eo) maximize Π\PiΠ. A contract fixes the transfer the retailer pays the supplier, as a function of what the supplier can verify: the order and, for some contracts, sales or leftover units, but never effort. The contracts compared are the buy back {wb,b}\{w_b, b\}{wb​,b}, quantity flexibility {wq,δ}\{w_q, \delta\}{wq​,δ}, revenue sharing {wr,ϕ}\{w_r, \phi\}{wr​,ϕ}, the sales rebate {ws,r,t}\{w_s, r, t\}{ws​,r,t} and the quantity discount wd(q)w_d(q)wd​(q). Under each, the retailer's profit πr(q,e)\pi_r(q, e)πr​(q,e) is his revenue pS(q,e)pS(q, e)pS(q,e) less the transfer and g(e)g(e)g(e).

Formalization targets

Goal

The goal combines the section's negative and positive results.

  1. Buy backs distort effort (Eq. (19)). For every b>0b > 0b>0, q>0q > 0q>0 and e>0e > 0e>0,
∂πr(q,e,wb,b)∂e<∂Π(q,e)∂e.\frac{\partial \pi_r(q, e, w_b, b)}{\partial e} < \frac{\partial \Pi(q, e)}{\partial e}.∂e∂πr​(q,e,wb​,b)​<∂e∂Π(q,e)​.
  1. The quantity discount aligns effort and splits profit. With
wd(q)=(1−λ)p S(q,eo)q+λc−(1−λ)g(eo)q,λ∈[0,1],w_d(q) = (1 - \lambda)p\,\frac{S(q, e^o)}{q} + \lambda c - (1 - \lambda)\frac{g(e^o)}{q}, \qquad \lambda \in [0, 1],wd​(q)=(1−λ)pqS(q,eo)​+λc−(1−λ)qg(eo)​,λ∈[0,1],

the following hold for every q>0q > 0q>0. The retailer earns πr(q,eo)=λΠ(q,eo)\pi_r(q, e^o) = \lambda\Pi(q, e^o)πr​(q,eo)=λΠ(q,eo) and the supplier earns (1−λ)Π(q,eo)(1 - \lambda)\Pi(q, e^o)(1−λ)Π(q,eo). The retailer's marginal profit of effort equals the channel's. His optimal efforts are the channel's. 3. The optimal order. If (qo,eo)(q^o, e^o)(qo,eo) maximizes Π\PiΠ, both firms' profits at effort eoe^oeo are maximized by qoq^oqo.

Milestones

The milestones follow the section's own claims: the integral form of SSS (p. 41); the first-order condition (18) for the chain-optimal effort; (19); the analogous strict inequalities for quantity flexibility (δ>0\delta > 0δ>0) and revenue sharing (ϕ<1\phi < 1ϕ<1), and the reverse inequality for the sales rebate (r>0r > 0r>0, q>tq > tq>t); the two displays of πr\pi_rπr​ under the quantity discount; and the fact that S(q,e)/qS(q, e)/qS(q,e)/q decreases in qqq.

Significance

The result separates two jobs a contract does. To coordinate the order quantity, buy backs, quantity flexibility and revenue sharing all shield the retailer from part of the demand risk or take part of his revenue. The same shield dulls his incentive to raise demand, so each one leads him to under-invest in effort. The sales rebate pushes the other way, toward too much effort. The quantity discount works because the retailer keeps every unit of realized revenue and bears all of his own effort cost. The schedule then prices the order against expected revenue at the optimal effort, so the order is coordinated without touching the effort incentive. Because πr(q,eo)=λΠ(q,eo)\pi_r(q, e^o) = \lambda\Pi(q, e^o)πr​(q,eo)=λΠ(q,eo) with λ\lambdaλ free in [0,1][0, 1][0,1], any split of the channel's optimal profit is attainable. The chapter extends this observation to retailers that also set price (p. 43).

The section's claims are proved on the page only in outline; several are introduced with "it can be shown". To our knowledge none has a machine-checked proof. Formalizing them requires differentiating expected sales in a parameter of the demand law. That step recurs throughout stochastic inventory and pricing models.

Difficulty

Most of the algebra is short. The substance is in the derivatives. ∂S(q,e)/∂e=−∫0q∂F(y∣e)/∂e dy\partial S(q, e)/\partial e = -\int_0^q \partial F(y \mid e)/\partial e\,dy∂S(q,e)/∂e=−∫0q​∂F(y∣e)/∂edy is a differentiation under the integral sign. The strict inequalities need this integral to be strictly negative. That in turn needs ∂F/∂e\partial F/\partial e∂F/∂e to be integrable and negative on a set of positive length, which is why q>0q > 0q>0 (and q>t≥0q > t \ge 0q>t≥0 for the sales rebate) matters.

The natural reading "the quantity discount makes (qo,eo)(q^o, e^o)(qo,eo) the retailer's joint optimum" is not what the page shows, and it fails in general. The page gives two partial statements: for each fixed qqq the retailer's effort incentive is the chain's, and at e=eoe = e^oe=eo his best order is qoq^oqo. Since πr(q,e)=Π(q,e)−(1−λ)Π(q,eo)\pi_r(q, e) = \Pi(q, e) - (1 - \lambda)\Pi(q, e^o)πr​(q,e)=Π(q,e)−(1−λ)Π(q,eo), the retailer can gain by moving qqq and eee together when λ\lambdaλ is small. The goal states exactly the two partial claims.

Formalization scope

The Lean namespace is CachonCoord.EffortNewsvendor. A structure Model collects the data: ppp and ccc with 0≤c<p0 \le c < p0≤c<p; a family of demand laws indexed by effort (probability measures on [0,∞)[0, \infty)[0,∞) with finite mean, no atom at 000, strictly increasing distribution function); the effort derivative ∂F(y∣e)/∂e\partial F(y \mid e)/\partial e∂F(y∣e)/∂e, negative for y>0y > 0y>0, e>0e > 0e>0; and ggg with g(0)=0g(0) = 0g(0)=0 and positive first and second derivatives for e>0e > 0e>0. SSS is defined as an expectation, and its integral form is a milestone. Derivative claims are HasDerivAt statements at interior efforts e>0e > 0e>0. The inequalities assert that both derivatives exist.

The following hypotheses are standing assumptions or disclosed additions:

  • the chapter's model paragraph (p. 7) and the zeros gr=gs=v=cr=0g_r = g_s = v = c_r = 0gr​=gs​=v=cr​=0 of p. 41;
  • as regularity, differentiation of e↦∫abF(y∣e) dye \mapsto \int_a^b F(y \mid e)\,dye↦∫ab​F(y∣e)dy under the integral sign, with interval-integrable ∂F/∂e\partial F/\partial e∂F/∂e;
  • 0≤c0 \le c0≤c (a production cost);
  • wq>0w_q > 0wq​>0 and δ≤1\delta \le 1δ≤1 for quantity flexibility (the contract's range, p. 24);
  • t≥0t \ge 0t≥0 for the sales rebate threshold;
  • q>0q > 0q>0 wherever wdw_dwd​, which divides by qqq, is used.

Revenue sharing and the sales rebate use §6.2's profit functions (pp. 21, 27) with this section's zeros, less g(e)g(e)g(e).

The page prints the last term of wdw_dwd​ as +(1−λ)g(eo)/q+(1 - \lambda)g(e^o)/q+(1−λ)g(eo)/q. With that sign the page's own displays πr(q,eo)=λΠ(q,eo)\pi_r(q, e^o) = \lambda\Pi(q, e^o)πr​(q,eo)=λΠ(q,eo) and πr(q,e)\pi_r(q, e)πr​(q,e) fail by 2(1−λ)g(eo)2(1 - \lambda)g(e^o)2(1−λ)g(eo). The formalization uses −(1−λ)g(eo)/q-(1 - \lambda)g(e^o)/q−(1−λ)g(eo)/q, under which both hold. wdw_dwd​ is the explicit printed schedule with this correction. It is not defined as "a schedule with πr=λΠ\pi_r = \lambda\Piπr​=λΠ", which would make the goal empty.

Not covered: the price-and-effort schedule at the bottom of p. 43, for which the page gives no argument. The cachon-2005 revenue-sharing effort results (RevShareCoord.Effort.*, deterministic revenue R(q,e)R(q, e)R(q,e)) are a different model and are not referenced. Proofs of any milestone, and a reusable library for differentiating newsvendor expectations in a parameter, are welcome.

Selected references

  • G. P. Cachon, Supply Chain Coordination with Contracts, in S. Graves and T. de Kok (eds.), Handbooks in Operations Research and Management Science, Vol. 11: Supply Chain Management, North-Holland, 2003, Ch. 6. https://doi.org/10.1016/S0927-0507(03)11006-7 (read in the author's 3rd draft, January 2003).
  • T. A. Taylor, Supply Chain Coordination under Channel Rebates with Sales Effort Effects, Management Science 48(8), 2002, 992–1007. https://doi.org/10.1287/mnsc.48.8.992.168
  • H. Krishnan, R. Kapuscinski, D. A. Butz, Coordinating Contracts for Decentralized Supply Chains with Retailer Promotional Effort, Management Science 50(1), 2004, 48–63. https://doi.org/10.1287/mnsc.1030.0154
  • G. P. Cachon, M. A. Lariviere, Supply Chain Coordination with Revenue-Sharing Contracts: Strengths and Limitations, Management Science 51(1), 2005, 30–44. https://doi.org/10.1287/mnsc.1040.0215
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Supply Chain Coordination with Contracts IV: Competing Newsvendors with Proportional Allocation Have a Unique Equilibrium, and a Coordinating Buy-Back Gives the Supplier ((p(n − 1) + b)/(pn))Π(q°)Textbook

Why competing retailers change the contracting problem

A supplier who sells through a single newsvendor retailer faces double marginalization: the retailer bears the whole cost of leftover stock but earns only the retail margin, so under a plain wholesale-price contract he orders less than the integrated supply chain would. The literature reviewed in G. P. Cachon's chapter Supply Chain Coordination with Contracts (Handbooks in OR & MS, vol. 11, 2003) shows that buy-back, revenue-sharing and related contracts correct this distortion. Section 6.5 asks what happens when the supplier sells through several retailers who compete for the same customers.

Competition can push in the opposite direction. When customers buy wherever stock is available, a retailer who stocks more also takes demand from his rivals, and he does not count that loss as a cost. This demand-stealing effect pushes the retailers towards over-ordering, which offsets double marginalization. §6.5.1 makes this precise in the proportional allocation model, in which total demand is split among the retailers in proportion to their inventories. The model goes back to the deterministic version of Wang and Gerchak (2001); related allocation models are those of Lippman and McCardle (1997) and Anupindi and Bassok (1999), and Mahajan and van Ryzin (2001) observe the same mitigation of the need for coordinating contracts.

This mission formalizes §6.5.1 of the chapter's January 2003 third draft, pp. 48–53.

The proportional allocation model

There are n≥2n \ge 2n≥2 retailers and one supplier. Total retail demand D≥0D \ge 0D≥0 is random, with distribution function FFF that is differentiable on (0,∞)(0,\infty)(0,∞) with density fff, strictly increasing on [0,∞)[0,\infty)[0,∞), and satisfies F(0)=0F(0)=0F(0)=0. The retail price is ppp and the supplier's unit production cost is ccc, with 0<c<p0 < c < p0<c<p. Goodwill costs, the salvage value and the retailers' handling cost are zero.

Retailer iii orders qi≥0q_i \ge 0qi​≥0. Write q=∑jqjq = \sum_j q_jq=∑j​qj​ and q−i=q−qiq_{-i} = q - q_iq−i​=q−qi​. Retailer iii receives the demand Di=(qi/q)DD_i = (q_i/q)DDi​=(qi​/q)D. Under a buy-back contract (w,b)(w, b)(w,b) he pays www per unit ordered and is refunded bbb per unit left over; b=0b = 0b=0 is the wholesale-price contract. His expected profit is

πi(qi,q−i)=E[pmin⁡(qi,Di)+b(qi−Di)+]−wqi=(p−w)qi−(p−b)qiq∫0qF(x) dx.\pi_i(q_i, q_{-i}) = \mathbb E\big[p\min(q_i, D_i) + b(q_i - D_i)^+\big] - wq_i = (p-w)q_i - (p-b)\frac{q_i}{q}\int_0^q F(x)\,dx .πi​(qi​,q−i​)=E[pmin(qi​,Di​)+b(qi​−Di​)+]−wqi​=(p−w)qi​−(p−b)qqi​​∫0q​F(x)dx.

Because total sales min⁡(q,D)\min(q, D)min(q,D) depend only on the total stock, the integrated chain earns Π(q)=pS(q)−cq\Pi(q) = pS(q) - cqΠ(q)=pS(q)−cq with S(q)=E[min⁡(q,D)]S(q) = \mathbb E[\min(q,D)]S(q)=E[min(q,D)], and its optimal stock qoq^oqo solves the newsvendor equation F(qo)=(p−c)/pF(q^o) = (p-c)/pF(qo)=(p−c)/p, Eq. (20). A Nash equilibrium is a profile of orders in which each qi∗q^*_iqi∗​ maximizes πi(⋅,q−i∗)\pi_i(\cdot, q^*_{-i})πi​(⋅,q−i∗​) over all orders x≥0x \ge 0x≥0. A contract coordinates the chain when its equilibrium total order is qoq^oqo.

Two contract prices appear on p. 52: the wholesale price w^(q)=p(1−1nF(q)−n−1n⋅1q∫0qF)\widehat w(q) = p\big(1 - \tfrac1n F(q) - \tfrac{n-1}{n}\cdot\tfrac1q\int_0^qF\big)w(q)=p(1−n1​F(q)−nn−1​⋅q1​∫0q​F) that induces total stock qqq, and the buy-back wholesale price

wb(b)=p−(p−b)[1n⋅p−cp+n−1n⋅1qo∫0qoF(x) dx].w_b(b) = p - (p-b)\left[\frac1n\cdot\frac{p-c}{p} + \frac{n-1}{n}\cdot\frac{1}{q^o}\int_0^{q^o}F(x)\,dx\right].wb​(b)=p−(p−b)[n1​⋅pp−c​+nn−1​⋅qo1​∫0qo​F(x)dx].

Formalization targets

Goal: the coordinating buy-back contract (pp. 51–53)

For n≥2n \ge 2n≥2, b<pb < pb<p and qoq^oqo solving (20), with w=wb(b)w = w_b(b)w=wb​(b): qoq^oqo maximizes Π\PiΠ; b<wb(b)<pb < w_b(b) < pb<wb​(b)<p; the profile in which every retailer orders qo/nq^o/nqo/n is the unique Nash equilibrium; and at that equilibrium

πi=p−bpn2 Π(qo),πs=wqo−cqo−b E[(qo−D)+]=p(n−1)+bpn Π(qo).\pi_i = \frac{p-b}{pn^2}\,\Pi(q^o), \qquad \pi_s = wq^o - cq^o - b\,\mathbb E[(q^o-D)^+] = \frac{p(n-1)+b}{pn}\,\Pi(q^o).πi​=pn2p−b​Π(qo),πs​=wqo−cqo−bE[(qo−D)+]=pnp(n−1)+b​Π(qo).

Milestones

The milestones are the section's own claims, in attack order: the newsvendor characterization (20); the inequality 1q∫0qF<F(q)\frac1q\int_0^qF < F(q)q1​∫0q​F<F(q); the closed form of πi\pi_iπi​ and its strict concavity in the retailer's own order (p. 50); the first-order condition and Eq. (21); the monotonicity and limits of the left side LnL_nLn​ of Eq. (22), giving a unique root for b<w<pb < w < pb<w<p; the unique, symmetric Nash equilibrium for every b<w<pb < w < pb<w<p; the increase of the equilibrium total in nnn; that w^(q)\widehat w(q)w(q) induces qqq, that w^(qo)>c\widehat w(q^o) > cw(qo)>c, and that the supplier's profit under wholesale pricing has negative slope at qoq^oqo; the coordinating price wb(b)w_b(b)wb​(b) with wb(b)>w^(qo)w_b(b) > \widehat w(q^o)wb​(b)>w(qo) for b>0b > 0b>0; and the ratio πs(qo,wb(0),0)/Π(qo)=(n−1)/n\pi_s(q^o, w_b(0), 0)/\Pi(q^o) = (n-1)/nπs​(qo,wb​(0),0)/Π(qo)=(n−1)/n (p. 53). A companion item states the endpoint b=pb = pb=p, at which the supplier takes all of Π(qo)\Pi(q^o)Π(qo).

Significance

The section answers two questions. First, with competing retailers a plain wholesale-price contract can coordinate the chain and still leave the supplier a positive margin, which a single retailer never allows. Second, that contract is not the supplier's best wholesale price, and it fixes a single division of profit. Buy-back contracts remove both limitations: the family (wb(b),b)(w_b(b), b)(wb​(b),b) coordinates for every b<pb < pb<p and moves the supplier's share continuously from (n−1)/n(n-1)/n(n−1)/n to all of Π(qo)\Pi(q^o)Π(qo). The ratio (n−1)/n(n-1)/n(n−1)/n also measures how little a coordinating contract adds when many retailers compete (80% of the optimal profit at n=5n = 5n=5).

The results are proved in the chapter, mostly by short computations, and none of them has been machine-checked. The formalization makes explicit what the page leaves implicit: that no equilibrium has a retailer ordering zero, the limits behind "from 0 to 1", and the density condition behind the strict sign on p. 52. It also produces a reusable proportional-allocation game and a Nash-equilibrium predicate for nonnegative real strategies.

Difficulty

The algebraic identities (the profits at the coordinating contract, the ratio (n−1)/n(n-1)/n(n−1)/n, the derivative at qoq^oqo) are routine once πi\pi_iπi​ has its closed form. The closed form itself requires computing the expectation with proportional shares and identifying E[min⁡(q,D)]\mathbb E[\min(q,D)]E[min(q,D)] with q−∫0qFq - \int_0^q Fq−∫0q​F.

The real obstacle is the uniqueness of the equilibrium. The page argues from first-order conditions, which describe only interior best responses. A complete proof must show that each retailer's profit is strictly concave in his own order, that no retailer orders zero in equilibrium, and that the all-zero profile (where πi\pi_iπi​ has q=0q = 0q=0 in a denominator) is not an equilibrium. Strict concavity is the delicate step. The second derivative mixes the density with the term 2q−iq3(qF(q)−∫0qF)\frac{2q_{-i}}{q^3}\big(qF(q) - \int_0^qF\big)q32q−i​​(qF(q)−∫0q​F), and concavity has to be established on the closed half-line, including the boundary qi=0q_i = 0qi​=0.

Formalization scope

Retailers are indexed by Fin n with n≥2n \ge 2n≥2 (the page's n>1n > 1n>1). The comparison in nnn also allows a single retailer, as the page does. Orders are real numbers qi≥0q_i \ge 0qi​≥0, and best responses range over all x≥0x \ge 0x≥0. The demand law is a probability measure on R\mathbb RR carried by [0,∞)[0,\infty)[0,∞) with finite mean, FFF is its cdf, and fff is a field with HasDerivAt F (f y) y for y>0y > 0y>0. These are the chapter's standing assumptions (p. 7). The condition c>0c > 0c>0 is needed for (20) to have a solution. The integrated optimum qoq^oqo enters each theorem through the hypothesis F(qo)=(p−c)/pF(q^o) = (p-c)/pF(qo)=(p−c)/p, which determines it uniquely. Transfers run from the retailers to the supplier.

Added or made explicit relative to the page: b<pb < pb<p in the concavity claim (at b=pb = pb=p the profit is linear); f(qo)>0f(q^o) > 0f(qo)>0 for the strict sign of the supplier's marginal profit; positivity of the total order wherever 1q∫0qF\frac1q\int_0^qFq1​∫0q​F appears. The page's printed slips (the first-order condition rescaled by q∗/(p−b)q^*/(p-b)q∗/(p−b), "F(qo)=(p−c)/cF(q^o) = (p-c)/cF(qo)=(p−c)/c", "w(b)w(b)w(b)") are corrected in the statements and kept in the milestone quotes.

Ruled out as trivializing: w^\widehat ww and wbw_bwb​ are the printed formulas, not "the price at which qoq^oqo is an equilibrium"; the supplier's profit is computed from the transfers, not as Π\PiΠ minus the retailers' profits; the equilibrium statement quantifies over all nonnegative deviations, so restricting attention to interior or symmetric profiles is not an option.

A complete development needs interval integrals of a cdf, the fundamental theorem of calculus for q↦∫0qFq \mapsto \int_0^qFq↦∫0q​F, and strict concavity from a strictly decreasing derivative. The proportional-allocation game and the Nash predicate are reusable for the other allocation models of §6.5. No platform item is referenced: the competing-retailer game of Cachon and Lariviere (2005), RevShareCoord.Competing.*, uses deterministic revenue functions and is a different model.

Selected references

  • G. P. Cachon, Supply Chain Coordination with Contracts, in S. Graves and T. de Kok (eds.), Handbooks in Operations Research and Management Science, vol. 11, North-Holland, 2003; read in the author's 3rd draft (Jan. 2003), §6.5.1. https://doi.org/10.1016/S0927-0507(03)11006-7
  • Y. Wang and Y. Gerchak, Supply chain coordination when demand is shelf-space dependent, Manufacturing & Service Operations Management 3(1), 2001, 82–87. https://doi.org/10.1287/msom.3.1.82.9998
  • S. A. Lippman and K. F. McCardle, The competitive newsboy, Operations Research 45(1), 1997, 54–65. https://doi.org/10.1287/opre.45.1.54
  • S. Mahajan and G. van Ryzin, Inventory competition under dynamic consumer choice, Operations Research 49(5), 2001, 646–657. https://doi.org/10.1287/opre.49.5.646.10603
  • G. P. Cachon and M. A. Lariviere, Supply chain coordination with revenue-sharing contracts: strengths and limitations, Management Science 51(1), 2005, 30–44. https://doi.org/10.1287/mnsc.1040.0215
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Supply Chain Coordination with Contracts V: With Market-Clearing Prices the Best Wholesale Price Earns θ/(2(1 + θ)) or θ/8, Below the (1 + θ)/8 a Full-Refund Buy-Back AttainsTextbook

Motivation

A supplier that sells through many competing retailers usually worries that competition among them pushes orders too high, because each retailer ignores the demand it takes from the others. Deneckere, Marvel and Peck (1997) identified the opposite failure. When the retail price is set by the market after demand is realized, retailers who hold too much stock in a weak market bid the price down, and anticipating this, perfectly competitive retailers order too little. The supplier then needs a contract that raises orders, and the classical justification for resale price maintenance (a price floor imposed on retailers) comes out of this model. G. P. Cachon's survey chapter Supply Chain Coordination with Contracts (Handbooks in OR & MS, Vol. 11, 2003) presents the model in §6.5.2 as a closed-form example. In it the supplier's best wholesale price contract is computed explicitly and compared with two contracts that recover the monopoly profit: resale price maintenance and a full-refund buy-back.

This mission is volume V of a series that formalizes the section capstones of that chapter, read in the author's 3rd draft (January 2003), pp. 53–58.

Setting

Fix θ>1\theta>1θ>1. Industry demand is low or high, each with probability 1/21/21/2. If the retailers hold a total stock qqq, the market clearing price is

pl(q)=(1−q)+ (low state),ph(q)=(1−qθ)+ (high state).p_l(q)=(1-q)^+\ \text{(low state)},\qquad p_h(q)=\Big(1-\frac q\theta\Big)^+\ \text{(high state)}.pl​(q)=(1−q)+ (low state),ph​(q)=(1−θq​)+ (high state).

Leftover inventory has no salvage value, and the supplier's production cost is zero.

  • Monopolist benchmark. A single firm orders a stock QQQ, observes the state, and sells xl≤Qx_l\le Qxl​≤Q (low) or xh≤Qx_h\le Qxh​≤Q (high) at the market clearing price. Its expected profit is 12pl(xl)xl+12ph(xh)xh\tfrac12p_l(x_l)x_l+\tfrac12p_h(x_h)x_h21​pl​(xl​)xl​+21​ph​(xh​)xh​, and Πo\Pi^oΠo is the maximum of this.
  • Wholesale price contract. The supplier charges www per unit. A continuum of retailers orders before demand is known and sells everything at the market clearing price. Their aggregate expected profit is
π(q)=12pl(q)q+12ph(q)q−wq.\pi(q)=\tfrac12p_l(q)q+\tfrac12p_h(q)q-wq .π(q)=21​pl​(q)q+21​ph​(q)q−wq.

Perfect competition means the retailers keep ordering until expected profit is zero. The competitive order is the q>0q>0q>0 with π(q)=0\pi(q)=0π(q)=0 and π>0\pi>0π>0 on (0,q)(0,q)(0,q). The supplier earns wqwqwq.

  • Resale price maintenance (pˉ,w)(\bar p,w)(pˉ​,w): retailers may not sell below pˉ\bar ppˉ​. When the clearing price would fall below pˉ\bar ppˉ​, only the demand at pˉ\bar ppˉ​ is sold, allocated in proportion to stock.
  • Buy-back (w,b)(w,b)(w,b): the supplier pays bbb per unsold unit. The market price then cannot fall below bbb, and retailers sell at most 1−b1-b1−b units (low) and θ(1−b)\theta(1-b)θ(1−b) units (high).

The page's notation q1(w)=2θ1+θ(1−w)q_1(w)=\frac{2\theta}{1+\theta}(1-w)q1​(w)=1+θ2θ​(1−w), q2(w)=θ(1−2w)q_2(w)=\theta(1-2w)q2​(w)=θ(1−2w), πs(w)\pi_s(w)πs​(w) and w∗(θ)w^*(\theta)w∗(θ) is kept in Lean under the names q1, q2, supplierProfit, wStar.

Formalization targets

Goal (pp. 55, 57)

With

πs∗={θ2(1+θ)θ≤3,θ8θ>3,\pi_s^*=\begin{cases}\dfrac{\theta}{2(1+\theta)}&\theta\le3,\\[4pt]\dfrac\theta8&\theta>3,\end{cases}πs∗​=⎩⎨⎧​2(1+θ)θ​8θ​​θ≤3,θ>3,​

the goal states four things:

  1. πs∗\pi_s^*πs∗​ is the greatest supplier profit wqwqwq over all wholesale prices and their competitive orders.
  2. w∗(θ)w^*(\theta)w∗(θ) attains it.
  3. The monopolist's maximum is Πo=(1+θ)/8\Pi^o=(1+\theta)/8Πo=(1+θ)/8, and πs∗<Πo\pi_s^*<\Pi^oπs∗​<Πo.
  4. Under the buy-back b=w=1/2b=w=1/2b=w=1/2 the competitive order is θ/2\theta/2θ/2 and the supplier earns exactly Πo\Pi^oΠo.

Milestones

  1. Πo=(1+θ)/8\Pi^o=(1+\theta)/8Πo=(1+θ)/8 (p. 54).
  2. The competitive order is q1(w)q_1(w)q1​(w) if w≥12−12θw\ge\tfrac12-\tfrac1{2\theta}w≥21​−2θ1​ and q2(w)q_2(w)q2​(w) otherwise, for 0≤w<10\le w<10≤w<1 (p. 55).
  3. w∗(θ)w^*(\theta)w∗(θ) maximizes πs\pi_sπs​ on [0,1)[0,1)[0,1), with the value πs∗\pi_s^*πs∗​ (p. 55).
  4. The orders and market clearing prices at w∗(θ)w^*(\theta)w∗(θ) (p. 55).
  5. Under resale price maintenance with pˉ=1/2\bar p=1/2pˉ​=1/2 and total stock θ/2\theta/2θ/2, πr(t)=q(t)(1+θ4θ−w)\pi_r(t)=q(t)\big(\frac{1+\theta}{4\theta}-w\big)πr​(t)=q(t)(4θ1+θ​−w) (p. 56).
  6. Under (pˉ,wˉ)(\bar p,\bar w)(pˉ​,wˉ) the competitive order is θ/2\theta/2θ/2 and the supplier earns Πo\Pi^oΠo (p. 57).
  7. Under the buy-back b=1/2b=1/2b=1/2 the retailers' profit is q(34−w−q2θ)q\big(\frac34-w-\frac q{2\theta}\big)q(43​−w−2θq​) for 1/2<q<θ/21/2<q<\theta/21/2<q<θ/2 (p. 57).
  8. 1/2>(1+θ)/(4θ)1/2>(1+\theta)/(4\theta)1/2>(1+θ)/(4θ) (p. 57).

Significance

The goal shows that in this model a wholesale price contract always falls short of the integrated profit, whatever θ\thetaθ. It also shows where the shortfall comes from: at the optimal wholesale price the low-state market price falls below the monopoly price 1/21/21/2 (milestone 4). Restoring the monopoly profit therefore requires a mechanism that holds the low-state price at 1/21/21/2. Resale price maintenance and a full-refund buy-back both do this, so the section gives a closed-form efficiency argument for vertical restraints that are often treated as anticompetitive. The section also contrasts the buy-back with revenue sharing, which coordinates the single newsvendor (§6.2) but not this model.

The results are proved on the printed pages by elementary algebra. None of them has a machine-checked proof, and nothing on Prove2Me covers this model. The mission produces checked versions of the case analysis, including the θ=3\theta=3θ=3 tie and the two regimes of the competitive order. It also adds a reusable encoding of "perfect competition" as the first zero of aggregate expected profit.

Difficulty

Every statement reduces to one-variable inequalities, but the case structure is easy to get wrong.

  • The retailers' profit is piecewise (prices hit zero at q=1q=1q=1 in the low state and at q=θq=\thetaq=θ in the high state). The competitive order lies on either side of q=1q=1q=1 depending on www.
  • The supplier's profit πs\pi_sπs​ is piecewise in www, and its second branch peaks at w=1/4w=1/4w=1/4 only when θ>2\theta>2θ>2.
  • The global optimum switches at θ=3\theta=3θ=3, where both prices are optimal.
  • A statement "the competitive order is q1(w)q_1(w)q1​(w)" needs the order to exist, to be unique, and to have positive profit everywhere below it. Exhibiting a root is not enough.
  • The buy-back profit is identically zero for q≥θ/2q\ge\theta/2q≥θ/2 when b=w=1/2b=w=1/2b=w=1/2. Only the "first zero" reading of perfect competition pins the order at θ/2\theta/2θ/2.

Formalization scope

All quantities are real numbers and θ>1\theta>1θ>1 throughout. The continuum of retailers enters only through the total order. No measure space of retailers is formalized, and footnote 26's multiplicity of individual equilibria is not stated. The sales rules under resale price maintenance (proportional allocation) and under the buy-back (price floor bbb) are written into the contract definitions, as the page describes them in words. The theorems use only pˉ=b=1/2\bar p=b=1/2pˉ​=b=1/2.

The formulas q1q_1q1​, q2q_2q2​, πs\pi_sπs​ and w∗w^*w∗ are definitions transcribed from the page. That they are the competitive order and the optimum is the content of the theorems. Defining Πo\Pi^oΠo or the competitive order by its closed form would trivialize the mission, so the competitive order is defined only by the zero-profit property and Πo\Pi^oΠo as a greatest element of the monopolist's feasible profits. The goal is stated over all real wholesale prices, so it also rules out profitable prices outside [0,1)[0,1)[0,1). Uniqueness of w∗(θ)w^*(\theta)w∗(θ) is not asserted at θ=3\theta=3θ=3.

The chapter's standing assumptions used here are risk neutrality and full information, together with the model paragraph of pp. 53–54 (two equally likely states, zero salvage value, zero production cost). No platform definition is referenced: no published item formalizes this model.

Selected references

  • G. P. Cachon, Supply Chain Coordination with Contracts, in S. Graves, T. de Kok (eds.), Handbooks in Operations Research and Management Science, Vol. 11: Supply Chain Management, North-Holland, 2003, §6.5.2 (3rd draft, January 2003, pp. 53–58). https://doi.org/10.1016/S0927-0507(03)11006-7
  • R. Deneckere, H. P. Marvel, J. Peck, Demand Uncertainty and Price Maintenance: Markdowns as Destructive Competition, American Economic Review 87(4), 619–641, 1997. https://www.jstor.org/stable/2951366
  • R. Deneckere, H. P. Marvel, J. Peck, Demand Uncertainty, Inventories, and Resale Price Maintenance, Quarterly Journal of Economics 111(3), 885–913, 1996. https://doi.org/10.2307/2946675
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Supply Chain Coordination with Contracts VII: In the Single-Location Base-Stock Model the Transfers t_I = (1 − λ)h_r, t_B = β_r − λβ Make the Retailer's Cost λc(s_r)Textbook

Motivation

A retailer can keep too little inventory even when its own stocking decision is optimal. In the single-location model of Cachon, Supply Chain Coordination with Contracts (2003), the supplier suffers a cost when the retailer has backorders, but the retailer does not bear that part of the cost. The supplier and retailer therefore prefer different base-stock levels. Section 6.7 asks whether payments tied to expected inventory and backorders can make the retailer choose the level that minimizes their combined cost. The result also describes how the contract divides that cost between the firms.

The model concerns a continuing operation with repeated replenishment opportunities and backordered demand. A base-stock policy keeps the retailer's inventory position at a chosen level by replacing units as demand occurs. Cachon reduces the cost calculation for such a policy to the distribution of demand over one replenishment lead time. That reduction allows the coordination question to be stated with one real stock-level decision rather than a full inventory trajectory. The chapter presents this model as a building block for its two-location system in §6.8 Cachon (2003).

Setting

Let DrD_rDr​ denote lead-time demand, the amount demanded while the retailer waits for replenishment. It is nonnegative and has a finite mean μr=E[Dr]\mu_r=\mathbb E[D_r]μr​=E[Dr​], distribution function FrF_rFr​, and density frf_rfr​. At inventory level s∈Rs\in\mathbb Rs∈R, expected inventory is Ir(s)=E[(s−Dr)+]I_r(s)=\mathbb E[(s-D_r)^+]Ir​(s)=E[(s−Dr​)+] and expected backorders are Br(s)=E[(Dr−s)+]B_r(s)=\mathbb E[(D_r-s)^+]Br​(s)=E[(Dr​−s)+], where x+=max⁡(x,0)x^+=\max(x,0)x+=max(x,0). The section assumes Fr(0)=0F_r(0)=0Fr​(0)=0 and a strictly increasing differentiable FrF_rFr​ on nonnegative levels. These assumptions place the optimum above zero.

The retailer pays holding cost hrIr(s)h_r I_r(s)hr​Ir​(s) and its own backorder cost βrBr(s)\beta_r B_r(s)βr​Br​(s). The supplier pays a further backorder cost βsBr(s)\beta_s B_r(s)βs​Br​(s). All three cost rates are positive. Thus cr(s)=hrIr(s)+βrBr(s)c_r(s)=h_r I_r(s)+\beta_r B_r(s)cr​(s)=hr​Ir​(s)+βr​Br​(s) and cs(s)=βsBr(s)c_s(s)=\beta_s B_r(s)cs​(s)=βs​Br​(s) are the firms' costs, while c(s)=cr(s)+cs(s)c(s)=c_r(s)+c_s(s)c(s)=cr​(s)+cs​(s) is the channel cost. Write β=βr+βs\beta=\beta_r+\beta_sβ=βr​+βs​. Because demand is backordered rather than lost, the section treats the sales rate as constant across the stock decisions and compares costs alone Cachon (2003), §6.7.1.

The proposed contract pays the retailer tIIr(s)+tBBr(s)t_I I_r(s)+t_B B_r(s)tI​Ir​(s)+tB​Br​(s) from the supplier, where tIt_ItI​ and tBt_BtB​ are transfer rates. A positive rate is a subsidy; a negative rate charges the retailer. For a parameter λ∈(0,1]\lambda\in(0,1]λ∈(0,1], the contract sets tI=(1−λ)hrt_I=(1-\lambda)h_rtI​=(1−λ)hr​ and tB=βr−λβt_B=\beta_r-\lambda\betatB​=βr​−λβ. The retailer's contracted cost is its original cost minus this transfer; the supplier's contracted cost is its original cost plus it. The parameter λ\lambdaλ describes a family of printed contract rates and is not itself a payment term Cachon (2003), p. 74.

Formalization targets

The milestones establish the two expectation identities, the channel's cost formula and strict convexity, the channel's critical ratio, the retailer's lower uncontracted stock level, and the retailer's cost after the printed transfer. In the notation above, the channel optimum sr∘s_r^\circsr∘​ is unique and satisfies

Fr(sr∘)=βhr+β;F_r(s_r^\circ)=\frac{\beta}{h_r+\beta};Fr​(sr∘​)=hr​+ββ​;

the uncontracted retailer has its own unique optimum sr∗s_r^*sr∗​ with sr∗<sr∘s_r^*<s_r^\circsr∗​<sr∘​. Three further statements of §6.7.1 complete the section: the signs of the transfer rates over the family (tI≥0t_I\ge0tI​≥0, with tI>0t_I>0tI​>0 exactly for λ<1\lambda<1λ<1, and {tB:0<λ≤1}=[−βs,βr)\{t_B:0<\lambda\le1\}=[-\beta_s,\beta_r){tB​:0<λ≤1}=[−βs​,βr​)); the decomposition

tIIr(y)+tBBr(y)=(tI+tB)Ir(y)+tB(μr−y);t_I I_r(y)+t_B B_r(y)=(t_I+t_B)I_r(y)+t_B(\mu_r-y);tI​Ir​(y)+tB​Br​(y)=(tI​+tB​)Ir​(y)+tB​(μr​−y);

and the equivalence with the newsvendor model: with lead-time demand as newsvendor demand, retail price p=hr+βrp=h_r+\beta_rp=hr​+βr​ and wholesale price w=hrw=h_rw=hr​, the newsvendor retailer's profit pS(q)−wqpS(q)-wqpS(q)−wq, with expected sales S(q)=E[min⁡(q,Dr)]S(q)=\mathbb E[\min(q,D_r)]S(q)=E[min(q,Dr​)], equals −cr(q)+βrμr-c_r(q)+\beta_r\mu_r−cr​(q)+βr​μr​. The mission goal is the coordinating identity of Eq. (33), together with the unique optimality it implies:

crλ(s)=λc(s),csλ(s)=(1−λ)c(s)for all s∈R and 0<λ≤1.c_r^\lambda(s)=\lambda c(s),\qquad c_s^\lambda(s)=(1-\lambda)c(s) \quad\text{for all }s\in\mathbb R\text{ and }0<\lambda\le1.crλ​(s)=λc(s),csλ​(s)=(1−λ)c(s)for all s∈R and 0<λ≤1.

Consequently, the retailer's contracted cost has the same unique minimizer sr∘s_r^\circsr∘​ as the channel cost. At each stock level the retailer's contracted cost is strictly increasing in λ\lambdaλ, which is the page's statement that the retailer's share of the cost increases with λ\lambdaλ. The result does not prescribe one fixed allocation of cost: each λ\lambdaλ in the stated interval gives a contract with the same coordinated stock level and a different retailer share Cachon (2003), Eq. (33), p. 74.

Significance

The theorem identifies an explicit transfer that corrects an incentive gap created by the supplier's backorder cost. Without it, the retailer sets stock according to βr\beta_rβr​, while the channel's stock decision uses βr+βs\beta_r+\beta_sβr​+βs​. Under the contract, the retailer bears the fraction λ\lambdaλ of total cost at every stock level, so its decision agrees with the integrated channel's decision. This conclusion connects a decentralized cost objective to the base-stock target used in the next section's two-location analysis Cachon (2003), §§6.7–6.8.

The chapter proves these claims informally; this mission asks for machine-checked Lean proofs of the expectation identities, convexity and optimality claims, and the contract identity. Its reusable output is the precise treatment of expected positive-part inventory and backorders under a demand law with finite mean. The local definitions may also support later formalizations of inventory contracts. Expected sales in the newsvendor comparison is the published SupplyChainTheory.expSales (definition SupplyChainTheory_contracts), referenced rather than redefined. The existing proved SupplyChainTheory.chain_optimal_fractile concerns a single-period newsvendor profit objective; its critical ratio is related mathematically but belongs to a different model and is not substituted for Eq. (31).

Difficulty

The algebra of the transfer rates is short, but the unique-optimum claim depends on more than algebra. It requires expected inventory and backorders to match the distribution formulas, the cost to have the required curvature at nonnegative levels, and the optimum to occur at a positive level. A formal statement that defines the retailer's contracted cost directly as λc\lambda cλc would erase the coordinating claim. The negative-stock region also matters: since demand is nonnegative, expected inventory vanishes there and cost is affine rather than strictly convex. The formulation must keep strict convexity on the range where it holds while still identifying the unique optimum among all real stock levels.

Formalization scope

Lean represents DrD_rDr​ by a probability measure on R\mathbb RR supported on [0,∞)[0,\infty)[0,∞), with an explicit integrable first moment. The density is a measurable nonnegative function whose induced measure is the demand law; the cdf is continuous, strictly increasing on [0,∞)[0,\infty)[0,∞), equals zero at zero, and has that density as its derivative at positive levels. These are the section's distribution assumptions. The positive rates hr,βr,βsh_r,\beta_r,\beta_shr​,βr​,βs​ are fields of one model, and Ir,BrI_r,B_rIr​,Br​ are defined by expectations. This rules out accidental zero values from nonintegrable real integrals. The cost functions are constructed from the expected inventory and backorders; the transfer is constructed from the two printed rates. The identities in Eqs. (28)–(33) are theorem targets, not definitions.

Stock levels are real, including negative levels, because the section does not explicitly restrict the decision set. The formal result states strict convexity on nonnegative levels and uniqueness of the cost minimizers over all real levels. The page's sentence that tI>0t_I>0tI​>0 for all λ∈(0,1]\lambda\in(0,1]λ∈(0,1] fails at λ=1\lambda=1λ=1, where tI=0t_I=0tI​=0; the formal statement asserts tI≥0t_I\ge0tI​≥0 with strict positivity exactly for λ<1\lambda<1λ<1. The contract range is exactly 0<λ≤10<\lambda\le10<λ≤1; λ=0\lambda=0λ=0 would make every retailer stock level cost-equivalent. The transfer sign is positive from supplier to retailer, as on p. 73. Risk neutrality and full information are the chapter's standing conventions. The continuous-review state process, supplier capacity, and proof that a base-stock policy attains the displayed long-run average are not modeled; the mission formalizes the section's explicit lead-time-demand cost reduction. Contributions that establish integrability, distribution identities, strict convexity, and critical-ratio optimality are all needed for closure.

Selected references

  • Gérard P. Cachon, Supply Chain Coordination with Contracts, in Handbooks in Operations Research and Management Science, vol. 11, North-Holland, 2003; source used here: author's third draft, January 2003, §6.7. DOI.
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Supply Chain Coordination with Contracts VI: With a Forecast Update, Buy-Back Terms with w₁ − w₂ + λc₂ = λc₁ Give the Retailer λΩ₁(q₁) and a Lower Period-2 Margin w₂ − c₂ < w₁ − c₁Textbook

Motivation

A newsvendor retailer who may order twice faces a tradeoff. Ordering late lets the retailer use a better demand forecast. Ordering early lets the supplier produce more cheaply, with longer procurement lead times and no overtime labor. Fisher and Raman (1996) document such forecast improvements between ordering epochs in fashion apparel. A decentralized supply chain must balance cheap early production against well-informed late production, and it is not obvious that a simple contract can induce both firms to strike the balance an integrated firm would choose.

This mission formalizes §6.6 of G. P. Cachon's survey chapter Supply Chain Coordination with Contracts (Handbooks in OR & MS, Vol. 11, 2003), read in the author's January 2003 draft. The section builds on Donohue (2000), who studied the same two-mode production problem under forced compliance. The chapter's model lets the supplier operate under voluntary compliance: she may deliver less than the retailer orders, and she may produce more in period 1 than was ordered. The question is whether a buy back contract with one wholesale price per ordering epoch still coordinates the supply chain.

Setting

A demand signal ξ≥0\xi \ge 0ξ≥0 with density ggg and distribution function GGG is observed once before the selling season. Given ξ\xiξ, demand DDD has distribution function F(⋅ ∣ ξ)F(\cdot\,|\,\xi)F(⋅∣ξ), continuous and strictly increasing on [0,∞)[0,\infty)[0,∞). Demand is stochastically increasing in the signal: F(x ∣ ξh)<F(x ∣ ξl)F(x\,|\,\xi_h) < F(x\,|\,\xi_l)F(x∣ξh​)<F(x∣ξl​) for ξh>ξl\xi_h > \xi_lξh​>ξl​. Expected sales are S(q ∣ ξ)=E[min⁡(q,D) ∣ ξ]S(q\,|\,\xi) = E[\min(q,D)\,|\,\xi]S(q∣ξ)=E[min(q,D)∣ξ]. Period 1 is before the signal and period 2 is after it. The retailer's total order is q1q_1q1​ after period 1 and q2≥q1q_2 \ge q_1q2​≥q1​ after period 2. The supplier's unit production cost is cic_ici​ in period iii, with c1<c2<pc_1 < c_2 < pc1​<c2​<p, where ppp is the retail price. Salvage values and goodwill costs are zero.

The supply chain's period-2 objective is

Ω2(q2 ∣ q1,ξ)=pS(q2 ∣ ξ)−c2q2+c2q1,\Omega_2(q_2\,|\,q_1,\xi) = pS(q_2\,|\,\xi) - c_2 q_2 + c_2 q_1 ,Ω2​(q2​∣q1​,ξ)=pS(q2​∣ξ)−c2​q2​+c2​q1​,

and q2(q1,ξ)q_2(q_1,\xi)q2​(q1​,ξ) maximizes it over q2≥q1q_2 \ge q_1q2​≥q1​. The supply chain's expected profit is Ω1(q1)=−c1q1+E[Ω2(q2(q1,ξ) ∣ q1,ξ)]\Omega_1(q_1) = -c_1 q_1 + E[\Omega_2(q_2(q_1,\xi)\,|\,q_1,\xi)]Ω1​(q1​)=−c1​q1​+E[Ω2​(q2​(q1​,ξ)∣q1​,ξ)].

Under the buy back contract {w1,w2,b}\{w_1, w_2, b\}{w1​,w2​,b} the retailer pays wiw_iwi​ per unit ordered in period iii, and the supplier refunds bbb per unsold unit. The retailer's period-2 profit is π2(q2 ∣ q1,ξ)=(p−b)S(q2 ∣ ξ)−(w2−b)q2+w2q1\pi_2(q_2\,|\,q_1,\xi) = (p-b)S(q_2\,|\,\xi) - (w_2-b)q_2 + w_2 q_1π2​(q2​∣q1​,ξ)=(p−b)S(q2​∣ξ)−(w2​−b)q2​+w2​q1​, and his period-1 profit is π1(q1)=−w1q1+E[π2(q2(q1,ξ) ∣ q1,ξ)]\pi_1(q_1) = -w_1 q_1 + E[\pi_2(q_2(q_1,\xi)\,|\,q_1,\xi)]π1​(q1​)=−w1​q1​+E[π2​(q2​(q1​,ξ)∣q1​,ξ)]. The supplier's period-2 profit Π2\Pi_2Π2​ and her period-1 profit Π1(x ∣ q1)\Pi_1(x\,|\,q_1)Π1​(x∣q1​), as functions of the stock xxx she holds, are given in the mission's Profits definition.

Formalization targets

Goal: the buy back contract coordinates

For λ∈[0,1]\lambda \in [0,1]λ∈[0,1] with

p−b=λp,w2−b=λc2,w1−w2+λc2=λc1,p - b = \lambda p,\qquad w_2 - b = \lambda c_2,\qquad w_1 - w_2 + \lambda c_2 = \lambda c_1,p−b=λp,w2​−b=λc2​,w1​−w2​+λc2​=λc1​,

the identities

π2(q2 ∣ q1,ξ)=λ(Ω2(q2 ∣ q1,ξ)−c2q1)+w2q1,π1(q1)=λ Ω1(q1)\pi_2(q_2\,|\,q_1,\xi) = \lambda\big(\Omega_2(q_2\,|\,q_1,\xi) - c_2 q_1\big) + w_2 q_1,\qquad \pi_1(q_1) = \lambda\,\Omega_1(q_1)π2​(q2​∣q1​,ξ)=λ(Ω2​(q2​∣q1​,ξ)−c2​q1​)+w2​q1​,π1​(q1​)=λΩ1​(q1​)

hold, so the supply chain's optima in both periods are the retailer's optima (with equivalence for λ>0\lambda > 0λ>0). In addition,

w2−c2=w1−(λc1+(1−λ)c2)<w1−c1(λ<1).w_2 - c_2 = w_1 - \big(\lambda c_1 + (1-\lambda)c_2\big) < w_1 - c_1 \quad (\lambda < 1).w2​−c2​=w1​−(λc1​+(1−λ)c2​)<w1​−c1​(λ<1).

Milestones

  1. The structure of the period-2 problem, Eqs. (25)–(26): q2(ξ)q_2(\xi)q2​(ξ) solves F(q2(ξ) ∣ ξ)=(p−c2)/pF(q_2(\xi)\,|\,\xi) = (p-c_2)/pF(q2​(ξ)∣ξ)=(p−c2​)/p and increases in ξ\xiξ, and the threshold ξ(q1)\xi(q_1)ξ(q1​) splits the signals into those that trigger a period-2 order and those that do not.
  2. The retailer's period-2 identity (p. 65).
  3. The supplier fills any period-2 order up to q2(q1,ξ)q_2(q_1,\xi)q2​(q1​,ξ), and for λ<1\lambda < 1λ<1 she does not fill a larger one (p. 65).
  4. The retailer's period-1 identity (p. 66).
  5. The first-order condition (27) for q1oq_1^oq1o​.
  6. The supplier's period-2 profit increases in her stock below q1q_1q1​, so she produces at least the period-1 order (p. 66).
  7. The supplier produces exactly the period-1 order (p. 67).
  8. The margin comparison (p. 67).

Significance

The result shows that the buy back contract, which coordinates the single-period newsvendor, extends to a setting with a forecast update and two production modes, even when the supplier is free to under-deliver or to stockpile. Profit can be divided arbitrarily through λ\lambdaλ. Coordination also forces the supplier's margin on expensive late production below her margin on cheap early production, which contradicts the intuition that the better-informed late order should command a premium. Milestone 7 rules out stranded inventory: under the coordinating terms the supplier never stocks more than the retailer ordered in period 1.

These results are established on paper in Cachon's chapter. No machine-checked version is known. The identities are algebraic. The supplier's production result needs differentiation of an expectation over the signal across the moving threshold ξ(x)\xi(x)ξ(x).

Difficulty

The retailer's identities reduce to algebra once the contract terms are substituted, and the margin comparison is one line. The substantive steps are the derivative formulas (27) and ∂Π1(x ∣ q1)/∂x=−c1+c2(1−G(ξ(x)))\partial \Pi_1(x\,|\,q_1)/\partial x = -c_1 + c_2(1 - G(\xi(x)))∂Π1​(x∣q1​)/∂x=−c1​+c2​(1−G(ξ(x))). The obvious move, differentiating inside the expectation term by term, fails because the period-2 optimum max⁡(q1,q2(ξ))\max(q_1, q_2(\xi))max(q1​,q2​(ξ)) has a kink at ξ=ξ(q1)\xi = \xi(q_1)ξ=ξ(q1​). The integrand switches between two regimes, and the switch point moves with q1q_1q1​. The supplier's period-1 profit is not differentiable at x=q1x = q_1x=q1​; only its right derivative is negative at q1oq_1^oq1o​. Turning the page's derivative statements into the global claim that x=q1ox = q_1^ox=q1o​ is her unique optimum needs a monotonicity argument on both sides of q1oq_1^oq1o​.

Formalization scope

The conditional law is a measurable family ξ↦Dξ\xi \mapsto D_\xiξ↦Dξ​ of probability measures on R\mathbb RR supported on [0,∞)[0,\infty)[0,∞), each with a finite mean, a continuous distribution function, and a distribution function strictly increasing on [0,∞)[0,\infty)[0,∞). The signal has a measurable density g≥0g \ge 0g≥0 with ∫0∞g=1\int_0^\infty g = 1∫0∞​g=1, and demand has a finite unconditional mean. These standing assumptions follow the chapter's p. 7 newsvendor model, together with the measurability needed for expectations over the signal. 0<c2<p0 < c_2 < p0<c2​<p makes the critical ratio lie in (0,1)(0,1)(0,1). Expected sales reuse the platform definition SupplyChainTheory.expSales (from SupplyChainTheory_contracts).

The optimum q2(q1,ξ)q_2(q_1,\xi)q2​(q1​,ξ) is a hypothesis-carried selection maximizing Ω2\Omega_2Ω2​ over q2≥q1q_2 \ge q_1q2​≥q1​. It is never an arbitrary function: a formalization that let q2(q1,ξ)q_2(q_1,\xi)q2​(q1​,ξ) be unconstrained would make π1=λΩ1\pi_1 = \lambda\Omega_1π1​=λΩ1​ a statement about meaningless orders. The thresholds ξ(q1)\xi(q_1)ξ(q1​) enter as solutions of (26) whose existence is assumed where the page assumes it. Optimal order quantities are taken over q1≥0q_1 \ge 0q1​≥0 and q2≥q1q_2 \ge q_1q2​≥q1​. Derivatives are stated with HasDerivAt (or HasDerivWithinAt for the right derivative at a kink).

Three corrections of the print are disclosed in the item notes:

  • the strict margin inequality fails at λ=1\lambda = 1λ=1;
  • the p. 66 identity for Π2(x,q1,q2,ξ)\Pi_2(x, q_1, q_2, \xi)Π2​(x,q1​,q2​,ξ) is off by the constant (1−λ)c2q1(1-\lambda)c_2q_1(1−λ)c2​q1​;
  • "retailer optimal equals chain optimal" needs λ>0\lambda > 0λ>0 in the converse direction.

Contributions are welcome on all milestones. A lemma that differentiates q↦E[max⁡q2≥qΩ2]q \mapsto E[\max_{q_2 \ge q} \Omega_2]q↦E[maxq2​≥q​Ω2​] with a density-driven threshold would be reusable beyond this mission.

Selected references

  • G. P. Cachon, Supply Chain Coordination with Contracts, in S. Graves and T. de Kok (eds.), Handbooks in Operations Research and Management Science, Vol. 11: Supply Chain Management, North-Holland, 2003, Ch. 6. https://doi.org/10.1016/S0927-0507(03)11006-7
  • K. L. Donohue, Efficient Supply Contracts for Fashion Goods with Forecast Updating and Two Production Modes, Management Science 46(11), 1397–1411, 2000. https://doi.org/10.1287/mnsc.46.11.1397.12088
  • M. Fisher and A. Raman, Reducing the Cost of Demand Uncertainty Through Accurate Response to Early Sales, Operations Research 44(1), 87–99, 1996. https://doi.org/10.1287/opre.44.1.87
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Supply Chain Coordination with Contracts VIII: In the Two-Location Base-Stock Model the Linear Transfers (39)–(41) Make the Optimal Base Stocks the Unique Nash EquilibriumTextbook

Motivation

In a supply chain with stock at two locations, a supplier holds inventory that replenishes a retailer, and the retailer serves customers. Each firm sets its own inventory level to minimize its own cost. The retailer bears only part of the cost of customer backorders, and the supplier bears none of the retailer's holding cost, so their incentives differ. The resulting equilibrium generally differs from the policy that minimizes total cost. Cachon and Zipkin (Management Science 45(7), 1999) studied this game and proposed linear transfer payments that align the firms' incentives. In the chapter Supply Chain Coordination with Contracts (Handbooks in OR & MS, vol. 11, 2003, doi:10.1016/S0927-0507(03)11006-7), Cachon re-derives that analysis, adds a parameter λ\lambdaλ that divides the retail-level costs between the firms, and answers two questions the original paper left open: whether the contracts allow an arbitrary division of cost, and whether the optimal policy is the unique equilibrium under the contracts. This mission formalizes the second answer, together with the analysis of the decentralized game and of the optimal policy that it rests on (§6.8 of the 2003 chapter, read in the author's January 2003 draft).

Setting

Two firms, a retailer rrr and a supplier sss, each use a base stock policy: firm iii keeps its inventory position equal to its base stock level si∈Rs_i \in \mathbb Rsi​∈R. A negative supplier base stock means planned backorders. Let DrD_rDr​ and DsD_sDs​ be the demands during the retailer's and the supplier's lead times. They are nonnegative with finite means μr\mu_rμr​, μs\mu_sμs​, and their distribution functions FrF_rFr​, FsF_sFs​ are continuous, zero at 000, strictly increasing on [0,∞)[0,\infty)[0,∞) and differentiable on (0,∞)(0,\infty)(0,∞). Holding costs are hrh_rhr​ and hsh_shs​, with 0<hs<hr0 < h_s < h_r0<hs​<hr​. Each backorder at the retailer costs the retailer βr>0\beta_r > 0βr​>0 and the supplier βs>0\beta_s > 0βs​>0 per unit time. Write β=βr+βs\beta = \beta_r + \beta_sβ=βr​+βs​.

At retailer inventory level yyy the expected on-hand stock is Ir(y)=E[(y−Dr)+]I_r(y) = E[(y-D_r)^+]Ir​(y)=E[(y−Dr​)+] and the expected backorders are Br(y)=E[(Dr−y)+]B_r(y) = E[(D_r-y)^+]Br​(y)=E[(Dr​−y)+]. The retail-level cost rates are cr(y)=hrIr(y)+βrBr(y)c_r(y) = h_rI_r(y) + \beta_rB_r(y)cr​(y)=hr​Ir​(y)+βr​Br​(y), cs(y)=βsBr(y)c_s(y) = \beta_sB_r(y)cs​(y)=βs​Br​(y) and c(y)=cr(y)+cs(y)c(y) = c_r(y) + c_s(y)c(y)=cr​(y)+cs​(y). Because the supplier may stock out, the retailer's actual inventory level is sr−(Ds−ss)+s_r - (D_s - s_s)^+sr​−(Ds​−ss​)+, and every retail-level quantity is averaged accordingly:

g(sr,ss)=E[g(sr−(Ds−ss)+)]=Fs(ss)g(sr)+∫ss∞g(sr+ss−x)fs(x) dx.g(s_r,s_s) = E\big[g(s_r - (D_s-s_s)^+)\big] = F_s(s_s)g(s_r) + \int_{s_s}^\infty g(s_r+s_s-x)f_s(x)\,dx .g(sr​,ss​)=E[g(sr​−(Ds​−ss​)+)]=Fs​(ss​)g(sr​)+∫ss​∞​g(sr​+ss​−x)fs​(x)dx.

With the supplier's inventory Is(y)=E[(y−Ds)+]I_s(y) = E[(y-D_s)^+]Is​(y)=E[(y−Ds​)+] and backorders Bs(y)=μs−y+Is(y)B_s(y) = \mu_s - y + I_s(y)Bs​(y)=μs​−y+Is​(y), the firms' costs and the chain's cost are

πr(sr,ss)=cr(sr,ss),πs(sr,ss)=hsIs(ss)+cs(sr,ss),Π=πr+πs.\pi_r(s_r,s_s) = c_r(s_r,s_s), \qquad \pi_s(s_r,s_s) = h_sI_s(s_s) + c_s(s_r,s_s), \qquad \Pi = \pi_r + \pi_s .πr​(sr​,ss​)=cr​(sr​,ss​),πs​(sr​,ss​)=hs​Is​(ss​)+cs​(sr​,ss​),Π=πr​+πs​.

A pair {sro,sso}\{s_r^o, s_s^o\}{sro​,sso​} minimizing Π\PiΠ is an optimal policy. A Nash equilibrium is a pair from which neither firm can lower its own cost by a unilateral change of its base stock.

Under a linear transfer the supplier pays the retailer tIIr(sr,ss)+tBrBr(sr,ss)+tBsBs(ss)t_II_r(s_r,s_s) + t_B^rB_r(s_r,s_s) + t_B^sB_s(s_s)tI​Ir​(sr​,ss​)+tBr​Br​(sr​,ss​)+tBs​Bs​(ss​) (a negative amount is a payment the other way). The Cachon–Zipkin contracts with parameter λ∈(0,1]\lambda \in (0,1]λ∈(0,1] are

tI=(1−λ)hr,tBr=βr−λβ,tBs=λhsFs(sso)1−Fs(sso).t_I = (1-\lambda)h_r, \qquad t_B^r = \beta_r - \lambda\beta, \qquad t_B^s = \lambda h_s\frac{F_s(s_s^o)}{1-F_s(s_s^o)} .tI​=(1−λ)hr​,tBr​=βr​−λβ,tBs​=λhs​1−Fs​(sso​)Fs​(sso​)​.

Formalization targets

Goal: the contracts coordinate, uniquely

If {sro,sso}\{s_r^o, s_s^o\}{sro​,sso​} is optimal with sso>0s_s^o > 0sso​>0 and λ∈(0,1]\lambda \in (0,1]λ∈(0,1], then under the contracts

πr=λc(sr,ss)−tBsBs(ss),πs=(hs+tBs)Is(ss)+(1−λ)c(sr,ss)+tBs(μs−ss),\pi_r = \lambda c(s_r,s_s) - t_B^sB_s(s_s), \qquad \pi_s = (h_s+t_B^s)I_s(s_s) + (1-\lambda)c(s_r,s_s) + t_B^s(\mu_s - s_s),πr​=λc(sr​,ss​)−tBs​Bs​(ss​),πs​=(hs​+tBs​)Is​(ss​)+(1−λ)c(sr​,ss​)+tBs​(μs​−ss​),

{sro,sso}\{s_r^o, s_s^o\}{sro​,sso​} is a Nash equilibrium, and it is the only one. The goal contains no numerical constants. It holds for every demand distribution in the class and every λ\lambdaλ in the range.

Milestones

  1. In the uncontracted game, every retailer best response exceeds s^r>0\hat s_r > 0s^r​>0, where Fr(s^r)=βr/(hr+βr)F_r(\hat s_r) = \beta_r/(h_r+\beta_r)Fr​(s^r​)=βr​/(hr​+βr​), and every supplier best response is positive (pp. 79–80).
  2. In the uncontracted game, for every sss_sss​ the retailer's optimal base stock is below the chain's; consequently the competition penalty (Π(s∗)−Π(so))/Π(so)(\Pi(s^*) - \Pi(s^o))/\Pi(s^o)(Π(s∗)−Π(so))/Π(so) is positive at every equilibrium s∗s^*s∗ (pp. 80–81).
  3. The partial derivatives (35)–(36) of Π\PiΠ, and every optimum with ss>0s_s > 0ss​>0 satisfies c′(sr)=hsc'(s_r) = h_sc′(sr​)=hs​, i.e. Fr(sr)=(hs+β)/(hr+β)F_r(s_r) = (h_s+\beta)/(h_r+\beta)Fr​(sr​)=(hs​+β)/(hr​+β) (37) (p. 83).
  4. Optima with ss≤0s_s \le 0ss​≤0 have sr+ss=sˉs_r + s_s = \bar ssr​+ss​=sˉ, where Pr⁡(Dr+Ds≤sˉ)=β/(hr+β)\Pr(D_r + D_s \le \bar s) = \beta/(h_r+\beta)Pr(Dr​+Ds​≤sˉ)=β/(hr​+β) (38) (p. 83).
  5. The cost identities (42)–(43) under the contracts (p. 84).
  6. Under the contracts the retailer's best response decreases in sss_sss​, and the supplier's marginal cost along it has the closed form printed on p. 84.

Significance

The goal says that a contract built from quantities both firms can measure, namely the retailer's inventory and backorders and the supplier's backorders, makes the system-optimal policy the only equilibrium. The firms therefore reach the optimum without coordinating on an equilibrium. The parameter λ\lambdaλ splits the retail-level costs between the firms in any proportion up to λ=1\lambda = 1λ=1. Milestone 2 shows the contract is needed: without transfers, decentralization is always strictly suboptimal when the supplier is charged for retail backorders. The transfers tIt_ItI​ and tBrt_B^rtBr​ are those of the single-location model (§6.7), even though the retailer's target fractile changes from β/(β+hr)\beta/(\beta+h_r)β/(β+hr​) to (β+hs)/(β+hr)(\beta+h_s)/(\beta+h_r)(β+hs​)/(β+hr​).

The results are proved in the source and in Cachon and Zipkin (1999), with informal derivative arguments. No machine-checked version is known. Formalizing them requires differentiating expectations of piecewise-linear convex functions of a random lead-time shortfall. The page's argument also assumes densities, which the formal statements avoid, and contains several printing slips (see below). These would be settled by a complete development.

Difficulty

The firms' costs are compositions: a convex single-location cost evaluated at the random level sr−(Ds−ss)+s_r - (D_s - s_s)^+sr​−(Ds​−ss​)+, which is concave in sss_sss​. The supplier's cost is therefore not obviously convex in sss_sss​; its convexity at sr=sros_r = s_r^osr​=sro​ depends on the value of tBst_B^stBs​ and on c′(sro)=hsc'(s_r^o) = h_sc′(sro​)=hs​. Uniqueness is the hard part. Under the contracts the retailer's best response sr(ss)s_r(s_s)sr​(ss​) decreases, but the supplier's marginal cost along that best response, Fs(ss)(hs−(1−λ)c′(sr(ss))+tBs)−tBsF_s(s_s)(h_s - (1-\lambda)c'(s_r(s_s)) + t_B^s) - t_B^sFs​(ss​)(hs​−(1−λ)c′(sr​(ss​))+tBs​)−tBs​, is not monotone in general when λ\lambdaλ is small, contrary to a literal reading of p. 84. A uniqueness argument has to show that it has at most one zero, not that it increases.

Formalization scope

Demand laws are probability measures on R\mathbb RR with no mass below 000, finite means, and continuous distribution functions, zero at 000, strictly increasing on [0,∞)[0,\infty)[0,∞) and differentiable on (0,∞)(0,\infty)(0,∞). These are the section's standing assumptions, together with 0<hs<hr0 < h_s < h_r0<hs​<hr​ and βr,βs>0\beta_r, \beta_s > 0βr​,βs​>0 (footnote 34 excludes the zero cases). Expectations are Lebesgue integrals: IrI_rIr​, BrB_rBr​, IsI_sIs​ and the two-location averages are defined by expectation, and the page's integral forms are consequences. Integrals against fs(x) dxf_s(x)\,dxfs​(x)dx are written against the law of DsD_sDs​, so no density hypothesis is made. Base stocks range over all of R\mathbb RR, and "optimal" means minimizing Π\PiΠ over R2\mathbb R^2R2; the existence of an optimum is a hypothesis, as on p. 77. Derivatives are stated with HasDerivAt. Independence of DrD_rDr​ and DsD_sDs​, implicit on the page, enters only through the convolution of their laws in (38).

The contracted costs are defined from the firms' original costs and the transfer payment. Defining them by the closed forms (42)–(43) would make the identities trivial and is ruled out.

Corrected slips: (42) is stated with λc(sr,ss)\lambda c(s_r,s_s)λc(sr​,ss​) where the page prints λΠ(sr,ss)\lambda\Pi(s_r,s_s)λΠ(sr​,ss​) (the difference λhsIs(ss)\lambda h_sI_s(s_s)λhs​Is​(ss​) does not depend on srs_rsr​). The retailer's single-location fractile on p. 79 is stated as βr/(hr+βr)\beta_r/(h_r+\beta_r)βr​/(hr​+βr​), not the printed β/(hr+β)\beta/(h_r+\beta)β/(hr​+β). The garbled display after (43) and the fsf_sfs​/FsF_sFs​ slip in the best-response derivative are not reproduced. Not included: the contraction condition (34), the case split for the optimal policy (p. 84), the case sso≤0s_s^o \le 0sso​≤0, and the alternative schemes of §6.8.5 (Lee–Whang, Chen). Contributions of those, or of a reusable library for derivatives of E[g(s−(D−t)+)]E[g(s - (D-t)^+)]E[g(s−(D−t)+)], are welcome. The platform's Clark–Scarf items (InventoryControl_clarkScarf, ClarkScarf.Serial.*) concern periodic-review echelon policies and are not reused.

Selected references

  • G. P. Cachon, Supply Chain Coordination with Contracts, in S. Graves and T. de Kok (eds.), Handbooks in Operations Research and Management Science, vol. 11, North-Holland, 2003, §6.8. https://doi.org/10.1016/S0927-0507(03)11006-7
  • G. P. Cachon and P. H. Zipkin, Competitive and cooperative inventory policies in a two-stage supply chain, Management Science 45(7), 936–953, 1999. https://doi.org/10.1287/mnsc.45.7.936
  • F. Chen and Y.-S. Zheng, Lower bounds for multi-echelon stochastic inventory systems, Management Science 40(11), 1426–1443, 1994. https://doi.org/10.1287/mnsc.40.11.1426
  • A. Federgruen and P. Zipkin, Computational issues in an infinite-horizon, multiechelon inventory model, Operations Research 32(4), 818–836, 1984. https://doi.org/10.1287/opre.32.4.818
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Algorithmic Game TheoryOperations ResearchOptimization·Captain: mikedeng1

Supply Chain Coordination with Contracts IX: An Internal Market at the Shadow Price w(α, Q) Allocates Output Optimally, and Paying Its Expectation per Unit Induces the Optimal Effort e°Textbook

Motivation

In most contracts of the supply chain coordination literature the transfer payments are fixed when the contract is signed: a wholesale price www, a buy-back rate bbb, a revenue share ϕ\phiϕ. Some settings need payments that respond to information arriving after signing, such as realized demand at several retailers and realized production output. Fixing the per-unit price in advance then fails twice: for some output realizations the retailers do not buy everything that was produced, and for others they want more than exists, so the supplier must ration, which invites strategic ordering and misallocation (Cachon and Lariviere, 1999).

Section 6.9 of Cachon's survey chapter Supply Chain Coordination with Contracts (Handbooks in OR & MS, vol. 11, 2003) studies an alternative after Kouvelis and Lariviere (2000): the supplier commits to hold an internal market for output after demand is observed, and pays her own production manager a fixed amount per unit of realized output. The model is a variant of Porteus and Whang (1991), who studied incentives between manufacturing and marketing managers in a firm. The section shows that this pair of mechanisms coordinates both the production decision and the allocation decision without the supplier observing either the demand shocks or the manager's effort.

This mission is part IX of a series formalizing the capstone results of that chapter.

Setting

One supplier employs a production manager and sells to two independent retailers. The constant demand elasticity is η>1\eta>1η>1.

  1. The manager chooses a production input level e≥0e\ge0e≥0. The output is Q=YeQ=YeQ=Ye, where Y∈[0,1]Y\in[0,1]Y∈[0,1] is a random variable. The manager incurs the cost c(e)c(e)c(e), strictly convex and increasing, with derivative c′c'c′.
  2. Retailer i∈{1,2}i\in\{1,2\}i∈{1,2} observes the realization αi\alpha_iαi​ of a random variable Ai>0A_i>0Ai​>0.
  3. The supplier allocates qiq_iqi​ units to retailer iii with q1+q2≤Qq_1+q_2\le Qq1​+q2​≤Q. Retailer iii earns revenue qipi(qi)q_ip_i(q_i)qi​pi​(qi​) with the inverse demand pi(qi)=αiqi−1/ηp_i(q_i)=\alpha_iq_i^{-1/\eta}pi​(qi​)=αi​qi−1/η​, that is, αiqi(η−1)/η\alpha_iq_i^{(\eta-1)/\eta}αi​qi(η−1)/η​.

If retailer one receives the share γ\gammaγ of QQQ, total retailer revenue is

π(γ,α,Q)=(α1γ(η−1)/η+α2(1−γ)(η−1)/η)Q(η−1)/η.\pi(\gamma,\alpha,Q)=\big(\alpha_1\gamma^{(\eta-1)/\eta}+\alpha_2(1-\gamma)^{(\eta-1)/\eta}\big)Q^{(\eta-1)/\eta}.π(γ,α,Q)=(α1​γ(η−1)/η+α2​(1−γ)(η−1)/η)Q(η−1)/η.

The optimal share is γo(α)=α1η/(α1η+α2η)\gamma^o(\alpha)=\alpha_1^\eta/(\alpha_1^\eta+\alpha_2^\eta)γo(α)=α1η​/(α1η​+α2η​) (Eq. (44)), and π(α,Q)=π(γo(α),α,Q)\pi(\alpha,Q)=\pi(\gamma^o(\alpha),\alpha,Q)π(α,Q)=π(γo(α),α,Q) is revenue under it. The expected supply chain profit is Π(e)=E[π(A,Ye)]−c(e)\Pi(e)=E[\pi(A,Ye)]-c(e)Π(e)=E[π(A,Ye)]−c(e), and the optimal effort eoe^oeo solves the first-order condition (45).

In the decentralized system, if the per-unit price is www, retailer iii's profit is πi(qi,w)=αiqi(η−1)/η−wqi\pi_i(q_i,w)=\alpha_iq_i^{(\eta-1)/\eta}-wq_iπi​(qi​,w)=αi​qi(η−1)/η​−wqi​. The contingent price is

w(α,Q)=(η−1η)(α1η+α2η)1/ηQ−1/η.w(\alpha,Q)=\Big(\frac{\eta-1}{\eta}\Big)(\alpha_1^\eta+\alpha_2^\eta)^{1/\eta}Q^{-1/\eta}.w(α,Q)=(ηη−1​)(α1η​+α2η​)1/ηQ−1/η.

The manager is paid a fixed amount per unit of realized output. With K=E[(A1η+A2η)1/ηY(η−1)/η]K=E\big[(A_1^\eta+A_2^\eta)^{1/\eta}Y^{(\eta-1)/\eta}\big]K=E[(A1η​+A2η​)1/ηY(η−1)/η], the payment is

(η−1η)(eo)−1/ηK/E[Y](46),\Big(\frac{\eta-1}{\eta}\Big)(e^o)^{-1/\eta}K/E[Y]\qquad(46),(ηη−1​)(eo)−1/ηK/E[Y](46),

and his expected utility is u(e)=(payment)⋅E[Ye]−c(e)u(e)=(\text{payment})\cdot E[Ye]-c(e)u(e)=(payment)⋅E[Ye]−c(e).

Formalization targets

Goal

The goal has two parts.

  1. For every realization α1,α2>0\alpha_1,\alpha_2>0α1​,α2​>0 and output Q>0Q>0Q>0, at the price w(α,Q)w(\alpha,Q)w(α,Q) retailer one's unique optimal order is γo(α)Q\gamma^o(\alpha)Qγo(α)Q and retailer two's is (1−γo(α))Q(1-\gamma^o(\alpha))Q(1−γo(α))Q. So the retailers order exactly QQQ, the allocation maximizes revenue over all feasible allocations, and
∂π(α,Q)∂Q=w(α,Q).\frac{\partial\pi(\alpha,Q)}{\partial Q}=w(\alpha,Q).∂Q∂π(α,Q)​=w(α,Q).
  1. If eo>0e^o>0eo>0 satisfies (45), then under the payment (46) the manager's unique optimal effort is eoe^oeo. The payment equals E[Qw(A,Q)∣eo]/E[Q∣eo]E[Qw(A,Q)\mid e^o]/E[Q\mid e^o]E[Qw(A,Q)∣eo]/E[Q∣eo], and the supplier's expected profit from the market is zero.

Milestones

  • (44): revenue is strictly concave in γ\gammaγ, and γo(α)\gamma^o(\alpha)γo(α) is the unique optimal share.
  • The closed form π(α,Q)=(α1η+α2η)1/ηQ(η−1)/η\pi(\alpha,Q)=(\alpha_1^\eta+\alpha_2^\eta)^{1/\eta}Q^{(\eta-1)/\eta}π(α,Q)=(α1η​+α2η​)1/ηQ(η−1)/η.
  • (45): Π(e)=Ke(η−1)/η−c(e)\Pi(e)=Ke^{(\eta-1)/\eta}-c(e)Π(e)=Ke(η−1)/η−c(e) is strictly concave, and an interior eoe^oeo is optimal if and only if ((η−1)/η)(eo)−1/ηK−c′(eo)=0((\eta-1)/\eta)(e^o)^{-1/\eta}K-c'(e^o)=0((η−1)/η)(eo)−1/ηK−c′(eo)=0.
  • The retailers' first-order condition, and the market allocation at w(α,Q)w(\alpha,Q)w(α,Q).
  • ∂π(α,Q)/∂Q=w(α,Q)\partial\pi(\alpha,Q)/\partial Q=w(\alpha,Q)∂π(α,Q)/∂Q=w(α,Q).
  • The identity (46).
  • The manager's optimal effort and the supplier's zero expected profit.

Significance

The result shows that one mechanism handles two separate information problems. The market price w(α,Q)w(\alpha,Q)w(α,Q) is the shadow price of output. Charging it makes the retailers' independent orders add up to exactly the output and split it as the integrated firm would, and the supplier never needs to observe AAA. Paying the manager the output-weighted expectation of that shadow price, a single number fixed in advance, aligns his marginal incentive with the supply chain's, and the supplier does not need to observe eee. The supplier breaks even on the market. Kouvelis and Lariviere (2000) show that in more general settings she breaks even or loses money, so any profit must come from fixed fees. The section therefore illustrates a general design principle: market-based transfer prices inside a firm, combined with linear output-based pay.

The derivations are short calculus on the page. Formalizing them pins down what the page leaves implicit: the range of efforts and allocations; the role of E[Y]>0E[Y]>0E[Y]>0 and of the integrability of the shock; the fact that each retailer's problem has a unique interior optimum only at a positive price; and how the realized output Q=0Q=0Q=0 enters the expectation E[Qw(A,Q)]E[Qw(A,Q)]E[Qw(A,Q)]. To our knowledge none of these statements has been machine-checked before.

Difficulty

The deterministic part requires real-power calculus with a non-integer exponent (η−1)/η∈(0,1)(\eta-1)/\eta\in(0,1)(η−1)/η∈(0,1). Strict concavity of γ↦γ(η−1)/η\gamma\mapsto\gamma^{(\eta-1)/\eta}γ↦γ(η−1)/η has to be used on the closed interval [0,1][0,1][0,1], where the derivative blows up at the endpoints. The retailer's optimum has to be shown to be interior even though the profit at q=0q=0q=0 is defined.

The stochastic part requires pulling the effort out of the expectation, E[π(A,Ye)]=Ke(η−1)/ηE[\pi(A,Ye)]=Ke^{(\eta-1)/\eta}E[π(A,Ye)]=Ke(η−1)/η, pointwise in the shock, including at realizations with Y=0Y=0Y=0. The natural first idea, to differentiate under the expectation sign, is unnecessary but tempting. The obstacle it hides is that w(α,Ye)w(\alpha,Ye)w(α,Ye) is undefined where Y=0Y=0Y=0, so the identity (46) only holds once Qw(A,Q)Qw(A,Q)Qw(A,Q) is read as its limit 000 at Q=0Q=0Q=0. Uniqueness of the manager's optimum depends on strict convexity of ccc alone, since his payment is linear in eee.

Formalization scope

All objects live in the namespace CachonCoord.InternalMarket. The deterministic file Revenue defines π(γ,α,Q)\pi(\gamma,\alpha,Q)π(γ,α,Q), γo(α)\gamma^o(\alpha)γo(α) (as the printed formula, not as an argmax), π(α,Q)\pi(\alpha,Q)π(α,Q), πi(qi,w)\pi_i(q_i,w)πi​(qi​,w) and w(α,Q)w(\alpha,Q)w(α,Q) with real powers (Real.rpow). The file Model bundles a probability space with measurable A1,A2>0A_1,A_2>0A1​,A2​>0 and Y∈[0,1]Y\in[0,1]Y∈[0,1], the elasticity η>1\eta>1η>1, and the cost ccc. The cost is strictly convex and increasing on [0,∞)[0,\infty)[0,∞) and has derivative c′c'c′ at every e>0e>0e>0. On top of these, Model defines Π\PiΠ, KKK, the payment (46) (by its printed left side, not as the ratio it is claimed to equal), expected output and market revenue, and the manager's utility (from the payment scheme, not by the printed formula). Derivatives are HasDerivAt statements and optima are IsMaxOn over [0,1][0,1][0,1] or [0,∞)[0,\infty)[0,∞).

The standing assumptions are those of the model paragraph on p. 92: risk neutrality and the distributional assumptions above. Added hypotheses, each disclosed in the item's Formalization Note:

  • E[Y]>0E[Y]>0E[Y]>0, because (46) divides by it.
  • Integrability of (A1η+A2η)1/ηY(η−1)/η(A_1^\eta+A_2^\eta)^{1/\eta}Y^{(\eta-1)/\eta}(A1η​+A2η​)1/ηY(η−1)/η.
  • A positive price in the retailer's first-order condition.
  • Differentiability of ccc only on (0,∞)(0,\infty)(0,∞).

The existence of an effort satisfying (45) is a hypothesis, as on the page. Clauses 1 of the goal are stated for fixed realizations, not as random variables.

A trivializing formalization would define γo(α)\gamma^o(\alpha)γo(α) as an argmax, or define the payment (46) as E[Qw]/E[Q]E[Qw]/E[Q]E[Qw]/E[Q]; neither is done here. Outside γ∈[0,1]\gamma\in[0,1]γ∈[0,1] and Q>0Q>0Q>0, Lean's real power returns junk values, and every statement restricts to that range. The companion claim that w(α,Q)w(\alpha,Q)w(α,Q) is the unique market-clearing price is not posed.

The formalization needs no infrastructure beyond Mathlib's real powers, convexity and Bochner integral. The concavity and first-order-condition lemmas for x↦axr−bxx\mapsto ax^{r}-bxx↦axr−bx with 0<r<10<r<10<r<1 may be reused for other constant-elasticity models. Contributions are welcome at any milestone; each is independent of the others except through the closed forms.

Selected references

  • G. P. Cachon, Supply Chain Coordination with Contracts, in S. Graves and T. de Kok (eds.), Handbooks in Operations Research and Management Science, Vol. 11: Supply Chain Management, North-Holland, 2003, Ch. 6, §6.9. https://doi.org/10.1016/S0927-0507(03)11006-7 (formalized from the author's 3rd draft, January 2003).
  • P. Kouvelis and M. A. Lariviere, Decentralizing cross-functional decisions: Coordination through internal markets, Management Science 46(8), 2000, 1049–1058. https://doi.org/10.1287/mnsc.46.8.1049.12025
  • E. L. Porteus and S. Whang, On manufacturing/marketing incentives, Management Science 37(9), 1991, 1166–1181. https://doi.org/10.1287/mnsc.37.9.1166
  • G. P. Cachon and M. A. Lariviere, Capacity choice and allocation: strategic behavior and supply chain performance, Management Science 45(8), 1999, 1091–1108. https://doi.org/10.1287/mnsc.45.8.1091
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Algorithmic Game TheoryOperations ResearchProbability·Captain: mikedeng1

Supply Chain Coordination with Contracts X: Under Forced Compliance, Options Contracts with Shares λ_l and min{λ_h, λ̂_h} Separate the Two Demand Types and Coordinate CapacityTextbook

Motivation

A manufacturer launching a new product often depends on a single supplier for a critical component, and the supplier must build capacity before demand is known. The manufacturer usually knows more about demand than the supplier does: her sales force, market research and order history give her a forecast the supplier cannot verify, and she has a reason to inflate it, since more capacity costs her nothing if the supplier pays for it. Whether contracts can make forecast sharing credible, and at what cost to the supply chain, is the subject of Cachon and Lariviere, "Contracting to assure supply: how to share demand forecasts in a supply chain" (Management Science 47(5), 2001, doi:10.1287/mnsc.47.5.629.10486). Section 6.10 of G. P. Cachon's survey chapter Supply Chain Coordination with Contracts (Handbooks in OR & MS, Vol. 11, 2003) presents a simplified version of that model, and this mission formalizes it from the author's January 2003 draft.

The section separates two regimes. Under forced compliance the supplier must build exactly the capacity the contract specifies; under voluntary compliance he may build less. The section's conclusion is that forced compliance allows both coordination and credible forecast sharing, while voluntary compliance allows forecast sharing only at the price of under-investment in capacity.

Setting

Demand DθD_\thetaDθ​ has one of two types θ∈{h,l}\theta \in \{h, l\}θ∈{h,l} with distribution function Fθ(x)=F(x∣θ)F_\theta(x) = F(x\mid\theta)Fθ​(x)=F(x∣θ). The page assumes Fθ(x)=0F_\theta(x) = 0Fθ​(x)=0 for x<0x < 0x<0, Fθ(x)>0F_\theta(x) > 0Fθ​(x)>0 for x≥0x \ge 0x≥0 (so demand has an atom at 000), FθF_\thetaFθ​ increasing and differentiable, and stochastic dominance Fh(x)<Fl(x)F_h(x) < F_l(x)Fh​(x)<Fl​(x) for all x≥0x \ge 0x≥0. The supplier SSS builds capacity kkk at cost ck>0c_k > 0ck​>0 per unit; after demand is observed he produces min⁡{Dθ,k}\min\{D_\theta, k\}min{Dθ​,k} at cost cp>0c_p > 0cp​>0 per unit; the manufacturer MMM earns r>cp+ckr > c_p + c_kr>cp​+ck​ per unit of demand satisfied; unused capacity is worth nothing.

Expected sales with xxx units of capacity are Sθ(x)=x−E[(x−Dθ)+]S_\theta(x) = x - E[(x - D_\theta)^+]Sθ​(x)=x−E[(x−Dθ​)+], and the supply chain's expected profit is

Ωθ(k)=(r−cp)Sθ(k)−ckk.\Omega_\theta(k) = (r - c_p)S_\theta(k) - c_k k .Ωθ​(k)=(r−cp​)Sθ​(k)−ck​k.

An optimal capacity kθok_\theta^okθo​ maximizes Ωθ\Omega_\thetaΩθ​ over k≥0k \ge 0k≥0, and Ωθo=Ωθ(kθo)\Omega_\theta^o = \Omega_\theta(k_\theta^o)Ωθo​=Ωθ​(kθo​).

In an options contract MMM buys qiq_iqi​ options at wow_owo​ each and pays wew_ewe​ for each option exercised. With k=qik = q_ik=qi​ her profit is Πθ(qi)=(r−we)Sθ(qi)−woqi\Pi_\theta(q_i) = (r - w_e)S_\theta(q_i) - w_o q_iΠθ​(qi​)=(r−we​)Sθ​(qi​)−wo​qi​ and the supplier's is (we−cp)Sθ(qi)+woqi−ckqi(w_e - c_p)S_\theta(q_i) + w_o q_i - c_k q_i(we​−cp​)Sθ​(qi​)+wo​qi​−ck​qi​. The contract with share λ\lambdaλ sets r−we=λ(r−cp)r - w_e = \lambda(r - c_p)r−we​=λ(r−cp​) and wo=λckw_o = \lambda c_kwo​=λck​. Under a wholesale price contract with price www the supplier earns πθ(k)=(w−cp)Sθ(k)−ckk\pi_\theta(k) = (w - c_p)S_\theta(k) - c_k kπθ​(k)=(w−cp​)Sθ​(k)−ck​k; the price inducing capacity kkk is wθ(k)=ck/Fˉθ(k)+cpw_\theta(k) = c_k/\bar F_\theta(k) + c_pwθ​(k)=ck​/Fˉθ​(k)+cp​ with Fˉθ=1−Fθ\bar F_\theta = 1 - F_\thetaFˉθ​=1−Fθ​, and the manufacturer then earns Πθ(k)=(r−wθ(k))Sθ(k)\Pi_\theta(k) = (r - w_\theta(k))S_\theta(k)Πθ​(k)=(r−wθ​(k))Sθ​(k).

With asymmetric information only MMM observes θ\thetaθ. Let π^\hat\piπ^ be the supplier's minimum acceptable profit, and define the shares

λl=1−π^Ωlo,λh=1−π^Ωho,λ^h=Ωlo−π^Ωl(kho),λH=min⁡{λh,λ^h}.\lambda_l = 1 - \frac{\hat\pi}{\Omega_l^o},\qquad \lambda_h = 1 - \frac{\hat\pi}{\Omega_h^o},\qquad \hat\lambda_h = \frac{\Omega_l^o - \hat\pi}{\Omega_l(k_h^o)},\qquad \lambda_H = \min\{\lambda_h, \hat\lambda_h\}.λl​=1−Ωlo​π^​,λh​=1−Ωho​π^​,λ^h​=Ωl​(kho​)Ωlo​−π^​,λH​=min{λh​,λ^h​}.

Formalization targets

Goal: forced-compliance separating contracts (§6.10.3, pp. 103–104)

The low type offers the options contract with share λl\lambda_lλl​ and initial order klok_l^oklo​, the high type the one with share λH\lambda_HλH​ and initial order khok_h^okho​. Assuming 0<π^<Ωlo0 < \hat\pi < \Omega_l^o0<π^<Ωlo​ and Ωl(kho)>0\Omega_l(k_h^o) > 0Ωl​(kho​)>0:

0<λl<λH<1,λl Ωh(klo)<λH Ωho,λH Ωl(kho)≤Ωlo−π^,0 < \lambda_l < \lambda_H < 1,\qquad \lambda_l\,\Omega_h(k_l^o) < \lambda_H\,\Omega_h^o,\qquad \lambda_H\,\Omega_l(k_h^o) \le \Omega_l^o - \hat\pi,0<λl​<λH​<1,λl​Ωh​(klo​)<λH​Ωho​,λH​Ωl​(kho​)≤Ωlo​−π^,

the supplier earns π^\hat\piπ^ from the low type and at least π^\hat\piπ^ from the high type, and each initial order kθok_\theta^okθo​ maximizes both firms' profits. The profit comparisons are stated between the contract profit functions, not between shares.

Milestones

  1. Sθ(x)=x−∫0xFθS_\theta(x) = x - \int_0^x F_\thetaSθ​(x)=x−∫0x​Fθ​ (p. 98).
  2. Ωθ\Omega_\thetaΩθ​ is concave, and k>0k > 0k>0 is optimal iff Fˉθ(k)=ck/(r−cp)\bar F_\theta(k) = c_k/(r - c_p)Fˉθ​(k)=ck​/(r−cp​) (p. 99).
  3. Ωl(k)<Ωh(k)\Omega_l(k) < \Omega_h(k)Ωl​(k)<Ωh​(k) for k>0k > 0k>0, hence Ωlo<Ωho\Omega_l^o < \Omega_h^oΩlo​<Ωho​ (implicit on p. 104).
  4. The options contract with share λ∈[0,1]\lambda \in [0,1]λ∈[0,1] gives Πθ=λΩθ\Pi_\theta = \lambda\Omega_\thetaΠθ​=λΩθ​ and the supplier (1−λ)Ωθ(1-\lambda)\Omega_\theta(1−λ)Ωθ​, so it coordinates (pp. 99–100).
  5. Under voluntary compliance, ∂π(kθo,kθo,θ)/∂k<0\partial\pi(k_\theta^o, k_\theta^o, \theta)/\partial k < 0∂π(kθo​,kθo​,θ)/∂k<0 (p. 100).
  6. A capacity k>0k > 0k>0 is optimal for the supplier under a wholesale price www iff w=wθ(k)w = w_\theta(k)w=wθ​(k) (p. 101).
  7. A stationary point k∗k^*k∗ of Πθ\Pi_\thetaΠθ​ satisfies Fˉθ(k∗)=Fˉθ(kθo)(1+fθ(k∗)Sθ(k∗)/Fˉθ(k∗)2)\bar F_\theta(k^*) = \bar F_\theta(k_\theta^o)\bigl(1 + f_\theta(k^*)S_\theta(k^*)/\bar F_\theta(k^*)^2\bigr)Fˉθ​(k∗)=Fˉθ​(kθo​)(1+fθ​(k∗)Sθ​(k∗)/Fˉθ​(k∗)2), so k∗<kθok^* < k_\theta^ok∗<kθo​ (p. 102).

Significance

The goal shows that with forced compliance a high-demand manufacturer can share her forecast credibly through the terms of a coordinating contract rather than its form: both types use the same contract family, the supply chain is coordinated in every state, and the only cost of asymmetric information is that the high type may be unable to push the supplier down to his reservation profit. The voluntary-compliance milestones show the other side: once the supplier may under-build, only the wholesale price affects his capacity, and the resulting capacity is strictly below the integrated optimum. Together they explain why compliance regimes matter in capacity contracting.

The results are established on the page with short arguments; none has a machine-checked proof. Formalizing them requires the derivative of expected sales for a distribution with an atom, the first-order characterization of a concave maximizer on a half-line, and careful bookkeeping of the incentive constraints. The demand and profit definitions are reusable for other capacity-procurement and newsvendor-type models.

Difficulty

The incentive constraints look like arithmetic on shares, but the strict inequality λl<λ^h\lambda_l < \hat\lambda_hλl​<λ^h​ needs Ωl(kho)<Ωlo\Omega_l(k_h^o) < \Omega_l^oΩl​(kho​)<Ωlo​: the low type's chain profit at the high type's capacity must be strictly below its optimum. The obvious argument via uniqueness of the maximizer is not available, because the page does not assume FθF_\thetaFθ​ strictly increasing, so Ωl\Omega_lΩl​ need not be strictly concave and may have a whole interval of maximizers. Likewise Ωlo<Ωho\Omega_l^o < \Omega_h^oΩlo​<Ωho​ needs a strict comparison of integrals of distribution functions. In the voluntary-compliance part, the derivative of wθ(k)w_\theta(k)wθ​(k) needs the density at k∗k^*k∗, and k∗<kθok^* < k_\theta^ok∗<kθo​ fails when that density is 000.

Formalization scope

Each demand law is a probability measure on R\mathbb RR and FθF_\thetaFθ​ is Mathlib's cdf. FθF_\thetaFθ​ is required to be differentiable only on (0,∞)(0,\infty)(0,∞), because the page's Fθ(0)>0F_\theta(0) > 0Fθ​(0)>0 makes it jump at 000. SθS_\thetaSθ​ is defined by the expectation x−E[(x−Dθ)+]x - E[(x - D_\theta)^+]x−E[(x−Dθ​)+], whose integrand is integrable because Dθ≥0D_\theta \ge 0Dθ​≥0 almost surely. Optimal capacities are passed as arguments characterized as maximizers over [0,∞)[0,\infty)[0,∞), never chosen; kθo>0k_\theta^o > 0kθo​>0 is footnote 46's assumption. Derivatives are HasDerivAt statements.

Hypotheses added relative to the page, all disclosed in the items: 0<π^<Ωlo0 < \hat\pi < \Omega_l^o0<π^<Ωlo​ and Ωl(kho)>0\Omega_l(k_h^o) > 0Ωl​(kho​)>0 in the goal (the page divides by Ωl(kho)\Omega_l(k_h^o)Ωl​(kho​) and needs λl∈(0,1)\lambda_l \in (0,1)λl​∈(0,1)); λ>0\lambda > 0λ>0 for the voluntary-compliance derivative (at λ=0\lambda = 0λ=0 it vanishes); Fˉθ(k∗)>0\bar F_\theta(k^*) > 0Fˉθ​(k∗)>0 and fθ(k∗)>0f_\theta(k^*) > 0fθ​(k∗)>0 for the non-coordination result. The page's assumption wθ′′>0w''_\theta > 0wθ′′​>0 is not needed and not imposed; its strict-concavity claim on p. 101 is not stated, because it would need FθF_\thetaFθ​ strictly increasing. The prior Pr⁡(θ=h)=ρ\Pr(\theta = h) = \rhoPr(θ=h)=ρ does not enter any statement. The page's "separating equilibrium" is formalized by its defining incentive and participation conditions, not by a general signalling-game solution concept; a predicate that holds by construction of λ^h\hat\lambda_hλ^h​ (for example λH≤λ^h\lambda_H \le \hat\lambda_hλH​≤λ^h​) is not an acceptable substitute for the profit inequalities. The fixed-fee condition of p. 105 is pure algebra on four numbers and is not included.

All definitions are local to the namespace CachonCoord.CapacityForecast. No platform theorem formalizes this model; the Snyder–Shen newsvendor definitions (SupplyChainTheory_contracts) and the revenue-sharing model of Cachon–Lariviere 2005 (RevShareCoord.*) concern different games and are not reused. Proofs of any milestone, and a sanity instance showing the model's hypotheses are satisfiable (for example demand with an atom pθp_\thetapθ​ at 000 and an exponential tail, ph<plp_h < p_lph​<pl​), are welcome.

Selected references

  • G. P. Cachon, Supply Chain Coordination with Contracts, in S. Graves and T. de Kok (eds.), Handbooks in Operations Research and Management Science, Vol. 11: Supply Chain Management, North-Holland, 2003, Ch. 6. doi:10.1016/S0927-0507(03)11006-7 (formalized from the author's 3rd draft, January 2003).
  • G. P. Cachon and M. A. Lariviere, Contracting to assure supply: how to share demand forecasts in a supply chain, Management Science 47(5), 629–646, 2001. doi:10.1287/mnsc.47.5.629.10486
  • R. E. Barlow and F. Proschan, Mathematical Theory of Reliability, Wiley, 1965 (increasing failure rate distributions, cited on p. 102).
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