Production planning problem with pricing under random yield: CVaR criterion

In this paper, we address a basic production planning problem with price dependent demand and stochastic yield of production. We use price and target quantity as decision variables to lower the risk of low yield. The value of risk control becomes more important especially for products with short life cycle. This is because, the profit implications of low yield might be unbearable in the short run. We apply Conditional Value at Risk (CVaR) to model the risk. CVaR measure is a coherent risk measure and thereby having nice conceptual and mathematical underpinnings. It is also widely used in practice. We consider the problem under general demand function and general distribution function of yield and find sufficient conditions under which the problem has a unique local maximum. We also both analytically and numerically analyze the impact of parameter change on the optimal solution. Among our results, we analytically show that with increasing risk aversion, the optimal price increases. This relation is opposite to that of in Newsvendor problem where the uncertainty lies in demand side.

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