Question

A small building contractor has recently experienced two successive years in which work opportunities exceeded the firm’s capacity. The contractor must now make a decision on capacity for next year. Estimate profits under each of the two possible states of nature are as shown in the table below. (*Profit in $ thousands)

Next Year’s Demand

Alternative                                          Low                             High         

Do nothing                                          $50*                            $60

Expand                                                20                              80

Subcontract                                         40                              70

a. If the contractor knows nothing about the probabilities of the two states of nature, what is recommended decision using the optimistic approach? what is recommended decision using the pessimistic approach?

b. If the contractor knows nothing about the probabilities of the two states of nature, what is recommended decision using minimax regret approach?

c. If the contractor knows the probability to have low demand is 30% and high demand is 70%. Calculate the EMV of three alternatives and provide recommendation. With perfect information on what the market exactly will be, Calculate the expected value of perfect information.

Answer 1

how demand Do nothing 50,000 Expand 20,000 sub contract 40,000 High Demand 60,000 80,550 70,000 a) Maximax: (Maximum of Rows) R1: 60000 . The decinion would be R2 : 80,0T0 to "fytend" Correspording to the Prz 70,om b) Maximin : (Minimans & Rown) R1: 50000.. The decision would be R2: 20,000 "Do Nothing" (corresponding to the - R38 40,000 50000 for Expected Rogol moine > Ro? sovoo + 4 xrono e sono R2: _* 20500 + L x 80800 2 50070 R3: ZX 10ET0+ * TOT 502 53000 . There are two choice "Do nothing & "Subcontract c) tigh demand ray off Table I low demand Do Nothing 50,000 Expand I 20,00 Sub contract 40,00 Sooyo POTO food Regret Table | low demand ao Nothing Chigh demand 20000 Fixpand sub contract | 30000 10000 10 000