The following payoff matrix shows the profit outcomes for three projects, A, B,
ID: 1251766 • Letter: T
Question
The following payoff matrix shows the profit outcomes for three projects, A, B, and C, for each of two possible product prices. There is a 60% probability the price will be $10 and a 40% probability the price will be $20.
Profit
Project P = $10 P = $20
A 20 80
B 40 60
C -26 140
a. Using the maximum expected value rule a decision maker would choose project B. Explain.
b. Using the mean variance rule a decision maker would also choose project B. Explain Why.
Use the figure below, which shows the linear demand and constant cost conditions facing a firm with a high barrier to entry, to answer the next three questions.
100
80
Price 60
& Cost
Quantity
(PLEASE NOTE: A vertical line runs from 100-200,000 (D) and A horizontal line runs across, between 60 & 40 to 200,000 (LAC=LMC).)
a. The firm will earn economic profit of $1,250,000. Explain.
b. If the entry barrier is removed consumers will be better off because consumers will enjoy greater consumer surplus. Explain.
c. $625,000, the dead weight loss, is caused by the market power created by the high entry barrier. Explain.
Explanation / Answer
a. Using the maximum expected value rule a decision maker would choose project B. Explain. First, we are going to need to calculate the expected values of A, B, and C. The expected value is just the weighted sum of the payoffs. E[A] = 0.6*20 + 0.4*80 = 44 E[B] = 0.6*40 + 0.4*60 = 48 E[C] = 0.6*(-26) + 0.4*140 = 40.4 Here, we see that project B has the highest expected value. So, we choose it under the maximum expected value rule. b. Using the mean variance rule a decision maker would also choose project B. Explain Why. The mean variance rule means we choose the project that has the highest mean divided by variance. The mean will be the same as the expected value, but we need to calculate the variances for each project. V = 0.4*(L-M)^2 + 0.6*(H-M)^2, where L is the low value, H is the high value, and M is the mean value. V[A] = 0.4*(20-44)^2 + 0.6*(80-44)^2 = 1008 V[B] = 0.4*(40-48)^2 + 0.6*(60-48)^2 = 112 V[C] = 0.4*(-26-40.4)^2 + 0.6*(140-40.4)^2 = 7715.68 Here, project B has the smallest variance. Since it has the largest mean, we already know that it will be the preferred project. But, if you like, you can divide each of the calculated expected values by each of the calculated variances. You will find that project B's mean/variance is higher than the others. I hope this has been HELPFUL The figure for the second question is unclear and I am unable to answer it confidently. If you post the question again with the figure as a picture, I can help more.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.