A manager is deciding whether or not to build a small facility. Demand is uncert

Question

A manager is deciding whether or not to build a small facility. Demand is uncertain and can be either at a high or low level. If the manager chooses a small facility and demand is low, the payoff is $100. If the manager chooses a small facility and demand is high, the payoff is $300. On the other hand, if the manager chooses a large facility and demand is low, the payoff is -$200, but if demand is high, the payoff is $800.

(a) What would be the best decision based on the Laplace criterion?

(b) What would be the best decision based on Hurwicz's criterion of realism using  = 0.6?

Explanation / Answer

Average Payoff for small facility=(100+300)/2=$200

Avg payoff for Large facility=(-200+800)/2=$300

Maxm Payoff=$300

Laplace criterion is $300

So, the manager should choose a large facility

b.) alpha=0.6

payoff small=0.6*300+0.4*100=$220

Payoff Large facility=0.6*800+0.4*-200=$400

Hurwicz's criterion= max(220,400)=400

So, the manager should choose a large facility

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