An airline decided to offer direct service from Akron to Clearwater beach, Flori
ID: 453289 • Letter: A
Question
An airline decided to offer direct service from Akron to Clearwater beach, Florida. Management must decide between full-price service using a company’s new fleet of jet aircraft and a discount-service using smaller capacity commuter planes. Management developed estimates of the contribution to profit for each type of service based upon two possible levels of demand for service on Clearwater beach: high, moderate, and low.
The following table shows the estimated quarterly profits (in thousands of dollars):
Demand for service
High
Medium
Low
Full price
900
760
–430
Discount
710
650
350
The probabilities for the demand is P(High) = 0.3, P(Medium) = 0.5, and P(Low) = 0.2, respectively.
a. What is the optimal decision strategy if perfect information were available?
b. What is the expected value for the decision strategy developed in part a?
c. Using the expected value approach, what is the recommended decision without perfect information? What is its expected value?
d. What is the expected value of perfect information?
Demand for service
High
Medium
Low
Full price
900
760
–430
Discount
710
650
350
Explanation / Answer
Demand for Service High Medium Low Full Price 900 760 -430 Discount 710 650 350 Probabilities 0.3 0.5 0.2 EMV of Full Price = 0.30 * 900 + 0.50 * 760 + 0.20 * -430 = 270 + 380 - 86 = 564 EMV of Discount = 0.30 * 710 + 0.50 * 650 + 0.20 * 350 = 213 + 325 + 70 = 608 Expected Value|Perfect Information It is calculated by multiplying highest payoff with respective probability. = 0.3 * 900 + 0.5 * 760 + 0.2 * 350 = 270 + 380 + 70 = 720 Expected Value of Perfect Information Expected Value|Perfect Information - Highest EMV = 720 - 608 = 112 a. Optimal Decision Strategy Demand for Service High Medium Low Full Price 900 760 -430 Discount 710 650 350 Decision Full Price Full Price Discount b. = 0.3 * 900 + 0.5 * 760 + 0.2 * 350 = 270 + 380 + 70 = 720 c. Since discount has highest EMV EMV of Discount = 0.30 * 710 + 0.50 * 650 + 0.20 * 350 = 213 + 325 + 70 = 608 d Expected Value of Perfect Information Expected Value|Perfect Information - Highest EMV = 720 - 608 = 112
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