Exercises in Quantitative Analysis

Decision Theory
1. Mickey Lawson is considering investing some money that he inherited.
The following payoff table gives the profits that would be realized
during the next year for each of three investment alternatives. Mickey
is considering:
STATES OF NATURE
DECISION
Good Economy
Poor Economy
ALTERNATIVE
Stock Market
80,000
-20,000
Bonds
30,000
20,000
CDs
23,000
23,000
Probability
0.5
0.5
(a) What decision would maximize expected profits?
(b) What is the maximum amount that should be paid for a perfect
forecast of the economy?
2. Todays Electronics specializes in manufacturing modern electronic
components. It also builds the equipment that produces the
components. Phyllis Weinberger, who is responsible for advising the
president of Todays Electronics on electronic manufacturing
equipment, has developed the following table concerning a proposed
facility:
Alternative
Large Facility
Medium-sized facility
Small Facility
No Facility

Strong Market
550,000
300,000
200,000
0

Profits ($)
Fair Market
110,000
129,000
100,000
0

Poor Market
-310,000
-100,000
-32,000
0

Determine the best alternative of the company using the following

criteria:
a. Maximax (optimistic)
b. Maximin (pessimistic)
c. Criterion of realism (Hurwicz) with = 0.6
d. Equally likely (Laplace)
e. Minimax regret after developing opportunity loss table.
3. Jerry Smith is thinking about opening a bicycle shop in his hometown.
Jerry loves to take his own bike on 50-mile trips with his friends, but he
believes that any small business should be started only if there is a

good chance of making a profit. Jerry can open a small shop, a large
shop, or no shop at all. The profits will
depend on the size of the shop and whether the market is favorable or
unfavorable for his products. Because there will be a 5-year lease on
the building that Jerry is thinking about using, he wants to make sure
that he makes the correct decision. Jerry is also thinking abouthiring
his old marketing professor to conduct a marketing research study. If
the study is conducted, the study could be favorable (i.e., predicting a
favourable market) or unfavorable (i.e., predicting an unfavourable
market). Develop a decision tree for Jerry.
4. Jerry Smith (see Problem 3) has done some analysis about the

profitability of the bicycle shop. If Jerry builds the large bicycle shop, he
will earn $60,000 if the market is favorable, but he will lose $40,000 if
the market is unfavorable. The small shop will return a $30,000 profit
in a favorable market and a $10,000 loss in an unfavorable market. At
the present time, he believes that there is a 5050 chance that the
market will be favorable. His old marketing professor will charge him
$5,000 for the marketing research. It is estimated that there is a 0.6
probability that the survey will be favorable. Furthermore, there is a 0.9
probability that the market will be favorable given a favourable
outcome from the study. However, the marketing professor has warned
Jerry that there is only a probability of 0.12 of a favorable market if the
marketing research results are not favorable. Jerry is confused. Should
Jerry use the marketing research?