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MULTIPLE CHOICE
1. When consequences are measured on a scale that reflects a decision maker's attitude toward profit,
loss, and risk, payoffs are replaced by
a. utility values.
b. multicriteria measures.
c. sample information.
d. opportunity loss.
ANS: A PTS: 1 TOP: Meaning of utility
2. The purchase of insurance and lottery tickets shows that people make decisions based on
a. expected value.
b. sample information.
c. utility.
d. maximum likelihood.
ANS: C PTS: 1 TOP: Introduction
5. Values of utility
a. must be between 0 and 1.
b. must be between 0 and 10.
c. must be nonnegative.
d. must increase as the payoff improves.
ANS: D PTS: 1 TOP: Developing utilities for monetary payoffs
6. If the payoff from outcome A is twice the payoff from outcome B, then the ratio of these utilities will
be
a. 2 to 1.
b. less than 2 to 1.
c. more than 2 to 1.
d. unknown without further information.
ANS: D PTS: 1 TOP: Meaning of utility
7. The probability for which a decision maker cannot choose between a certain amount and a lottery
based on that probability is
a. the indifference probability.
b. the lottery probability.
c. the uncertain probability.
d. the utility probability.
ANS: A PTS: 1 TOP: Developing utilities for monetary payoffs
8. A decision maker has chosen .4 as the probability for which he cannot choose between a certain loss of
10,000 and the lottery p(25000) + (1 p)(5000). If the utility of 25,000 is 0 and of 5000 is 1, then
the utility of 10,000 is
a. .5
b. .6
c. .4
d. 4
ANS: B PTS: 1 TOP: Developing utilities for monetary payoffs
9. When the decision maker prefers a guaranteed payoff value that is smaller than the expected value of
the lottery, the decision maker is
a. a risk avoider.
b. a risk taker.
c. an optimist.
d. an optimizer.
ANS: A PTS: 1 TOP: Risk avoiders versus risk takers
11. For a game with an optimal pure strategy, which of the following statements is false?
a. The maximin equals the minimax.
b. The value of the game cannot be improved by either player changing strategies.
c. A saddle point exists.
d. Dominated strategies cannot exist.
ANS: D PTS: 1 TOP: Identifying a pure strategy
13. A 3 x 3 two-person zero-sum game that has no optimal pure strategy and no dominated strategies
a. can be solved using a linear programming model.
b. can be solved algebraically.
c. can be solved by identifying the minimax and maximin values.
d. cannot be solved.
ANS: A PTS: 1 TOP: Larger mixed strategy games
14. For a two-person zero-sum game, which one of the following is false?
a. The gain for one player is equal to the loss for the other player.
b. A payoff of 2 for one player has a corresponding payoff of 2 for the other player.
c. The sum of the payoffs in the payoff table is zero.
d. What one player wins, the other player loses.
ANS: C PTS: 1 TOP: Introduction to game theory
15. If the maximin and minimax values are not equal in a two-person zero-sum game,
a. a mixed strategy is optimal.
b. a pure strategy is optimal.
c. a dominated strategy is optimal.
d. one player should use a pure strategy and the other should use a mixed strategy.
ANS: A PTS: 1 TOP: Mixed strategy games
16. If it is optimal for both players in a two-person, zero-sum game to select one strategy and stay with
that strategy regardless of what the other player does, the game
a. has more than one equilibrium point.
b. will have alternating winners.
c. will have no winner.
d. has a pure strategy solution.
ANS: D PTS: 1 TOP: Identifying a pure strategy
17. For a two-person, zero-sum, mixed-strategy game, each player selects its strategy according to
a. what strategy the other player used last.
b. a fixed rotation of strategies.
c. a probability distribution.
d. the outcome of the previous game.
ANS: C PTS: 1 TOP: Mixed strategy games
18. When the utility function for a risk-neutral decision maker is graphed (with monetary value on the
horizontal axis and utility on the vertical axis), the function appears as
a. a straight line
b. a convex curve
c. a concave curve
d. an ‘S’ curve
ANS: A PTS: 1 TOP: Risk avoiders versus risk takers
19. If a game larger than 2 X 2 requires a mixed strategy, we attempt to reduce the size of the game by
a. identifying saddle points
b. looking for dominated strategies
c. inverting the payoff matrix
d. eliminating negative payoffs
ANS: B PTS: 1 TOP: A larger mixed strategy game
20. To select a strategy in a two-person, zero-sum game, Player A follows a ______ procedure and Player
B follows a ______ procedure.
a. maximax, minimin
b. maximax, minimax
c. maximax, maximax
d. maximin, minimax
ANS: D PTS: 1 TOP: Introduction to game theory
TRUE/FALSE
1. The decision alternative with the best expected monetary value will always be the most desirable
decision.
2. When monetary value is not the sole measure of the true worth of the outcome to the decision maker,
monetary value should be replaced by utility.
3. The outcome with the highest payoff will also have the highest utility.
4. Expected utility is a particularly useful tool when payoffs stay in a range considered reasonable by the
decision maker.
5. To assign utilities, consider the best and worst payoffs in the entire decision situation.
9. The risk neutral decision maker will have the same indications from the expected value and expected
utility approaches.
10. The utility function for a risk avoider typically shows a diminishing marginal return for money.
ANS: T PTS: 1 TOP: Developing utilities for monetary payoffs
11. A game has a pure strategy solution when both players' single-best strategies are the same.
12. A game has a saddle point when pure strategies are optimal for both players.
13. A game has a saddle point when the maximin payoff value equals the minimax payoff value.
14. The logic of game theory assumes that each player has different information.
15. With a mixed strategy, the optimal solution for each player is to randomly select among two or more
of the alternative strategies.
16. The expected monetary value approach and the expected utility approach to decision making usually
result in the same decision choice unless extreme payoffs are involved.
17. A risk neutral decision maker will have a linear utility function.
18. Given two decision makers, one risk neutral and the other a risk avoider, the risk avoider will always
give a lower utility value for a given outcome.
19. Generally, the analyst must make pairwise comparisons of the decision strategies in an attempt to
identify dominated strategies.
20. When the payoffs become extreme, most decision makers are satisfied with the decision that provides
the best expected monetary value.
ANS:
Answer not provided.
2. Give two examples of situations where you have decided on a course of action that did not have the
highest expected monetary value.
ANS:
Answer not provided.
3. Explain how utility could be used in a decision where performance is not measured by monetary value.
ANS:
Answer not provided.
4. Explain the relationship between expected utility, probability, payoff, and utility.
ANS:
Answer not provided.
5. Draw the utility curves for three types of decision makers, label carefully, and explain the concepts of
increasing and decreasing marginal returns for money.
ANS:
Answer not provided.
6. Game theory models extend beyond two-person, zero-sum games. Discuss two extensions (or
variations).
ANS:
Answer not provided.
PROBLEM
1. For the payoff table below, the decision maker will use P(s1) = .15, P(s2) = .5, and P(s3) = .35.
State of Nature
Decision s1 s2 s3
d1 5000 1000 10,000
d2 15,000 2000 40,000
Payoff Probability
10,000 .85
1000 .60
2000 .53
5000 .50
Let U(40,000) = 10 and U(15,000) = 0 and find the utility value for each payoff.
c. What alternative would be chosen according to expected utility?
ANS:
2. A decision maker who is considered to be a risk taker is faced with this set of probabilities and payoffs
State of Nature
Decision s1 s2 s3
d1 5 10 20
d2 25 0 50
d3 50 10 80
Probability .30 .35 .35
For the lottery p(80) + (1 p)(50), this decision maker has assessed the following indifference
probabilities
Payoff Probability
50 .60
20 .35
10 .25
5 .22
0 .20
10 .18
25 .10
Rank the decision alternatives on the basis of expected value and on the basis of expected utility.
ANS:
3. Three decision makers have assessed utilities for the problem whose payoff table appears below.
State of Nature
Decision s1 s2 s3
d1 500 100 400
d2 200 150 100
d3 100 200 300
Probability .2 .6 .2
ANS:
a.
b. Person A is a risk avoider, Person B is fairly risk neutral, and Person C is a risk avoider.
c. For person A, EU(d1) = .734 EU(d2) = .912 EU(d3) = .904
For person B, EU(d1) = .56 EU(d2) = .62 EU(d3) = .61
For person C, EU(d1) = .332 EU(d2) = .276 EU(d3) = .302
Decision 1 would be chosen by person C. Decision 2 would be chosen by persons A and
B.
ANS:
EV = .75(200) + .25(50) = 137.50
Risk premium is 137.50 50 = 87.50
5. Determine decision strategies based on expected value and on expected utility for this decision tree.
Use the utility function
ANS:
Let U(500) = 1 and U(0) = 0. Then
6. Burger Prince Restaurant is considering the purchase of a $100,000 fire insurance policy. The fire
statistics indicate that in a given year the probability of property damage in a fire is as follows:
a. If Burger Prince was risk neutral, how much would they be willing to pay for fire
insurance?
b. If Burger Prince has the utility values given below, approximately how much would they
be willing to pay for fire insurance?
ANS:
a. $1,075
b. $5,000
7. Super Cola is considering the introduction of a new 8 oz. root beer. The probability that the root beer
will be a success is believed to equal .6. The payoff table is as follows:
ANS:
a. Risk averse
b. Produce root beer as long as p 60/105 = .571
8. Chez Paul is contemplating either opening another restaurant or expanding its existing location. The
payoff table for these two decisions is:
State of Nature
Decision s1 s2 s3
New Restaurant $80,000 $20,000 $160,000
Expand $40,000 $20,000 $100,000
Paul has calculated the indifference probability for the lottery having a payoff of $160,000 with
probability p and $80,000 with probability (1p) as follows:
ANS:
a. A risk avoider
b. Amount Utility
$40,000 32
$20,000 56
$100,000 72
9. The Dollar Department Store chain has the opportunity of acquiring either 3, 5, or 10 leases from the
bankrupt Granite Variety Store chain. Dollar estimates the profit potential of the leases depends on the
state of the economy over the next five years. There are four possible states of the economy as
modeled by Dollar Department Stores and its president estimates P(s1) = .4, P(s2) = .3, P(s3) = .1, and
P(s4) = .2. The utility has also been estimated. Given the payoffs (in $1,000,000's) and utility values
below, which decision should Dollar make?
Utility Table
ANS:
Buy 3 leases.
PTS: 1 TOP: Decision making using utility
10. Consider the following two-person zero-sum game. Assume the two players have the same two
strategy options. The payoff table shows the gains for Player A.
Player B
Player A Strategy b1 Strategy b2
Strategy a1 3 9
Strategy a2 6 2
Determine the optimal strategy for each player. What is the value of the game?
ANS:
Mixed strategy:
11. Consider the following two-person zero-sum game. Assume the two players have the same three
strategy options. The payoff table below shows the gains for Player A.
Player B
Player A Strategy b1 Strategy b2 Strategy b3
Strategy a1 3 5 2
Strategy a2 2 1 2
Strategy a3 2 1 5
Is there an optimal pure strategy for this game? If so, what is it? If not, can the mixed-strategy
probabilities be found algebraically? What is the value of the game?
ANS:
There is not an optimal pure strategy.
However, there are dominated strategies.
Strategy a3 is dominated (by strategy a1) and can be eliminated.
Then strategy b1 is dominated (by strategy b2) and can be eliminated.
Now it is a 2 x 2 game.
Mixed-strategy probabilities are found algebraically: p = .3, (1 p) = .7, q = .4, (1 q) = .6
Value of game = 0.8
12. Suppose that there are only two vehicle dealerships (A and B) in a small city. Each dealership is
considering three strategies that are designed to take sales of new vehicles from the other dealership
over a period of four months. The strategies, assumed to be the same for both dealerships, are:
Dealership B
Cash Rebate Free Options 0% Loan
Dealership A b1 b2 b3
Cash Rebate a1 2 2 1
Free Options a2 3 3 1
0% Loan
3 2 0
a3
Identify the pure strategy for this two-person zero-sum game. What is the value of the game?
ANS:
An optimal pure strategy exists for this game:
13. Consider the following two-person zero-sum game. Assume the two players have the same two
strategy options. The payoff table shows the gains for Player A.
Player B
Player A Strategy b1 Strategy b2
Strategy a1 4 8
Strategy a2 11 5
Determine the optimal strategy for each player. What is the value of the game?
ANS:
The optimal mixed strategy solution for this game:
Player A should select Strategy a1 with a .6 probability and Strategy a2 with a .4 probability.
Player B should select Strategy b1 with a .3 probability and Strategy b2 with a .7 probability.
14. Consider the following two-person zero-sum game. Assume the two players have the same three
strategy options. The payoff table shows the gains for Player A.
Player B
Player A Strategy b1 Strategy b2 Strategy b3
Strategy a1 6 5 2
Strategy a2 1 0 3
Strategy a3 3 4 3
Is there an optimal pure strategy for this game? If so, what is it? If not, can the mixed-strategy
probabilities be found algebraically?
ANS:
There is not an optimal pure strategy. The optimal mixed-strategy probabilities can be found
algebraically.
Player A should select Strategy a1 with a .2 probability and Strategy a2 with a .8 probability.
Player B should select Strategy b1 with a .5 probability and Strategy b3 with a .5 probability.
15. Consider the following two-person zero-sum game. Assume the two players have the same three
strategy options. The payoff table below shows the gains for Player A.
Player B
Player A Strategy b1 Strategy b2 Strategy b3
Strategy a1 3 2 4
Strategy a2 1 0 2
Strategy a3 4 5 3
Is there an optimal pure strategy for this game? If so, what is it? If not, can the mixed-strategy
probabilities be found algebraically? What is the value of the game?
ANS:
There is not an optimal pure strategy. Strategy a1 is dominated by Strategy a3, and then Strategy b1 is
dominated by Strategy b2. The optimal mixed-strategy probabilities can be found algebraically.
Player A should select Strategy a2 with a .8 probability and Strategy a3 with a .2 probability.
Player B should select Strategy b2 with a .5 probability and Strategy b3 with a .5 probability.
16. Two banks (Franklin and Lincoln) compete for customers in the growing city of Logantown. Both
banks are considering opening a branch office in one of three new neighborhoods: Hillsboro, Fremont,
or Oakdale. The strategies, assumed to be the same for both banks, are:
Lincoln Bank
Hillsboro Fremont Oakdale
Franklin Bank b1 b2 b3
Hillsboro a1 4 2 3
Fremont a2 6 2 3
Oakdale a3 1 0 5
Identify the neighborhood in which each bank should locate a new branch office. What is the value of
the game?
ANS:
Franklin should select Hillsboro; Lincoln should select Fremont. Value of game = 2,000 customers
17. Consider the following problem with four states of nature, three decision alternatives, and the
following payoff table (in $'s):
s1 s2 s3 s4
d1 200 2600 -1400 200
d2 0 200 - 200 200
d3 -200 400 0 200
ANS:
a. Person 1 -- risk taker; Person 2 -- risk neutral; Person 3 -- risk avoider
b. Risk avoider would pay $400; Risk taker would pay $200
c. Person 1 -- d1; Person 2 -- d1; Person 3 -- d1
18. Metropolitan Cablevision has the choice of using one of three DVR systems. Profits are believed to
be a function of customer acceptance. The payoff to Metropolitan for the three systems is:
System
Acceptance Level I II III
High $150,000 $200,000 $200,000
Medium $ 80,000 $ 20,000 $ 80,000
Low $ 20,000 -$ 50,000 -$100,000
System
Acceptance Level I II III
High .4 .3 .3
Medium .3 .4 .5
Low .3 .3 .2
The first vice president believes that the indifference probabilities for Metropolitan should be:
Amount Probability
$150,000 .90
$ 80,000 .70
$ 20,000 .50
-$ 50,000 .25
The second vice president believes Metropolitan should assign the following utility values:
Amount Utility
$200,000 125
$150,000 95
$ 80,000 55
$ 20,000 30
-$ 50,000 10
-$100,000 0
ANS:
a. Risk Taker -- Second Vice President
Risk Avoider -- First Vice President
b. First Vice President -- System I
Second Vice President -- System III
c. Risk Neutral Vice President -- System I
19. Consider a two-person, zero-sum game where the payoffs listed below are the winnings for Player A.
Identify the pure strategy solution. What is the value of the game?
Player B Strategies
Player A Strategies b1 b2 b3
a1 5 5 4
a2 1 6 2
a3 7 2 3
ANS:
Optimal pure strategies: Player A uses strategy a1; Player B uses strategy b3.
Value of game: Gain of 4 for Player A; loss of 4 for Player B.
20. Consider a two-person, zero-sum game where the payoffs listed below are the winnings for Company
X. Identify the pure strategy solution. What is the value of the game?
Company Y Strategies
Company X Strategies y1 y2 y3
x1 3 5 9
x2 8 4 3
x3 7 6 7
ANS:
Optimal pure strategies: Company X uses strategy x3; Company Y uses strategy y2.
Value of game: Gain of 6 for Company X; loss of 6 for Company Y.
21. Consider the following two-person, zero-sum game. Payoffs are the winnings for Company X.
Formulate the linear program that determines the optimal mixed strategy for Company X.
Company Y Strategies
Company X Strategies y1 y2 y3
x1 4 3 9
x2 2 5 1
x3 6 1 7
ANS:
Max GAINA
22. Shown below is the solution to the linear program for finding Player A's optimal mixed strategy in a
two-person, zero-sum game.
ANS:
a. Player A's optimal mixed strategy: Use strategy A1 with .05 probability
Use strategy A2 with .60 probability
Use strategy A3 with .35 probability
b. Player B's optimal mixed strategy: Use strategy B1 with .50 probability
Use strategy B2 with .50 probability
Do not use strategy B3