ECON 330

# ECON 330 - 1 Review for in-class portion of Test#2(on...

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Review for in-class portion of Test #2 (on objectives 11-16) Note : comparing means based on dependent samples will not be on the in-class portion of the test. 1. A developer wants to decide whether to build a small, medium-sized, or large condominium complex on newly purchased land on the outskirts of Galveston, Texas. The payoff table below shows, for each size of complex, the anticipated net profit (in \$1000s) under each of three potential levels (low, medium, and high) of demand for new condominiums in the area. [Source: adapted from Anderson et al (2000)] Level of demand for condominiums Alternatives Low Medium High Small complex 40 0 400 400 Medium complex 100 600 600 Large complex -300 300 900 Note : In answering the following questions, show the major steps you take in arriving at your answers. For each of the following approaches, identify which size complex to build consistent with that approach: (a) minimax regret (b) optimistic (c) conservative. Assume that the developer believes there is a probability of .20 that the level of demand will be low, a probability of .30 that the level of demand will be medium, and a probability of .50 that the level of demand will be high. (d) By the EV criterion, what size complex should be built and what is the EV of building that size complex? (e) What is EVPI, the expected value of perfect information? 2. In the scenario below, the company seeks the decision strategy with the highest expected net profit. scenario : A company that specializes in pattern recognition software wants to decide which of two new products to develop over the next three months, a motion detector or a smoke detector. If it chooses to develop the motion detector, it estimates that it has a probability of .7 of success (in developing the detector), in which case its net profit will be \$390,000, and a probability of .3 of failure, in which case its net profit will be -\$10,000. If it chooses to develop the smoke detector, it estimates it has a probability of .5 of success (in developing the detector) and a probability of .5 of failure; if it fails, its net profit will be -\$30,000. If the company is successful in developing the smoke detector, it will want to decide whether or not to seek safety certification from United Laboratories. If it chooses to seek certification, it estimates a .30 probability of getting a commercial grade certification for a net profit of \$895,000, a .60 probability of getting a residential certification for a net profit of \$695,000, and a .10 probability of being denied certification for a net profit of -\$35,000; it if chooses to not seek certification, its net profit will be -\$30,000. [

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