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Practice Questions on Decision Analysis
1. (Q 34 in textbook) A group of medical professionals is consideringthe construction of a private clinic. If the medical demand is high (i.e.,there is a favorable market for the clinic), the physicians could realize anet profit of $100,000. If the market is not favorable, they could lose$40,000. Of course, they don’t have to proceed at all, in which casethere is no cost. In the absence of any market data, the best physicianscan guess is that there is a 50-50 chance that the clinic will besuccessful. •Construct a decision tree to help analyze this decision problem. •What should the physicians do?
Do not construct Favorable Market $100,000 Unfavorable Market -$40,000 Construct Clinic B Favorable MarketUnfavorable MarketA A Construct Clinic B Do not construct $0 0.5 0.5
FavorableMarket $100,000 $30,000 Unfavorable Market -$40,000ExpectedMonetary Value of Node B: 0.5 X $100,000 + 0.5 X (-$40,000) = $30,000 At Node A: there are two alternatives Construct Clinic $30,000 Do not construct $0 Thus, choose “Construct Clinic”, Expected Monetary Value of Node A becomes $30,000. Construct Clinic B Do not construct $0 0.5 0.5 $30,000 A
2) The physicians have been approached by a market research firm that offers toperform a market study at a fee of $5000. The market researchers claim thattheir experience enables them to make the following estimations: •P (a favorable market | a favorable market-study result) = 0.82 •P (an unfavorable market | a favorable market market-study result) = 0.18 •P (an unfavorable market | an unfavorable market-study result) = 0.89 •P (a favorable market | an unfavorable market-study result) = 0.11 •P (a favorable market-study result) = 0.55 •P (an unfavorable market-study result) = 0.45 a)Construct a decision tree to help analyze this decision problem. b)What should the physicians do? c)What is the maximum amount of money that physicians should be willing topay for a market-study
Do not $0 construct Favorable Market $100,000 Solution Result F 0.89 Unfavorable Market Do not construct -$5,000
A Construct Clinic B Unfavorable MarketDo not constructConduct Market StudyC Favorable Result Unfavorable Result D Do not constructConstruct Clinic F E Favorable MarketUnfavorable MarketDo not constructG Favorable MarketUnfavorable MarketConstruct Clinic
Do not $0 construct Favorable Market $100,000 Favorable Market Result F 0.89 Unfavorable Market Do not construct -$5,000
Unfavorable Market -$40,000 A Construct Clinic B Conduct Market StudyC FavorableResult Unfavorable D Do not constructConstruct Clinic E Favorable MarketUnfavorable MarketG Favorable Market-$5,000 $95,000 -$45,000 $95,000 -$45,000 0.5 0.5 0.82 0.18 0.11 0.55 0.45 Construct Clinic