Question

A plant manager wants to know how much he should be willing to pay for perfect market research. Currently there are two states of nature facing his decision to expand or do nothing. Under favorable market conditions the manager would make $100,000 for the large plant and $5,000 for the small plant. Under unfavorable market conditions the large plant would lose $80,000 and the small plant would make $0. If the two states of nature are equally likely, how much should she pay for perfect information?

a) 0 b) 25000 c) 40000 D) 100000 E)145000

Answer 1

Answer : b) 25000

Note :

Favorable market condition ( F1) = 0.5

Favorable market condition (F2) = 0.5

Given, for the small plant favorable market condition is $5,000, while unfavorable market condition = $0

hence, F1 * $5,000 + F2 * $0

= 0.5 * 5,000 + 0.5 * 0

= $2500

Now, for the large plant,

Favorable market condition = $100,000

Unfavorable market condition = ( - $50,000)

F1 * $100,000 + F2 * (-$50,000)

0.5 * 100,000 + 0.5 * (-50,000)

50,000 + 25,000

$25,000

As for the large plant total profit that can be made is $25,000 which can be used for the research that is she can pay for the perfect information.