Steves Mountain Bicycle Shop is considering three options fo

Steves Mountain Bicycle Shop is considering three options for its facility next year. Steve can expand his current shop, move to a larger facility, or make no change. With a good market, the annual payoff would be $76,000 if he expands, $90,000 if he moves, and $40,000 if he does nothing. With an average market, his payoffs will be $30,000, $41,000, and $15,000, respectively. With a poor market, his payoff will be -$17,000, -$28,000, and -$2,000.

a What is the best option based on optimistic criterion?

b What is the best option based on conservative criterion?

cWhat is the best option using minimax regret criterion?

d Suppose the probability of a good market is 0.4 and the probability of an average market is 0.35. What is the best option under the expected value criterion?

Solution

(a)

In optimistic criterion results in the maximum payoff of the maximum market. Here Expands is the best option based on optimistic criterion.

(b) In conservative criterion results in the minimum payoff of the maximum market. Here nothings is the best obtion based on conservative criterion.

(c)

The minimax regret criterion is that minimizes the maximum regret associated with each alternative.

Here Expands is the best option based on minimax regret criterion.

d

For expands

76000*0.4+30000*0.35-17000*0.25=36650

For moves

90000*0.4+41000*0.35-28000*0.25=43350

For nothing

40000*0.4+15000*0.35-2000*0.25=20750

So, nothing is the best option under the expected value criterion.