QUESTION 6 Miles is considering buying a new pickup truck fo

QUESTION 6

Miles is considering buying a new pickup truck for his lawn service firm. The economy in town seems to be growing, and he is wondering whether he should opt for a subcompact, compact, or full-size pickup truck. The smaller truck would have better fuel economy, but would sacrifice capacity and some durability. A friend at the Bureau of Economic Research told him that there is a 30% chance of lower gas prices in his area this year, a 20% chance of higher gas prices, and a 50% chance that gas prices will stay roughly unchanged. Based on this information, Miles has developed a decision table that indicates the profit amount he would end up with after a year for each combination of truck and gas prices.

States of Nature

Alternatives

Lower gas prices

Gas prices unchanged

Higher gas prices

Probability

.3

.5

.2

Subcompact

$16,000

$21,000

$23,000

Compact

$15,000

$20,000

$22,000

Full size

$18,000

$19,000

$6,000

Calculate the expected monetary value for subcompact?

Solution

Expected monetary value is the total of the weighted outcomes associated with a decision.

EMV = (16000 x 0.3) + (21000 x 0.5) + (23,000 x 0.2)

= 4,800 + 10,500 + 4,600

= 19,900

The expected monetary value for subcompact is 19,900