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I know that expected value is used where there is uncertainty in decision-making but expected value is the sum of all expected outcomes but the problem is what does the ‘outcomes’ mean by?
Sometimes the expected value is used to calculate the sales unit in one the NPV question in the past but sometimes it is used to get all possible profits.
I am confused where the expected value should be used and how to define it. I have seen your lecture on EV but you only calculate possible profits in profit table. Sometimes, the expected value is given in column but other times in rows so how should we calculate is based on how it is given in the question, true?
It does not mater which you have as the rows and which you have as the columns. Provided you understand what is happening then the answer will be the same.
If expected values are required then there will be probabilities given in the question and the item for which you have the probabilities is the uncertain item.
The requirement in the question will make it clear what it is you are having to decide – i.e. what the choices available are – and you calculated the expected value for each of the possible choices and choose the highest.
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I have seen ur lecture about pay-off table where the demand was already given so you are able to calculate how many units have been sold to customers and how much did the contract required.
But can you please explain to me how can we calculate the pay-off table in the question [Cement Co] IF WE SUPPOSE that the demand level is to be taken as supply level & then determine outcomes for each level of the demand.
Actually, I have made a table but I need your answer to match it with my answer so I will be able to sure whether I have done that correctly. Can you please explain the calculation to me?
The question Cement does give the possible demand levels and the probability of each level occurring.
The decision to be made is as to which level of production to choose (and the question makes it clear that they will choose production equal to one of the three possible levels of demand).
So, if (for example) they choose to produce 350,000 bags, then the various profit outcomes are as follows:
If demand is 350,000 the profit will be 350,000 x (9 – 4) = 1,750,000
If demand is 280,000 the profit will be 280,000 x (9 – 4) = 1,400,000 (the profit on the ones sold), less 70,000 x (4 + 0.50) = 315,000 (the cost of making and disposing of the ones that are not sold). So a total profit if 1,400,000 – 315,000 = 1,085,000
If the demand is 200,000 the profit will be (200,000 x (9-4)) less (150,000 x (4 + 0.5)) = 325,000
You should be able now to check the rest of the profits in the table from the printed answer 🙂
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Thanks for your answer Sir 🙂
I have already grasped that when demand level is given in the question what would be outcome at each level [thanks to your lectures] BUT I am not getting the answer when the supply level is given but not the demand level.
I asked you IF we take the given demand level as supply level in CEMENT CO then what would be the outcome on each demand level
If I could rephrase in another way like that if CEMENT Co [let’s say Supply level is given as 350,000 bags; 280,000 bags; 200,000 bags] then what would be the outcome at each level of demand?
Supply has nothing to do with it.
The question asks for the level of production. It also says they they will produce at one of the three levels of demand, so they will produce either 350,000 or 280,000 or 200,000.
Whichever of the three levels of production they choose, the demand might be any of the three levels – so what they end up selling and what they end up having to pay to dispose is different.
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If we are not given a demand level in ANY question but instead a supply level is given; Is it possible to calculate the possible outcomes at the demand level?
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Sir John, I have made the payoff table by changing the demand and supply levels as columns & rows and vice versa.
In table 1, I have used Demand in Rows AND Supply in Column.
Table 1:
[Supply]—–[Probability]———————-[Demand]
————————————[350,000]—–[280,000]—–[200,000]
350,000———0.25————–1750———–1400———-1000
280,000———0.45————–1085———–1400———-1000
200,000———0.30—————325————-640———–1000Outcome 1:
Proft (350,000 x 5) = 1750Outcome 2:
Profit (280,000 x 5) = 1400 – 315 = 1085And goes on…..
Table 2
In table 2, I have used Demand in Column AND Supply in Rows.
[Demand]—–[Probability]———————[Supply]
————————————[350,000]—–[280,000]—–[200,000]
350,000———0.25————–1750———–1400———-1000
280,000———0.45————–1085———–1400———-1000
200,000———0.30—————325————-640———–1000Outcome 1:
Profit (350,000 x 5) = 1750Outcome 2:
Profit (280,000 x 5) = 1400 – 315 = 1085And goes on…..
Can you please state whether I have used the right strategy for both scenarios?
Your table 2 is correct, but your table 1 is completely wrong for two reasons.
Firstly the supply is the decision we have to make and does not have probabilities. It is the demand that has the various probabilities.
Secondly, the rows should appear as follows if you choose to show it this way round:
Supply………………………………………………Demand
—————————–350,000—————280,000—————-200,000
350,000———————1,750——————1,085——————–325
280,000———————1,400——————-1,400——————-640
200,000———————1,000——————-1,000——————1,000Probabilities—————–0.25——————–0.45——————–0.3
The answer will of course end up being the same.
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