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Hi Sir,
Please could you clarify how did we get to the answer?
Gam Co sells electronic equipment and is about to launch a new product onto the market. It needs to prepare its budget for the coming year and is trying to decide whether to launch the product at a price of $30 or $35 per unit.
The following information has been obtained from market research:
Price per unit $30
Probability Sales volume
0.4 120,000
0.5 110,000
0.1 140,000Price per unit $35
Probability Sales volume0.3 108,000
0.3 100,000
0.4 94,000Notes:
(1) Variable production costs would be $12 per unit for production volumes up to and including 100,000 units each year. However, if production exceeds 100,000 units each year, the variable production cost per unit would fall to $11 for all units produced.
(2) Advertising costs would be $900,000 per annum at a selling price of $30 and $970,000 per annum at a price of $35.
(3) Fixed production costs would be $450,000 per annum.
(c) Briefly explain the maximin decision rule and identify which price should be chosen by management if they use this rule to decide which price should be charged. (3 marks)
The answer is as per here:
Under this rule, the decision – maker selects the alternative which offers the most attractive worst outcome, i.e. the alternative which maximises the minimum profit. In the case of Gam Co, this would be the price of $35 as the lowest profit here is $742,000 as compared to a lowest profit of $740,000 at a price of $30.
I couln’t get either 740,000 or 742,000 with the expected values?
Thank you
Leo
The maximin criteria is nothing to do with expected values.
If they decide on a selling price of $30 then if they sell 120,000 the profit will be:
(120,000 x (30 – 11)) – 900,000 – 450,000 = $930,000
If they sell 110,000, then the profit will be: (110,000 x (30 – 11) – 900,000 – 450,000 = $740,000
If they sell 140,000, then the profit will be (140,000 x (30 – 11) – 900,000 – 450,000 = $1,310,000
Therefore with a selling price of $30, the worst outcome is a profit is $740,000.If you do the same calculations for a selling price of $35, then the worst outcome is a profit of $742,000.
A selling price of $35 therefore gives the highest of the worst outcomes and is the decision under the maximin rules.
I do suggest that you watch my free lectures on decision making under uncertainty where all the rules are explained with examples.
The lectures are a complete free course for Paper PM and cover everything needed to be able to pass the exam well.Thank you Sir, I understand to keep the two approaches separated.
in my calculations, I was including the probability for any of those outcomes, and then deciding according to the maximin criteria. It is clearer now, I will just ignore the probability of each outcome if the question asks any of the maximin/minimax or regret.
Thank you
Leo
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