A group of Physicians must build an addition to their existing private clinic. They are considering three different sized additions; a small addition, a medium addition and a large addition. If the medical demand is high (there is a favorable market for the addition) they would realize a net profit of $100,000 with a large addition, a net profit of $40,000 with a medium addition and a net profit of $10,000 with a small addition. If the medical demand is low (there is an unfavorable market for the addition) they would realize a net loss of $40,000 with the large addition, a net loss of $10,000 with the medium addition and a net profit of $5,000 with the small addition. The Physicians were also able to assign the following utility preference values to each of the potential payoffs they could encounter. Utility of $100,000 is 1.0, U ($40,000) is 0.9, U ($10,000) is 0.6, U ($5,000) is 0.5, U ($-10,000) is 0.4, and U ($-40,000) is 0.0. The physicians also have a reliable forecast indicating a 40% probability of the high medical demand. Using expected monetary value theory, what should they do and what is the expected value of that decision? Using expected utility theory, what should they do and what is the expected utility of that decision?

Answers

Answer 1

Answer:

Therefore , the solution of the given problem of probability comes out to be the medium addition because it has the greatest expected utility (0.72).

What is probability, exactly?

The primary goal of the structures within a methodology expression known as criteria is to provide an indication of the probability that the assertion is true or that a specific event will occur. Any number between zero and one, at which 0 is frequently indicated as a possibility and 1 has frequently used to denote a level of confidence, can be used to represent chance. The chance that a specific event will occur is displayed in a probability diagram.

Here,

The following formula can be used to determine each option's anticipated financial value:

=> EMV of big addition = (0.4 * $100,000) plus (0.6 * -$40,000) for a total of $16,000.

=> EMV of the middle addition is

= (0.4 * $40,000) plus (0.6 * -$10,000) for a total of $14,000.

=> EMV of a minor addition = (0.4 * 10,000) plus (0.6 * 5,000), which equals $6,000

The large addition should be chosen by the physicians as it has the greatest expected financial value of $16,000.

dividing each outcome's usefulness value by its likelihood, then adding the results:

=> (0.4 * 1.0) + (0.6 * 0.0) = 0.4 is the EU of the big addition.

=> (0.4 * 0.9) + (0.6 * 0.6) = 0.72 is the EU of medium addition.

Smaller EU = (0.4 * 0.5) + (0.6 * 0.6) = 0.58

The doctors should choose the medium addition because it has the greatest expected utility (0.72), according to expected utility theory.

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Answers

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Answers

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Answers

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