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Decision Making

Kenneth Brown is the principal owner of Brown Oil, Inc. After quitting his university teaching job,, Ken has been able to increase his annual salary by a factor of over 100. At the present time, Ken is forced to consider purchasing some more equipment for Brown Oil because of competition. His alternatives are shown in the following table:

EQUIPMENT FAVORABLE MARKET ($) UNFAVORABLE MARKET ($)
Sub 100 300,000 -200,000
Oiler J 250,000 -100,000
Texan 75,000 -18,000

For example, if Ken purchases a Sub 100 and if there is a favorable market, he will realize a profit of $300,000. On the other hand, if the market is un-favorable, Ken will suffer a loss of $200,000. But Ken has always been a very optimistic decision maker.

Although Ken Brown is the principal owner of Brown Oil, his brother Bob is credited with making the company a financial success. Bob is vice president of finance. Bob attributes his success to his pessimistic attitude about business and the oil industry. Given the information, it is likely that Bob will arrive at a different decision. What decision criterion should Bob use, and what alternative will he select?

The Lubricant is an expensive oil newsletter to which many oil giants subscribe, including Ken Brown. In the last issues, the letter described how the demand for oil products would be extremely high. Apparently, the American consumer will continue to use oil products even if the price of these products doubles. Indeed, one of the articles in the Lubricant states that the chances of a favorable market for oil products was 70%, while the chance of an unfavorable market was only 30%. Ken would like to use these probabilities in determining the best decision.

A) What decision model should be used?
B) What is the optimal decision?
C) Ken believes that the $300,000 figure for the Sub 100 with a favorable market is too high. How much lower would this figure have to be for Ken to change his decision made in part (b)?

Solution Preview

Although Ken Brown is the principal owner of Brown Oil, his brother Bob is credited with making the company a financial success. Bob is vice president of finance. Bob attributes his success to his pessimistic attitude about business and the oil industry. Given the information from problem 3.-17, it is likely that Bob will arrive at a different decision. What decision criterion should Bob use, and what alternative will he select?

A pessimistic decision maker will use the Maximin decision rule to make a decision. He would consider the worst consequences of each possible course of action and will select the one that has the least worst consequence.
The worst consequence here is when the market is unfavorable.
Equipment Unfavorable Market
Sub 100 (200,000)
Oiler J (100,000)
Texan (18,000)

The maximum payoff for the Brown oil when we are ...

Solution Summary

Solution determines the optimal decision in the given scenarios.

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