The NBA finals feature the Denver Nuggets and the Miami Heat. A manufacturer has two choices:...

 

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The NBA finals feature the Denver Nuggets and the Miami Heat. A manufacturer has two choices: 1. Produce shirts and souvenirs for Denver. This is worth $10,000 if Denver wins and $900 if Denver loses. 2. Produce shirts and souvenirs for Miami. This is worth $10,000 if Miami wins and $900 if Miami loses. 3. Produce shirts and souvenirs for UC Davis: This is worth $3600 regardless of the outcome of the NBA finals. Suppose that the probability that Denver wins is 60%. (a) Calculate expected value for each of the three options. What choice would a risk-neutral manufacturer make? (b) Suppose that next door to the manufacturer, there is fortune teller who can perfectly predict who will win the NBA finals. If the fortune tells the factory owner that they can predict the winner for $2500, is it worth it to the risk-neutral factory owner to pay? What is the most that the manufacturer would be willing to pay? (c) Now suppose that the manufacturer is risk-averse with a utility function given by U(W) = VW, What is the expected utility of each option? What choice would the risk-averse manufacturer make? (d) Did your answer in part (c) change relative to your answer in part (a)? Briefly explain why or why not. (e) Finally, suppose the manufacturer could choose to split production and produce some items for Denver and some items for Miami. The items for the winning team are worth $5,000 and the items for the losing team are worth $450. Would the risk-adverse manufacturer prefer this to their choice in part (c)? Briefly explain why or why not. The NBA finals feature the Denver Nuggets and the Miami Heat. A manufacturer has two choices: 1. Produce shirts and souvenirs for Denver. This is worth $10,000 if Denver wins and $900 if Denver loses. 2. Produce shirts and souvenirs for Miami. This is worth $10,000 if Miami wins and $900 if Miami loses. 3. Produce shirts and souvenirs for UC Davis: This is worth $3600 regardless of the outcome of the NBA finals. Suppose that the probability that Denver wins is 60%. (a) Calculate expected value for each of the three options. What choice would a risk-neutral manufacturer make? (b) Suppose that next door to the manufacturer, there is fortune teller who can perfectly predict who will win the NBA finals. If the fortune tells the factory owner that they can predict the winner for $2500, is it worth it to the risk-neutral factory owner to pay? What is the most that the manufacturer would be willing to pay? (c) Now suppose that the manufacturer is risk-averse with a utility function given by U(W) = VW, What is the expected utility of each option? What choice would the risk-averse manufacturer make? (d) Did your answer in part (c) change relative to your answer in part (a)? Briefly explain why or why not. (e) Finally, suppose the manufacturer could choose to split production and produce some items for Denver and some items for Miami. The items for the winning team are worth $5,000 and the items for the losing team are worth $450. Would the risk-adverse manufacturer prefer this to their choice in part (c)? Briefly explain why or why not.

Answer rating: 100% (QA)

a To calculate the expected value for each option we multiply the value of each outcome by its corresponding probability and sum them up For producing shirts and souvenirs for Denver Expected value 06 ... View the full answer