Flaw of Averages is perhaps the most important reason for using simulation. This question will walk...
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Flaw of Averages is perhaps the most important reason for using simulation. This question will walk you through steps to experience flaw of averages yourself. Consider the hypothetical case of a marketing manager who has just been asked by his boss to forecast demand for a new generation microchip. "That's difficult for a new product," responds the marketing manager, "but I am confident that annual demand will be between 50,000 and 150,000 units." "Give me a number to take to the CEO and the production people," barks the boss. "I cannot tell production people to build a production line with a capacity between 50,000 and 150,000 units!" The phrase "Give me a number" is a dependable leading indicator of an encounter with the Flaw of Averages, but the marketing manager dutifully replies: "If you need a single number, I suggest you use the average 100, 000 for the capacity." Based on his several years of experience, the boss estimates that the variable production cost of this special microchip is going to be $0.10. They can sell this chip for $5.1. He puts together a proposal for the CEO including the following table: Capacity Created Average demand Projected Sold Quantity Production Cost Average Revenue Projected (Average) Profit 100,000 100, 000 100,000 $0.1 x 100,000 $10,000 $5.1 x 100,000 = $510,000 $510,000-$10,000 $500,000 Please build a Monte Carlo simulation model to test if average profit is indeed going to be $500,000. Your model is going to assume uncertain demand with integer uniform distribution between 50,000 and 150,000 units. Once you build your model and run it for at least 20,000 iterations, answer the following questions: (i) What is the average profit in your model? How is it different that the average profit suggested in the above table? (2 marks) (ii) What is the maximum possible profit observed in your model? How does that compare to the suggested average profit in the above table? (2 marks) (iii) Based on results of your model can you say that profit at average demand is equal to average profit? (2 marks) Flaw of Averages is perhaps the most important reason for using simulation. This question will walk you through steps to experience flaw of averages yourself. Consider the hypothetical case of a marketing manager who has just been asked by his boss to forecast demand for a new generation microchip. "That's difficult for a new product," responds the marketing manager, "but I am confident that annual demand will be between 50,000 and 150,000 units." "Give me a number to take to the CEO and the production people," barks the boss. "I cannot tell production people to build a production line with a capacity between 50,000 and 150,000 units!" The phrase "Give me a number" is a dependable leading indicator of an encounter with the Flaw of Averages, but the marketing manager dutifully replies: "If you need a single number, I suggest you use the average 100, 000 for the capacity." Based on his several years of experience, the boss estimates that the variable production cost of this special microchip is going to be $0.10. They can sell this chip for $5.1. He puts together a proposal for the CEO including the following table: Capacity Created Average demand Projected Sold Quantity Production Cost Average Revenue Projected (Average) Profit 100,000 100, 000 100,000 $0.1 x 100,000 $10,000 $5.1 x 100,000 = $510,000 $510,000-$10,000 $500,000 Please build a Monte Carlo simulation model to test if average profit is indeed going to be $500,000. Your model is going to assume uncertain demand with integer uniform distribution between 50,000 and 150,000 units. Once you build your model and run it for at least 20,000 iterations, answer the following questions: (i) What is the average profit in your model? How is it different that the average profit suggested in the above table? (2 marks) (ii) What is the maximum possible profit observed in your model? How does that compare to the suggested average profit in the above table? (2 marks) (iii) Based on results of your model can you say that profit at average demand is equal to average profit? (2 marks)
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Related Book For
Smith and Roberson Business Law
ISBN: 978-0538473637
15th Edition
Authors: Richard A. Mann, Barry S. Roberts
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