A team of scientists is due to spend six months in Antarctica carrying out

research. One major piece of equipment they will be taking is subject to

breakdowns caused by the sudden failure of a particular component. Because a
failed component cannot be repaired, the team intend to carry a stock of spare
units of the component, but it will cost them roughly $3,000 for each spare unit
they take with them. However, if the equipment breaks down and a spare is not
available, a new unit will have to be specially flown in and the team will incur a
total cost of $4,000 for each unit that is delivered in this way. An engineer who
will be traveling with the team has estimated that the number of spares that will
be required during the six months follows the probability distribution shown
below:

No. of spares required 0 1 2 3

Probability 0.2 0.3 0.4 0.1

Determine the number of spares that the team should carry if their objective is to
minimize expected costs.

Should risk (utility) and/or other non-monetary factors be considered in this

decision?

Assigned Problem 2 – Based on Chapter 5 Powerpoint Presentation

A building contractor is submitting an estimate to a potential customer for

carrying out some construction work at the customer’s premises. The builder
reckons that if he offers to carry out the work for $150,000, there is a 0.2
probability that the customer will agree to the price, a 0.5 probability that a price
of $120,000 would eventually be agreed, and a 0.3 probability that the customer
will simply refuse the offer and give the work to another builder. If the builder
offers to carry out the work for $100,000, he reckons that there is a 0.3 probability
that the customer will accept this price, a 0.6 probability that the customer will
bargain so that a price of $80,000 will eventually be agreed, and a 0.1 probability
that the customer will refuse the offer and take the work elsewhere. (continued on
next slide)

Determine which price the builder should quote in order to maximize the
expected payment he receives from the customer.

Suppose that, after some questions, the builder is able to make the following
statements:

“I am indifferent between receiving $120,000 for certain or entering a lottery that

will give me a 0.9 probability of $150,000 and a 0.1 probability of winning $0.”
“I am indifferent between receiving $100,000 for certain or entering a lottery that
will give me a 0.85 probability of winning $150,000 and a 0.15 probability of
winning $0.”

“I am indifferent between receiving $80,000 for certain or entering a lottery that

will give ma a 0.75 probability of winning $150,000 and a 0.25 probability of
winning $0.”

Sketch the builder’s utility function and comment on what it shows.

In the light of the above statements, which price should the builder now quote to
the customer and why?

 1.No of spares Required Probability 0 -0.2 ;1 -0.3 ;2- 0.4 ;3- 0.1. The expected
number of spares is 0*0.2 + 1*0.3 + 2*0.4+ 3*0.1 =0.3+0.8+0.3 =1.4
Logically we can see that spare quantity comes between 1 and 2. If we choose 2
then we have to pay $3000 extra and we also want to minimize total cost . If
unluckly we need 2 ,then we will pay only $1000 ($4000-$3000) extra which is
less then $3000 so considering the total cost minimization factor we should
choose 1 .
Note: If in this question ,new unit occur more then $6000 ,instead of $4000
,then we will choose 2 because if we required 2 then we have to pay more
then $3000 extra ,which is greater then $3,000 for each spare unit they take
with them.