SIE 321 Probabilistic Models in OR Homework 3

Problem 1. Jean Clark is the manager of the Midtown Saveway Grocery Store. She now needs to
replenish her supply of strawberries. Her regular supplier can provide as many cases as
she wants. However, because these strawberries already are very ripe, she will need to sell
them tomorrow and then discard any that remain unsold. Jean estimates that she will be
able to sell 13, 14, 15, 16, or 17 cases tomorrow. She can purchase the strawberries for
$10 per case and sell them for $21 per case. Jean now needs to decide how many cases
to purchase.
Jean has checked the store’s records on daily sales of strawberries. On this basis, she
estimates that the demand probability distribution is
Demand (cases) 13 14 15 16 17
Probability 0.28 0.3 0.11 0.16 0.15

(a) Develop a decision analysis formulation of this problem by identifying the decision
alternatives, the states of nature, and the payoff matrix.
(b) How many cases of strawberries should Jean purchase if she uses the maximin payoff
criterion?
(c) How many cases should be purchased according to the maximum likelihood criterion?
(d) How many cases should be purchased according to the expected payoff decision rule?
(e) How many cases should be purchased according to the minimax regret decision rule?
(f) If Jean’s utility function is given by u(t) = t 2 , what is her optimal decision?

Problem 2. Warren Buffy is an enormously wealthy investor who has built his fortune through his
legendary investing acumen. He currently has been offered three major investments and
he would like to choose one. The first one is a conservative investment that would perform
very well in an improving economy and only suffer a small loss in a worsening economy.
The second is a speculative investment that would perform extremely well in an improving
economy but would do very badly in a worsening economy. The third is a counter-cyclical
investment that would lose some money in an improving economy but would perform well
in a worsening economy.
Warren believes that there are three possible scenarios over the lives of these potential
investments: (1) an improving economy, (2) a stable economy, and (3) a worsening econ-
omy. He is pessimistic about where the economy is headed, and so has assigned proba-
bilities of 0.6, 0.2, and 0.2, respectively, to these three scenarios. He also estimates that
his profits (in millions of dollars) under these respective scenarios are those given by the
following table:

Improving Stable Worsening

Investment Economy Economy Economy
Conservative 30 5 0
Speculative 30 15 −30
Counter-cyclical 25 10 −5
Probability 0.6 0.2 0.2

1
 Which investment should Warren make under each of the following criteria?

(a) Maximin payoff criterion.

(b) Expected payoff criterion.
(c) Minimax regret criteirion.
(d) Warren believes that his preferences may be best represented by a utility function
u(t) = c ln t = 2c ln t 2 , where c = 3.

Problem 3. Dwight Moody is the manager of a large farm with 1,000 acres of arable land. For greater
efficiency, Dwight always devotes the farm to growing one crop at a time. He now needs
to make a decision on which one of four crops to grow during the upcoming growing
season. For each of these crops, Dwight has obtained the estimates of crop yields and
net incomes per bushel under various weather conditions. After referring to historical
meteorological records, Dwight also estimated the probabilities for the weather during
the growing season:

Expected Yield, Bushels per acre

Weather Crop 1 Crop 2 Crop 3 Crop 4 Probability
Dry 50 60 60 15 0.33
Moderate 55 15 30 30 0.48
Wet 35 40 40 30 0.19

Which crop should Dwight grow according to

(a) maximin criterion

(b) expected payoff criterion
(c) minimax regret criterion
(d) what is Dwight’s EVPI in this case?