A firm is considering their pricing strategy. The firm wants to charge a price o

Question

A firm is considering their pricing strategy. The firm wants to charge a price of $5 or $10. The number of units sold depends on the state of the economy. If the economy is growing, the firm believes it will sell 943 units when it charges $5, and the firm believes it will sell 617 units when it charges $10. If there is a recession, the firm will sell 1,134 units at a price of $5 and they will sell 388 units if they charge $10. The firm believes the probability of a growing economy is 0.77. The firm may set the price after they know the state of the economy. What is the expected value? Round your answer to one decimal.

Explanation / Answer

This situation can be better represented by a Game Theory matrix.

Firm has two pricing Strategy. Let's name them first.

A : Charge a price of $5

B : Charge a price of $10

There are two states of the economy - Growing and Recession

Strategy A and Growing : 943units

Strategy B and Growing : 617 units

Strategy A and recession : 1134

Strategy B and recession : 388

Payoff from both the strategies shall be as follws :

Expected Revenue from A ($5) = 0.77 ( Payoff from Growing) + 0.23 (Payoff from recession)

= 0.77 * 943 * 5 + 0.23 * 1134 * 5 =$4934.5

Same way expected Revenue from B ($10) = 0.77 (Payoff from Growing) + 0.23 (Payoff from Recession)

= 0.77 (617) + 0.23(388) = $564.33

Strategy A i.e. Charging $5 price seems fine for the company.

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