Myrtle Air Express decided to offer direct servide from Cleveland to Myrtle Beac

Question

Myrtle Air Express decided to offer direct servide from Cleveland to Myrtle Beach. Management must decide between a full-price service using the company's new fleet of jet aircraft and a discount service using smaller-capacity commuter planes. It is clear that the best choice depends on the market reaction to the service Myrtle Air offers.

Management developed estimates of the contribution to profit for each type of service based on three possible levels of demand for service to Myrtle Beach: strong, medium and weak.

The following table shows the estimated quarterly profits (in thousands of dollars):

Suppose that management of Myrtle Air Express has developed the following utility function:

U(950) = 100, U(750) = 84, U(600) = 72, U(450) = 58, U(300) = 47, and U(-400) = 0.

Use the expected utility approach to determine the optimal decision.

What is the expected utility of the optimal choice? (Round to one decimal place.)

Your Answer:

Question 5 options:

Demand for Service Service Strong Medium Weak Full Price 950 600 -400 Discount 750 450 300 Probability 0.4 0.3 0.3

Explanation / Answer

Answer

Expected Utility of Wealth with probabilities p ,q , (1-p-q) of getting W1, W2 and W3 respectively

= p*U(W1) + q*U(W2) + (1-p-q)*(U(W3)

Expected Utility for Full Price service (using same concept as above formula)

= 0.4*U(950) + 0.3*U(600) + 0.3*U(-400)

Putting Values from above we get

EU = 0.4*100 + 0.3*72 + 0.3*0

= 40 + 21.6 + 0

= 61.6

Expected Utility for Discount Price service (using same concept as above)

= 0.4*U(750) + 0.3*U(450) + 0.3*U(300)

Putting Values from above we get

EU = 0.4*84 + 0.3*58 + 0.3*47

= 65.1

Expected Utility Of discounting service > Expected Utility Of Full Price

Hence Using the expected utility approach, optimal choice must be Discounting Service

and Its

Expected Utility (Discounting Price) = 65.1 ( As calculated above)

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