Doug is concerned with setting a correct production level. He can produce 1000 u

Question

Doug is concerned with setting a correct production level. He can produce 1000 units or 2000 units, and regardless of demand, will produce what he chooses, either 1000 or 2000 since he must produce this before realizing demand. Regardless of production, there is a 40% chance of high demand (2500 units) and a 25% chance of low demand (750 units) and a 35% chance of average demand (1200 units). Each unit costs $8.00 to produce and sells for $11. He can only sell the minimum of either demand or production (since he can't sell what he doesn't make and can't sell what isn't demanded).

Which production decision should he make if he wishes to have an opportunity for the highest profit level he could possibly achieve(maximax strategy)?

A.) 1000

B.) 2000

Explanation / Answer

Expected number of demand of units = 0.40x2500 + 0.25x750 + 0.35x1200

= 1607

Expected profit when 1000 units are produced = 1000x(11-3) = $3000

Expected profit when 2000 units are produced = 1607x11 - 2000x8

= $1677

Maximum profit when 1000 units are produced = $3000

Maximum profit when 2000 units are produced = 2000x3 = $6000

By maximax strategy, he should chose (B) 2000

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