Question

A firm is considering producing a new product.Prior to producing,the firm can conduct a marketing campaign (e.g., advertise heavily) or not. Suppose that a marketing campaign costs $1 million. Suppose that if the product is marketed and produced, it will generate revenues of $8 million while costing $2 million to produce; so profit will be $5 million (= $(8 − 2 − 1) million) .
If the product is marketed, but not produced, it will generate no revenue and no production cost; so profit will be -$1 million (i.e., just the cost of the marketing campaign). If the product is not marketed, but produced, it will generate a revenue of $4 million but cost $1 million to produce; so profit will be $3 million. Finally, if the product is neither marketed, nor produced, then profit will be $0. Determine the optimal strategy for this firm using the following methods:
1- Minimax – Maximin criterion
2- Max likelihood criterion
3- Bayers’ Decision Rule

Answer 1

Decision tree is as follows:

Total profit for strategy of market and produce is $ 5, which is the highest of all.

Therefore, optimal strategy is to market and produce

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Information about chance events (states of nature, i.e. quantum of demand) and probabilities is missing. So, Minimax, Maximin, Max likelihood and Bayes' rules are not applicable