Assignment - Read the following fictional scenarioand write a report that addresses the questions shown below:
The managing director of a Belgian outdoor catering company has to decide whether or not to lease new capital equipment. She knows that the demand for their services will depend on the situation in the macroeconomy in Belgium. The possible outcomes are summarised in this contingency table:
|
Demand Conditions
|
Probability
|
Leasing
|
No leasing
|
|
Profit
|
Utility
|
Profit
|
Utility
|
|
Above normal
|
0.25
|
80
|
92
|
60
|
76
|
|
Normal
|
0.50
|
50
|
40
|
34
|
60
|
|
Below normal
|
0.25
|
0
|
0
|
20
|
20
|
Profits are measured in 000s of € and Utility is measured in 000s of Utils.
1. Explain what is meant by the term 'expected profit'. What would the expected profit from each decision?
2. Explain what is meant by the term 'expected utility'. What would be the expected utility from each decision?
3. How would the decision whether to lease new equipment be influenced by the managing director's attitude towards risk?
4. What methods are available to the managing director to reduce the risk involved in this decision?
Word limit - 1800 words maximum.
Assessment criteria -
Effectiveness of the explanation of expected profit and expected utility
Thoroughness of the discussion about attitudes towards risk and methods of risk reduction.
Structure and presentation of material, including the use of the Harvard Citation and Referencing system
Reading - The following references are starting points for your reading about this task:
Frank, R.H. (2003) Microeconomics and Behavior. 5th ed., New York: McGraw-Hill - pp. 209-223
Pindyck, R.S. and Rubinfeld, D.L. (2013) Microeconomics. 8th ed., International edition, New Jersey: Pearson - Chapter 5.