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November 29th, 2001

Handout #25, page 1 of 25

**SAMPLE FINAL: EES&OR 252 Final Examination (1997-1998)
**

Please do not begin the exam until you are instructed to do so. Name (printed clearly): _______________________________________________ 1. Count the number of pages in this exam. There should be 34 pages including this one. The exam has 15 problems. 2. This exam is closed-book and closed-notes. You may use a calculator, a foreign language dictionary, and one 8.5" x 11" sheet of paper with notes on one side if you wish. Please sit in alternate seats if possible. 3. The exam has 15 problems worth a total of 200 points. The value of each problem is stated at the beginning of the problem. 4. Write your answers in this exam and turn in the entire exam at the end of testing period. If you make a false start please remember to erase or scratch out your work. 5. Please write clearly and show your work. You will not receive credit for illegible work or if you do not show your work. Partial credit will be given where appropriate. For problems with numerical answers, please draw a box around the final answer; this will facilitate our work. 6. The exam lasts three hours. After time is called, you will have five minutes to turn in your exam. We will not accept any exams that are turned in after this deadline. 7. In the spirit of the Honor Code, the TA's will not remain in the classroom during the exam. If you have any questions, come see us outside. Clarifications will be announced to the entire class. 8. Unless stated otherwise the characters in the exam prefer more money to less and follow the Five Rules of Actional Thought. 9. Do not make any additional assumptions. 10. Good luck and make good decisions. In recognition and in the spirit of the Honor Code, I certify that I will neither receive nor give unpermitted aid on this exam and that I will report, to the best of my ability, all Honor Code violations observed. Name (signed): _______________________________________________ For grading use only. 1 /30 11 /10 12 /16 2 /4 3 /10 13 /15 14 /16 4 /4 5 /10 15 /20 6 /10 7 /18 8 /15 9 /7 10 /15

MS&E 252

November 29th, 2001

Handout #25, page 2 of 25

1. Part I

Definitions and Distinctions (30 points) (10 points)

Consider the following terms. Briefly define the terms that are appropriate distinctions for use in Decision Analysis. If the term is not an appropriate distinction for Decision Analysis, explain why and list an appropriate distinction that we use instead.

**a) (2 points) prospect b) (2 points) Clairvoyant c) (2 points) dependence d) (2 points) u-value e) (2 points) risk attitude
**

Part II (10 points) Please provide short answers to the following questions.

a) (2 points) What is the definition of a decision? b) (2 points) What constitutes the decision basis? c) (2 points) What is the clarity test and why is it important? d) (2 points) What is a distinction and why is it important in decision analysis? e) (2 points) What do we mean when we say that a distinction is material?

Part III (10 points) Short answer questions – please be concise, we are looking for the main idea, not the details.

a) (2 points) Define sunk cost. Give a brief example. b) (2 points) Define certain equivalent. c) (2 point) Briefly explain the concept of e-value. How would you calculate an e-value or a deal? d) (2 points) Explain the relationship, if any, between preference probabilities and u-values. e) (2 points) What is deterministic sensitivity analysis (tornado diagrams, or sensitivity to range)

and why do we use it?

MS&E 252

November 29th, 2001

Handout #25, page 3 of 25

2.

The Five Rules (4 points) probabilities. Do you agree with him? Explain why or why not. (3 points)

a) (2 points) Scott says that the Five Rules allow us to multiply prospect dollar values times b) (2 points) Oz has just spent five hours assessing Randy's u-curve. Unfortunately, Randy

knocked over his drink and all the u-values washed away. Oz is left with the following u-curve:

u

wealth

-100 -50 0 50 100

Randy needs to determine his PISP for an uncertain deal within the next few minutes. What would you recommend Oz do? (3 points) 3. u-curves (10 points)

Angus satisfies the delta-property and has an initial wealth of $500. Angus states that he is indifferent between a sure $500 and the following deal: (Assume he has no other deals relevant to any of the deals in this problem)

$1500 0.8 0.2

a) (2 points) Provide the simplest form of Angus' u-curve. b) (2 points) What is Angus' risk tolerance? c) (2 points) What probability, p, would make Angus indifferent between a sure $0 and a deal where

he could win $100 with probability p or lose $100 with probability 1-p?

-$500

**d) (2 points) What is Angus' certain equivalent for the following deal:
**

$500 0.8 0.2

MS&E 252

November 29th, 2001

Handout #25, page 4 of 25

e) (2 points) Malcolm is a risk preferring delta-person. Will his risk odds (in any unit) be greater or less than Angus'? 4. Probability (4 points)

An unrelated man and woman each have two children. The man says, "My oldest child is a boy." The woman says, "At least one of my children is a boy." Assume: {having a boy | &} = {having a girl | &} = 0.5 The sex of the first child is not relevant to the sex of the second child. a) (2 points) What is the chance that the man has two boys?

**b) (2 points) What is the chance that the woman has two boys?
**

5. Probability Assessments (10 points)

You need probability assessments from two experts: Jim from The Weather Channel and Mary from CNN weather news. You want to assess their beliefs about the chances of rain during the upcoming weekend. After some deliberation with each of them, you obtained their individual assessments in terms of the following four events (assume that the distinction "Rain on a given day" has passed the clarity test): • • • • A: B: C: D: Rain on Saturday, given & Rain on Sunday, given & Rain on Saturday, or Sunday, or both days, given & Rain on Saturday and Sunday, given &

**a) (5 points) Is it possible for the probability assessments of Jim and Mary to differ from each
**

other? Why or why not? The following are the probabilities that each of the experts assigned to the four events happening, given their background state of information: Jim: Mary: A: 60 percent A: 50 percent B: 60 percent B: 60 percent C: 80 percent C: 75 percent D: 24 percent D: 35 percent b) (5 points) As a decision analyst, would you feel comfortable using Jim’s, Mary’s, both, or neither probability assessment? Why? 6. Understanding Clairvoyance (10 points) Support your answer. (Use a picture if necessary)

a) (5 points) For a non-delta person, explain how you would calculate the value of clairvoyance. b) (5 points) The value of clairvoyance for a delta person can be calculated as the difference

between the value of the deal with free clairvoyance and the value of the deal with no clairvoyance. Clearly explain what is it about the delta property that allows us to do this?

MS&E 252

November 29th, 2001

Handout #25, page 5 of 25

7.

The Interesting Clairvoyant (18 points)

Dominique, a risk-neutral decision-maker, is sailing solo across the Pacific; she stops at an island where she faces the following decision:

A 0.5

$100

I

0.5 A’ $0

A 0.5

$20

II

0.5 A’ $80

The island is inhabited by a clairvoyant. Unfortunately, the clairvoyant, when dealing with a specific person, either always lies or always tells the truth. If Dominique assigns probability p to the clairvoyant always telling her the truth, for what range of values of p is she willing to pay $20 for the clairvoyant’s information on A? 8. Troublemakers (15 points)

Ted has become suspicious that his teammate Brian is a troublemaker. Ted separates all people into two types: troublemakers and non-troublemakers. Troublemakers come late to meetings more often that non-troublemakers. Assume Ted has defined this distinction so that it passed the clarity test. Over the past three meetings, Brian has been late to the first and third meeting, and on-time for the second. Ted makes the following statement: "If you know a person is (or is not) a troublemaker, then his lateness to one meeting tells you nothing about lateness to other meetings."

**a) (5 points) Draw a relevance diagram representing Ted’s state of information. Draw the diagram
**

with as few arrows as possible. Ted assesses the following probabilities. • If a person is a troublemaker, he or she will be late 80% of the time. • If a person is a non-troublemaker, he or she will be late 20% of the time. The world is full of troublemakers; Ted assigned a prior probability of 60% Brian was a troublemaker.

MS&E 252

November 29th, 2001

**b) (10 points) In the light of Brian's attendance record, what probability should Ted assign to
**

Brian's being a troublemaker? 9. Relevance Diagram (7 points)

Handout #25, page 6 of 25

Examine the following relevance diagram.

C

D

E

A

B

Check all statements implied by the diagram, given you can make any necessary, but ‘legal’ operations. (‘Legal’operations, i.e. an operation or a sequence of operations allowed within the rules of relevance diagrams) A and B are not relevant given D and & A and B are relevant given & A and B are not relevant given & D and B are relevant given A and & D and B are not relevant given A and & D and E are not relevant given & D and E are relevant given B and &

MS&E 252

November 29th, 2001

Handout #25, page 7 of 25

10.

Decision Diagram (15 points)

Examine the following decision diagram.

a b c d e f First Purchase g First Report Second Purchase i Second Report k Value

h

j

Location

l Alpha Indication

o m

q n Beta Indication r Weather

p

s

Part I (8 points) Give the name of each arrow in the above diagram. Your choices are information (which includes non-forgetting), functional, direct value, and relevance arrows. a. k. b. l. c. m. d. n. e. o. f. p. g. q. h. r. i. s. j. Part II (3 points) Explain briefly what arrows a, h, and o mean. Part III (4 points) What if I add a new uncertainty node to the diagram? Call it node A. I tell you the following: • The decision maker will have clairvoyance on A before the first decision is made. • The value function also includes A. • A is not relevant to the two indications given & • A is not relevant to the weather given the indications and &. If I put node A into the diagram, what arrow or arrows do I need to add? (Add the fewest number of arrows necessary.)

MS&E 252

November 29th, 2001

Handout #25, page 8 of 25

11.

Research and Development Decision (10 points)

R&D Effort

Value

Technical Success

Market Success

a) (4 points) In many R&D decision situations, you will be able to observe the technical success of

a new product before you decide on the level of marketing effort. Market success is relevant to the level of technical success and is influenced by the marketing effort decision. Redraw the decision diagram with a “Marketing Effort” decision node added.

b) (2 points) Explain in words what the arrow from the “R&D Effort” decision node to the

**“Technical Success” uncertainty node means.
**

c)

(4 points) Draw a decision tree representing the R&D decision problem (with the marketing effort decision). Assume that each uncertain distinction has two degrees: High and Low. For each of the decisions, you have two alternatives: Large Effort and Small Effort. Let's Make a Deal (16 points)

12.

Tommy D. is a contestant on the game show "Let’s Make a Deal" and does not follow the delta property. Assume he faces no other uncertain deals. On stage there are three boxes (A,B, and C): one contains $100; the other two are empty. The rules of the game are as follows: Tommy D. first chooses one of the three boxes. Then Monty Hall, the game show host who knows where the prize is, shows that one of the two boxes that Tommy D. did not choose is indeed empty. (If Tommy D. happened to select the box with the prize, Monty is equally likely to open either of the other two.) Monty then gives Tommy D. the opportunity to switch his choice to the remaining unopened box, or stick with the box he originally chose. After this decision, Tommy D. gets what is inside the box he has: either the prize or nothing.

**a) (3 points) Draw the decision diagram, representing Tommy D.’s decision opportunity, in
**

assessed form.

**b) (2 points) Draw the decision diagram, representing Tommy D.’s decision opportunity, in
**

inferential form. Please do not put this diagram in canonical form, i.e., leave the influence arrows in.

Suppose Tommy D. believes that the three boxes are equally likely to contain the prize. Tommy D. states that his PISPs for deals One, Two, and Three are $25, $30, and $50 respectively.

MS&E 252 One $100 1/3 2/3 $0

November 29th, 2001 Two $100 1/2 1/2 $0 2/3 1/3

Handout #25, page 9 of 25 Three $100

$0

c) (5 points) After making an initial selection and being shown an empty box, should Tommy D. switch to the unopened box or stick with his original selection? What is Tommy's chance of winning?

d) (2 points) What box should Tommy D choose initially? e) (4 points) Monty Hall offers to tell Tommy D. which box the prize is in before he makes his

initial choice. What is Tommy's PIBP for this information? 13. Trixie and Howy Baby (15 points)

Trixie (T) makes Howy Baby (HB) a proposition. She has a box full of certificates that entitle the owner to call a coin toss heads or tails, and if the call is correct, the owner wins some quantity of money. Half of the certificates entitle the owner to $20 upon calling the coin correctly, and the rest of the certificates entitle the owner to $200 upon calling the coin correctly. In either case, if the owner calls the coin incorrectly, the payment is $0. T is charging $x for the right to draw a certificate and $15 to flip the coin. If HB pays the $x he can reach in and pick a certificate. After he knows which certificate he has drawn, HB can choose whether or not to continue by paying the $15 and then flipping the coin. Over the range of prospects possible in this deal, HB's u-curve is given by: u(x) = -42.6 + .169x HB believes that he is equally likely to draw either certificate and {Heads|Certificate Drawn, &} = {Heads|&} = 0.5.

a) (7 points) What is HB's PIBP for T’s proposition? (What is the largest $x HB should pay?) b) (2 points) We now know that T is charging $35 for the right to draw a certificate. The $15

**charge to flip the coin still applies. Should he play?
**

c)

(6 points) Suppose that the Clairvoyant offers to tell HB how the coin will land if he plays and chooses to flip the coin and he must pay the Clairvoyant before he draws the certificate. What is HB’s PIBP for the Clairvoyant’s information?

MS&E 252

November 29th, 2001

Handout #25, page 10 of 25

14.

A Shot in the Arm (16 points)

The flu season just started, and Bill is wondering if he should get a flu shot. Bill assigns a PISP of $1000 to getting the flu at some point during the flu season. Bill believes there is a 20% chance he will become sick if he does not get the flu shot. He also believes that if he gets a flu shot he is certain not to get sick. You may assume for this problem that Bill is risk neutral.

**a) (3 points) Draw the decision diagram representing Bill's decision.
**

Unfortunately, Bill also has a fear of needles; getting a shot is a very traumatic experience. Before interviewing Bill about his PISP for getting a shot, you want to get some idea about its sensitivity. You assume that Bill's PISP will lie between $0 and -$300. b) (4 points) Draw a sensitivity analysis chart, showing how the CE of each alternative changes with Bill's PISP of getting a flu shot (we call these one-way sensitivities of CE to PISP of the shot). Put both alternatives on the same graph. What PISP would Bill need to assign to getting a flu shot for him to be indifferent between the two alternatives? In an interview, you have assessed Bill’s PISP for getting a shot; it equals -$150. However, he has become less sure of his assessment of the probability of getting the flu.

c)

(3 points) Draw a sensitivity to probability chart, showing how the CE of each alternative changes with Bill’s probability of getting the flu with no shot. What probability would Bill need to assign for him to be indifferent between the two alternatives?

After a short discussion, Bill goes back to his original probability assessment of 20%. d) (3 points) Draw the decision tree for Bill's decision. What is the best alternative? What is its CE? However, a thought strikes Bill during the interview; if someone in his working group gets the flu, his chances of getting the flu will increase. He wishes to understand the value of clairvoyance on this new distinction (a teammate getting the flu). e) (3 points) Draw a decision diagram for Bill's decision to buy clairvoyance. Use a report node. 15. Norma Vestor (20 points)

Norma Vestor has a risk averse u-curve and follows the delta property over the prospects in this problem. Her risk tolerance equals $20, and she likes to invest in companies. Norma believes the probability that the price of oil will rise equals fifty percent. She also believes the probability that the price of sugar will rise equals fifty percent, and furthermore, she believes that the price of sugar and the price of oil are irrelevant given her background state of information. Norma currently owns no deals relevant to the price of oil or to the price of sugar, and none of her currently owned deals relate to the deals below in any way. She intends to buy shares of one or more of the following companies. A share of the Kane Company, for which an increase in sugar price gives Norma a $10 profit from that share. Otherwise she gets $0 profit from that share. A share of Exxoff, for which an increase in oil price gives Norma a $10 profit from that share. Otherwise she gets $0 profit from that share. A share of Glacier Incorporated, for which an increase in oil price gives Norma a $0 profit from that share. Otherwise she gets $10 profit from that share.

**a) (4 points) Find Norma's personal indifferent buying price for one share of Kane, assuming that
**

she buys no other shares of any company.

MS&E 252

November 29th, 2001

Handout #25, page 11 of 25

**b) (2 points) Find Norma's personal indifferent buying price for one share of Exxoff, assuming that
**

she buys no other shares of any company

**c) (2 points) Find Norma's personal indifferent buying price for one share of Glacier, assuming that
**

she buys no other shares of any company. Norma has purchased one share of Exxoff. She intends to buy one more share of some company in addition to her first Exxoff share. She will choose from a share of Kane, a share of Glacier, and another share of Exxoff (the second share will pay out the same as the first).

**d) (4 points) Given that Norma owns one share of Exxoff, find Norma's personal indifferent buying
**

price for a share of Kane.

**e) (4 points) Given that Norma owns one share of Exxoff, find Norma's personal indifferent
**

buying price for a second share of Exxoff.

**f) (4 points) Given that Norma owns one share of Exxoff, find Norma’s personal indifferent price
**

for a share of Glacier.

MS&E 252

November 29th, 2001

Handout #25, page 12 of 25

**Final Exam Solutions
**

1. Definitions and Distinctions (30 points)

Part I (10 points) a) A prospect is the combination of an alternative that the decision maker chooses and a possibility that may be realized in the future of the decision maker's life. b) The Clairvoyant is a person who can answer any question about events in the past, present, or future without exercising judgment. c) Dependence is not an appropriate distinction for Decision Analysis. Instead we use the distinction relevance which is defined such that two distinctions are relevant if knowledge about one distinction changes the probability distribution about another distinction. d) u-value is a scaled preference probability. e) Risk attitude is the decision maker's attitude or willingness towards risk and is reflected through a u-curve. A person can be risk neutral, risk averse, or risk preferring. Part II (10 points) a) A decision is an irrevocable allocation of resources. b) The decision basis consists of the following: Alternatives: What we can do Information: What we know Preferences: What we want c) To pass the clarity test, the clairvoyant must be able to answer a question about a distinction without exercising judgment. It is a important tool in facilitating communication. d) A distinction divides the world into mutually exclusive an collectively exhaustive events. Distinctions are important to the understanding of decision situations. e) A distinction is material if it has the possibility of changing the decision. Part III (10 points) a) A sunk cost is a past irrevocable allocation of resources that has no relevance to the evaluation of the future prospect. An example would be the money spent on a pair of non refundable symphony tickets. b) The certain equivalent is equal to the decision maker's personal indifferent selling price of an uncertain deal that he/she owns. c) The e-value of a deal is the probability weighted average of the dollar measures associated to the prospects of the deal. An e-value is calculated by multiplying the probability of a possible outcome times the dollar measure associated to that outcome and summing over all possible outcomes. d) u-values are scaled preference probabilities. e) Deterministic sensitivity precedes probabilistic analysis in the evaluation phase of the Decision Analysis cycle. It is used to determine the most sensitive variables or uncertainties that need to be included in the probabilistic analysis. 2. The Five Rules (4 points) does not have time or need to reassess the u-curve. u-curves (10 points)

a) No. The Five Rules only allow us to multiply probabilities and preference probabilities. b) Oz should either add a new scale to the u-axis or approximate Randy's CE graphically. He

3.

**a) We can subtract $500 from each prospect and we are left with the following deal:
**

$1000 0.8 $0 ~ 0.2 -$1000

MS&E 252

November 29th, 2001

Handout #25, page 13 of 25

From this we see that Angus' risk odds for +/- $1000 (r1000) = 4. Therefore, his u-curve can be represented by: u(x) = a + br1000-x/1000 where x is measured in dollars. Now we need to select a and b. The simplest form is a little subjective. I like to u(0) = 0. This means a = -b. So let's let a = 1 and b = -1. We know have: u(x) = 1 - r1000-x/1000 b) risk tolerance = 1/ln(risk odds) = 1/ln(41/1000 ) = $721. c) r100 = r 1000100/1000 = r 10001/10 = 1.149. p 100 = r 100/(1+ r100) = 0.53. d)

$1500 - $1000 = $500 0.8 $500 - $1000 = -$500 ~ 0.2 -$500 - $1000 = -$1500

e) Less, because his p will be less. 4. Probability (4 points) There are four possibilities: M1M2 M1F2 F1M2 F1F2 a) We know that the first child is a boy. So we are left with: M1M2 and M1F2. Thus, {M1M2 | First Child is a boy,&} = 1/2. b) We know that at least on child is a boy. So we are left with: M1M2, M1F2, and F1M2. Thus, {M1M2|At least one boy,&} = 1/3. 5. Probability Assessments (10 points) a) Yes. Probability assessments reflect an individual's state of information rather than a state of nature. b) Jim's assessment of the four events is inconsistent whereas Mary's is consistent. Therefore a decision analysts should feel comfortable with Mary's assessment, but not Jim's. 6. Understanding Clairvoyance (10 points) a) The value of clairvoyance for a non-delta person can be calculated through iteration. If we define the price of clairvoyance as b, we begin by setting this price to zero and calculate the certain equivalent of the deal having paid b for clairvoyance. Continue this process, increasing b until the decision maker is indifferent between the deal without clairvoyance and the deal with clairvoyance. b) In calculating the difference between the value of the deal with free clairvoyance and the deal with no clairvoyance, you are calculating the personal indifference selling price of clairvoyance. However, if the decision maker is a delta person, we know that adding (or subtracting) a fixed amount, delta, from all the prospects of a deal lead to an increase (or decrease) in the certain equivalent of the deal by the same amount, delta. Therefore, the buying price for clairvoyance is equal to the selling price of clairvoyance. 7. The Interesting Clairvoyant

MS&E 252

November 29th, 2001

Handout #25, page 14 of 25

Truth

$100

I

100p

p 1-p

Lies

$0

“A”

Truth

$20

II

0.5 80-60p

p 1-p

Lies

$80

Truth

0.5

$0

I

“ A’ ” 100-100p

p 1-p

Lies

$100

Truth

$80

II

60p+20

p 1-p

Lies

$20

CE without clairvoyance = $50 CE with clairvoyance = 0.5[max(100p, 80-60p)] + 0.5[max(100-100p, 20+60p)] By setting the two possible values equal to each other, it is easy to see that Dominique is indifferent between the two alternatives when p = 0.5 100p = 80-60p 100-100p = 20+60p p = 0.5 p = 0.5 When p > 0.5, CE with clairvoyance = 0.5[100p] + 0.5[20+60p] = 80p+10 When p < 0.5, CE with clairvoyance = 0.5[80-60p] + 0.5[100-100p] = 90-80p To determine which values of p Dominique will be willing to pay $20 for clairvoyance, must look at the case when p > 0.5 and p < 0.5 separately. We know that the CE without clairvoyance = $50 so that the CE with clairvoyance must be equal to or greater than $50+$20=$70. Thus we have the following equations: p > 0.5 80p+10 = 70 p = 3/4

MS&E 252

November 29th, 2001

Handout #25, page 15 of 25

p < 0.5

90-80p = 70 p = 1/4

From this we can see that after paying $20 for clairvoyance, the CE with clairvoyance will be greater or equal to the CE without clairvoyance when p > 3/4 and when p < 1/4. 8. a) Troublemakers

1 meeting on time

st

Troublemakers

2nd meeting on time

3 meeting on time

rd

b) 0.857. To get this answer, you need to draw a tree with the following distinctions: Trouble Maker, Arrival to 1st meeting, Arrival to 2nd meeting, Arrival to 3rd meeting and flip it to get a tree in the following order: Arrival to 1st meeting, Arrival to second meeting, Arrival to 3rd meeting, Trouble Maker. You do not need to find the probabilities for every possibility. Using Bayes rules you can find the probability you need with only a few calculations. 9. Relevance Diagram (7 points) The only statements implied by the diagram are the first and the sixth: A and B are not relevant given D and & D and E are not relevant given & 10. Decision Diagrams (15 points)

Part I (8 points) a. direct value b. informational c. informational d. informational e. direct value f. informational g. functional h. informational i. functional j. informational

k. l. m. n. o. p. q. r. s.

direct value functional functional functional functional direct value relevance relevance relevance

Part II (3 points) a. A direct value arrow from a decision to the value node indicates which value model should be used based on which alternatives were chosen. b. An informational arrow indicates that the result of the uncertainty or decision is known before the decision it points to is made c. A functional arrow points into a deterministic node from the uncertainties or decisions that are used in the calculation of the deterministic node.

MS&E 252

November 29th, 2001

Handout #25, page 16 of 25

Part III (4 points)

A

a b c d e f First Purchase g First Report Second Purchase i Second Report k Value

h

j

Location

l Alpha Indication

o m

q n Beta Indication r Weather

p

s

11. a) Research and Development Decision (10 points)

R&D Effort

Marketing Effort

Value

Technical Success

Market Success

b) This is an influence arrow. The probability distribution of Technical Success may change depending on which alternative is chosen. c) R&D Effort Tech. Market Market Suc. Effort Success

MS&E 252

Large H Small Large Large

**November 29th, 2001
**

H L

Handout #25, page 17 of 25

H L H L

L

Small

H L

Large H Small Small Large

H L H L H L

L

Small

H L

12. a.

Let’s Make a Deal (16 points)

Initial Choice

Final Choice

$

Box MH Shows

b.

Box Prize Is In

MS&E 252

November 29th, 2001

Handout #25, page 18 of 25

Initial Choice

Final Choice

$

Box MH Shows

Box Prize Is In

**c. Let's draw the probability trees in assessed form, conditioned on Tommy D's (TD's) initial choice. Choose A
**

Box Prize Is In Box MH Shows “B” 1/6

1/2 1/2

A

1/3

“C” “C”

1/6

B

1/3 1/3

1/3

C

“B”

1/3

Choose B

Box Prize Is In Box MH Shows

A

1/3

“C”

1/3

“A”

1/2 1/2

1/6

B

1/3 1/3

“C” “A”

1/6

C

1/3

Choose C

MS&E 252

November 29th, 2001

Handout #25, page 19 of 25

Box Prize Is In A

1/3

**Box MH Shows “B”
**

1/3

B

1/3

“A”

1/3

“A”

1/3

1/6

C

1/2 1/2

“B”

1/6

**Now we need to place these in inferential form - flip the tree. Choose A
**

Box MH Shows Box Prize Is In A

1/6 1/3

“B”

0 1/2

B

2/3

0

C

1/3

A

1/6 1/2 1/3

“C”

0

B

2/3

1/3

C

0

After MH show TD the empty box, the probability the prize is in the unopened unchosen box is 2/3. So Tommy should switch and his chance of winning will be 2/3 - not 1/2 or 1/3. Choose B

MS&E 252

November 29th, 2001

Handout #25, page 20 of 25

**Box MH Shows Box Prize Is In A
**

0 0

“A”

1/2

B

1/3 2/3

1/6

C

1/3

A

1/3 1/2 2/3

“C”

0

B

1/3

1/6

C

0

**Same logic as above. Choose C
**

Box MH Shows Box Prize Is In A

0 0

“A”

1/2

B

2/3 1/3

1/3

C

1/6

A

1/3 1/2 2/3

“B”

0

B

1/3

0

C

1/6

Same logic as above. d. It does not matter which box Tommy D initially picks - he always trades and the probability of winning is always 2/3. Here is an even better solution. When Tommy D. makes his initial choice there is a 1/3 chance he has picked the prize. There is 2/3 chance the prize is in one of the other two boxes. You could think of these other two boxes with one big box with two compartments - 1 & 2. MH tells Tommy D. that the prize is not in compartment 1. This does not change the chance it is in the large box, so the probability it is in compartment 2 is 2/3.

MS&E 252

November 29th, 2001

Handout #25, page 21 of 25

e. Before talking to MH,TD is facing a deal with a 2/3 chance of $100 and and 1/3 chance of $0. His PISP for this is $50. After TD gets MH's information he will have a sure $100. Therefore, his PIBP for the information is $100 - $50 = $50. Notice, this result is true even though TD does not follow the delta-property. 13. Trixie and Howy Baby (15 points)

Win 85 200

1/2

200-15 = 185

Flip 85

1/2 1/2

**Lose Don't Flip Win 0
**

1/2

0-15 = -15 0 20-15 = 5

Draw 42.5 Flip -5

1/2 1/2

20 Don't Flip

Lose

0-15 = -15 0

0 Don't Draw

The above diagram assumes that the cost to draw is zero. Since HB follows the delta-property we can see that the most he should pay to play is $42.50. b. $35 is less than HB's PIBP -- he should play. His CE is $42.50 - $35 = $7.50. c. Let's leave the amount HB pays as a variable and call it x. Here is the tree conditioned the clairvoyant saying "H", the "T" tree is the same.

185-x 200

1/2

Flip 85

200-15-x= 185-x

Draw 95-x

1/2

Don't Flip -x 5-x Flip -5 20-15-x = 5-x

20 Don't Flip -x

0 Don't Draw

After talking to the clairvoyant, HB's CE is 95-x. If x is greater than 42.5 HB would chose not to draw without the clairvoyant's information. Let's consider the following cases: 0 < x <= 42.5 CE with Clairvoyance = 95-x CE w/o = 42.5-x 42.5 < x <= 95 CE with Clairvoyance = 95-x CE w/o = 0 VOC = 52.5 VOC = 95-x

MS&E 252

November 29th, 2001

Handout #25, page 22 of 25

x > 95

CE with Clairvoyance = 0

CE w/o = 0

VOC = 0

**Here is a plot of the above:
**

VOC In this range the VOC is independent of how much HB has to pay to draw! 52.5 In this range HB is choosing to play even though the game costs more than the PIBP you found in part a.

42.5

95

x

Therefore, if the HB has to pay $35 to draw the VOC = $52.5. 14. a) A Shot in the Arm (16 points)

Acquire Flu this season

Shot Decision

b)

CE of alternatives -$300 -$200 No Shot

Value

-$100 Get Shot $0

$0

PISP of shot

-$200

-$300

c)

MS&E 252

$0 -$150 CE of alternatives

November 29th, 2001

Handout #25, page 23 of 25

Get Shot

No Shot -$1000

0.0

p=0.15

p

1.0

d)

Get Shot CE=-$150 Flu 0 1 No Flu Flu 0.2 0.8 No Flu -$1150

-$150 -$1000

No Shot

$0

e)

Buy Clairvoyance

Report

Shot Decision

Value

Flu Indication

Flu | No Shot

15.

Norma Vestor (20 points)

Recognize first that Norma follows the delta property, and therefor her PIBP for a deal she does not own equals her PISP of that deal if she did own it. Create the following distinctions for the rest of this problem:

MS&E 252 November 29th, 2001 • Sugar Price S = Sugar price rises ¬S = Sugar price does not rise • Oil Price O = Oil price rises ¬O = Oil price does not rise We will use the following u-function to represent Norma's u-curve.

x 20

Handout #25, page 24 of 25

u( x ) = 1 − e

−

a) The following tree represents the deal of owning one share of Kane:

S .5 u = .20 PISP = $4.38 .5 ¬S

u-values $10 0.39

$0

0

b) Norma's PIBP equals $4.38. c) Norma's PIBP equals $4.38. Parts b and c have similar trees to part a: a fifty-fifty chance for ten dollars versus zero dollars. Thus they all have the same PISP (and PIBP). d) Norma's PIBP for a share of Kane equals $4.38. The following tree represents the deal of owning a share of Exxoff and a share of Kane.

O .5 S .5 u = .35 PISP = $8.76 .5 ¬S 0.20 0.51 .5 ¬O O .5 .5 ¬O

u-values $20 0.63

$10

0.39

$10

0.39

$0

0

Norma's PISP for the share of Kane equals the PISP of both shares minus the PISP of the Exxoff share. In diagram form, letting s equal the PISP of the Kane share:

Norma Exxoff share Kane share

Indifferent

Norma Exxoff share +s

So, her PISP equals $8.76 - $4.38 = $4.38. Therefore, her PIBP also equals $4.38 (the same as a share of Kane without the Exxoff share). e) Norma's PIBP for a second share of Exxoff equals $3.22.

MS&E 252 November 29th, 2001 The following tree represents the deal of owning two shares of Exxoff.

Handout #25, page 25 of 25

O .5 u = .32 PISP = $7.60 .5 ¬O

u-values $20 0.63

$0

0

So, her PIBP for the second Exxoff share equals $7.60 - $4.38 = $3.22 (lower that the first Exxoff share). f) Norma's PIBP for a share of Glacier equals $5.62. The following tree represents the deal of owning a share of Exxoff and a share of Glacier.

O .5 u = .39 PISP = $10 .5 ¬O

u-values $10 0.39

$10

0.39

Note that Norma will always get a profit of $10, no matter how oil prices rise or fall. Her PIBP for the Glacier share equals $10 - $4.38 = $5.62 (higher than the share of Glacier without the Exxoff share)

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