In your own words, explain how to obtain the “expected value of perfect informat
ID: 3247697 • Letter: I
Question
In your own words, explain how to obtain the “expected value of perfect information” for any payoff table, which has probabilities associated with each state of nature.Then, provide an example, drawing from any of the payoff tables in Problems 1-17 in the back of Chapter 12. If no probabilities are given for the states of nature, then assume equal likelihood.
Here is the problem: A farmer in Iowa is considering either leasing some extra land or investing in savings certificates at the local bank. If weather conditions are good next year, the extra land will give the farmer an excellent harvest. However, if weather conditions are bad, the farmer will lose money. The savings certificates will result in the same return, regardless of the weather conditions. The return for each investment, given each typer of weather condition, is shown in the following payoff table.
Weather Weather Decision Good Bad Lease land $90,000 $-40,000 Buy savings certificate 10,000 10,000Explanation / Answer
probabilities are not given for the states of nature, then assuming equal likelihood i.e 1/2 or 0.5 each for good and bad weather
Expected gain on lease land=90000*0.5+(-40000)*0.5=25000
Expected gain on bying saving certificate=10000*0.5+10000*0.5=10000
since Expected gain on lease land is more than the expected gain on buying saving certificate, so lease land option should be used.