Economics homework help

| December 30, 2015

The prospective operator of a shoe store has the opportunity to locate in an established shopping centre. Alternatively, at lower cost, the prospective operator can locate in a new centre, whose development has recently been completed. If the new centre turns out to be very successful, it is expected that annual store profits from location in it would be £130,000. If the new centre is only moderately successful, annual profits would be £60,000. If the new centre is unsuccessful, an annual loss of £10,000 would be expected. The profits to be expected from location in the established centre will also depend to some extent on the degree of success of the new centre, as potential customers may be drawn to it. If the new centre was unsuccessful, annual profits for the shoe store located in the established centre would be expected to be £90,000. However, if the new centre was moderately successful, the expected profits would be £70,000, while they would be only £30,000 if the new centre turned out to be very successful. All profits are inclusive of location cost. The probability that the new shopping centre will be very successful is 0.4 and the probability it will be moderately successful is also 0.4.

(a) Draw the decision tree for this problem.

(b) According to the expected monetary value criterion, where should the shoe store be located? Assume a risk-neutral decision-maker.

(c) Explain briefly how a perfect forecast of shopping centre success changes the order of the decision tree in (a)


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