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A member of a group of medical practitioners is considering opening
his own private medical practice. He estimates that if demand for his
services is high he could realise a profit of $500,000. If demand is low
he could lose $200,000.
(a) If the medical practitioner follows the criterion of regret what should he do? (2 marks)
His best guess is that there is a 50-50 chance that the practice would be successful.
(b) What should he do if he follows the EMV criterion? (2 marks)
(c) What is the expected value of perfect information? (1 mark)
A market research firm offers to perform a study of the market for a
fee of $25,000. Their past experience enables them to make the following
There is a 90% chance that they would successfully predict a
favourable market (ie demand would be high) and an 80% chance they would
successfully predict an unfavourable market.
(d) Using the market research experience, calculate the revised
probabilities of demand given predictions of a favourable market and an
unfavourable market. (4 marks)
(e) Based on these revised probabilities what should the medical
practitioner do? Support your answer with EVSI and ENGSI calculations.
(f) Tversky and Kahneman describe three types of heuristics that
people use in judgments under uncertainty. What do they mean by the term
heuristics? Briefly describe the ones that they mention. Give one
example from your own experience of a bias that might result from each
of these heuristics.