The document discusses three dilemmas facing a mango farmer: whether to lease or retain an orchard, whether to spend $1,000 on a climatology firm, and how rain impacts profits. It introduces concepts like expected value and probability to help analyze the dilemmas probabilistically and determine the best strategies. For example, it considers the expected profits of leasing versus retaining based on the likelihood of rain and the climatology firm's predictions.
The document discusses three dilemmas facing a mango farmer: whether to lease or retain an orchard, whether to spend $1,000 on a climatology firm, and how rain impacts profits. It introduces concepts like expected value and probability to help analyze the dilemmas probabilistically and determine the best strategies. For example, it considers the expected profits of leasing versus retaining based on the likelihood of rain and the climatology firm's predictions.
The document discusses three dilemmas facing a mango farmer: whether to lease or retain an orchard, whether to spend $1,000 on a climatology firm, and how rain impacts profits. It introduces concepts like expected value and probability to help analyze the dilemmas probabilistically and determine the best strategies. For example, it considers the expected profits of leasing versus retaining based on the likelihood of rain and the climatology firm's predictions.
The document discusses three dilemmas facing a mango farmer: whether to lease or retain an orchard, whether to spend $1,000 on a climatology firm, and how rain impacts profits. It introduces concepts like expected value and probability to help analyze the dilemmas probabilistically and determine the best strategies. For example, it considers the expected profits of leasing versus retaining based on the likelihood of rain and the climatology firm's predictions.
List the Dilemmas 1. Should it lease or retain? 2. Should it spend on Climatology firm? 3. What is the impact of rain?
Look for information that helps solving the dilemmas.
Filter out the information that is going to add confusion Expected Value – Long-run average • The expected value, or mean, of a random variable is a measure of its central location. E(x) = µ = Σx. P(x)
• The expected value is a weighted average of the values the
random variable may assume. • Weights are the probabilities • The probability gives information about what can be expected (on average) in the long term (repeated multiple times) • It is NOT a prediction for a specific future occurrence rather than a generalization across multiple occurrences. Combining Probabilities and Monetary Values aids in identifying expected loss and expected gain Decision alternatives: • Different possible strategies the decision maker can employ Payoff: • Consequence resulting from a specific combination of a decision alternative given the uncertainties • Payoffs are expressed in profit, cost, time, distance or any other appropriate measure. Expected value (EV) approach • To solve decision problems under uncertainties • Using probabilistic information of the outcomes • Variance and Standard Deviation • The variance summarizes the variability in the values of a random variable
Var(x) = σ 2 = Σ(x - µ)2 P(x)
• The variance is a weighted average of the squared deviations of a random variable from its mean. • The standard deviation, σ , is defined as the positive square root of the variance
For Finance specialization: Read Chapter 5.4
Decision in the absence of climate information
• What is the average profit that Pansare could earn by leasing the farm? • What is the expected (average) profit that Pansare could earn by holding the farm till harvest? • Which one is better? • Is it worth spending $1000 on the climatology firm? • How likely are their predictions correct. • How did you arrive at your conclusion? • What is the probability that it will rain according to the firm, based on past judgements? • What is the probability that it will not rain according to the firm? • How likely are they to give a correct prediction? Given that Pansare has taken the climatology opinion, • What is the expected profit if the firm predicts rain? • Should he hold or lease if the firm predicts rain? • Given that the firm has predicted rain, how likely is it to rain? • What is the expected profit if the firm predicts no rain? • Should he hold or lease if the firm predicts no rain? Dilemmas • Should the family lease the orchard to a merchant immediately, or keep the orchard to harvest themselves? • Unseasonable rain during the flowering stage could be harmful, damaging at least 40 per cent of the crop and often ruining the entire crop. However, moderate rains at the time of the fruit’s maturity could improve the fruit size and quality. • Decide it was worth spending $1,000 to get information from the climatology
