Firm X Is Currently Selling a Consumer Good at a Standard

question 15

Essay

Firm X is currently selling a consumer good at a standard price, but is also considering cutting its price. The main risk facing the firm concerns the course of the economy in the near-term: whether the economy will grow at a steady pace (G) or whether it will experience a recession (R). The table below shows the firm's possible profit results (in $ millions). Finally, the firm judges that there is a 70% chance of growth and a 30% chance of a recession.
$\begin{array} { | l | c | c | } \hline & \text { Growth } & \text { Recession } \\\hline \text { Standard Price } & 20 & - 10 \\\hline \text { Cut Price } & 15 & 0 \\\hline\end{array}$ (a) Firm X must make its decision now (before knowing the future course of the economy). Which pricing policy maximizes its expected profit?
(b) Now suppose that Firm X can wait and decide its pricing decision after it knows the course of the economy. Determine its best pricing decisions and its overall expected profit.
(c) Firm X has hired a macroeconomic forecaster. The macro forecast is either positive (+) or negative (–). In the past, the forecaster has made positive forecasts prior to 4 of 7 periods of economic growth: Pr(+|G) = 4/7. In turn, he has made negative forecasts prior to 2 of 3 recessions: Pr(–|R) = 2/3. Compute Pr(G|+) and Pr(G|–)
(d) Suppose the forecasting report can be purchased for $.2 million. Should Firm X buy the report? Explain your answer.

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Definitions:

Money Demanded

The total amount of money that households and firms want to hold at any given time, influenced by income levels, interest rates, and economic activity.

Market Interest Rate

The prevailing rate at which borrowers can obtain money from lenders, influenced by supply and demand in the money market.

Store of Value

An asset that can be saved, retrieved, and exchanged at a later time, and is predictably useful when retrieved.

Liquidated

The process of converting assets into cash or other forms of payment, often used in bankruptcy proceedings.