Conducting research is costly, and the costs must be weighed against the value of the information gathered. Consider a com- pany faced with a competitor's price reduction. Should the company also reduce price in order to maintain market share, or should the company maintain its current price? The com- pany has conducted some preliminary research showing the financial outcomes of each decision under two competitor re- sponses: the competition maintains its price or the competition lowers its price further. The company feels pretty confident that the competitor cannot lower its price further and assigns that outcome a probability (p) of 0.7, which means the other outcome would have only a 30 percent chance of occurring (1– p = 0.3). These outcomes are shown in the table below: Competitive Response Maintain Price Reduce Price Company action p = 0.7 (1-p) = 0.3 Reduce Price $160,000 $120,000 Maintain Price $180,000 $100,000 For example, if the company reduces its price and the com- petitor maintains its price, the company would realize $160,000, and so on. From this information, the expected monetary value (EMV) of each company action (reduce price or maintain price) can be determined using the following equation: EMV = (p)(financial outome,) If the value of perfect information is more than the cost + (1 – p)(financial outcome(1 -p) of conducting the research, then the research should be under- taken (that is, EMVP> cost of research). However, if the value of the additional information is less than the cost of obtaining The company would select the action expected to deliver the greatest EMV. More information might be desirable, but is it worth the cost of acquiring it? One way to assess the value of ad- ditional information is to determine the expected value of perfect information (EMVpj), calculated using the following equation: more information, the research should not be conducted. EMVPI = EMVcertainty - EMVpest alternative where = (p) (highest financial outcome,) + (1 – p) (highest financial outcome(1 -p) EMV, Vcertainty

Conducting research is costly, and the costs must be weighed against the value of the information gathered. Consider a com- pany faced with a competitor's price reduction. Should the company also reduce price in order to maintain market share, or should the company maintain its current price? The com- pany has conducted some preliminary research showing the financial outcomes of each decision under two competitor re- sponses: the competition maintains its price or the competition lowers its price further. The company feels pretty confident that the competitor cannot lower its price further and assigns that outcome a probability (p) of 0.7, which means the other outcome would have only a 30 percent chance of occurring (1– p = 0.3). These outcomes are shown in the table below: Competitive Response Maintain Price Reduce Price Company action p = 0.7 (1-p) = 0.3 Reduce Price $160,000 $120,000 Maintain Price $180,000 $100,000 For example, if the company reduces its price and the com- petitor maintains its price, the company would realize $160,000, and so on. From this information, the expected monetary value (EMV) of each company action (reduce price or maintain price) can be determined using the following equation: EMV = (p)(financial outome,) If the value of perfect information is more than the cost + (1 – p)(financial outcome(1 -p) of conducting the research, then the research should be under- taken (that is, EMVP> cost of research). However, if the value of the additional information is less than the cost of obtaining The company would select the action expected to deliver the greatest EMV. More information might be desirable, but is it worth the cost of acquiring it? One way to assess the value of ad- ditional information is to determine the expected value of perfect information (EMVpj), calculated using the following equation: more information, the research should not be conducted. EMVPI = EMVcertainty - EMVpest alternative where = (p) (highest financial outcome,) + (1 – p) (highest financial outcome(1 -p) EMV, Vcertainty

Microeconomic Theory

12th Edition

ISBN:9781337517942

Author:NICHOLSON

Publisher:NICHOLSON

Chapter18: Asymmetric Information

Section: Chapter Questions

Problem 18.6P

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