Managerial Economics & Business Strategy 8th Edition by Michael Baye,Jeff Prince

Exercise 11

As the manager of Smith Construction, you need to make a decision on the number of homes to build in a new residential area where you are the only builder. Unfortunately, you must build the homes before you learn how strong demand is for homes in this large neighborhood. There is a 60 percent chance of low demand and a 40 percent chance of high demand. The corresponding (inverse) demand functions for these two scenarios are P = 300,000 - 400 Q and P = 500,000 - 275 Q, respectively. Your cost function is C ( Q ) = 140,000 + 240,000 Q. How many new homes should you build, and what profits can you expect?