Risk Aversion and Decision Making John Smith is the production manager of Elmo’s GlueCompany. Because of limited capacity, the company can produce only one of two possible products.The two products are:a. A space-age bonding formula that has a 15% probability of making a profit of $1,000,000 for thecompany and an 85% chance of generating $200,000 in profit.b. A reformulated household glue that has a 100% chance of making a profit of $310,000.John gets a bonus of 20% of the profit from his department. John has the responsibility to choosebetween the two products. Assume John is more risk-averse than the top management of Elmo’sGlue Company.Required1. Which product will John choose? Why?2. Is this the product Elmo’s would choose? Why or why not? Assume the company is risk-neutral.3. How can Elmo’s change its reward system to have John consistently make decisions that are consistentwith top management’s wishes?
Risk Aversion and Decision Making John Smith is the production manager of Elmo’s Glue
Company. Because of limited capacity, the company can produce only one of two possible products.
The two products are:
a. A space-age bonding formula that has a 15% probability of making a profit of $1,000,000 for the
company and an 85% chance of generating $200,000 in profit.
b. A reformulated household glue that has a 100% chance of making a profit of $310,000.
John gets a bonus of 20% of the profit from his department. John has the responsibility to choose
between the two products. Assume John is more risk-averse than the top management of Elmo’s
Glue Company.
Required
1. Which product will John choose? Why?
2. Is this the product Elmo’s would choose? Why or why not? Assume the company is risk-neutral.
3. How can Elmo’s change its reward system to have John consistently make decisions that are consistent
with top management’s wishes?
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