Question

Consider a consumer who is searching for the lowest price for good X. The consumer knows that 75 percent of the time she will find a store charging $10 and 25 percent of the times she will find a store charging $7. The expected benefit from an additional search is:

as long as i know the answer. i want detail reason so that i will be able to use it for other application questions

so please provide step by step works

A.

$3.

B.

$0.75.

C.

$2.25.

D.

$0.

Answer 1

We are given that the consumer has a 75% probability that she would find a store charging $10 and 25% probability that she will find a store charging $7.

So it is clear that for 75% of the times , she is getting $0 additional benefit as she pays $10 while for the 25% times she would be getting $3 as the additional benefit ie $10-$7= $3

Expected value = P_A*A+P_B*B

Here A is the probability that she is gaining $0 by paying $10 ie 0.75

B is the probability that she is gaining $3 by paying $7 with a probability of 0.25

Expected value = 0.75*0+0.25*3 = 0+0.75= $0.75

So she would be gaining $0.75 with the additional research. Option B is the answer.

(You can comment for doubts )