9781118041581

Summary 579

Lawrence, D. B. The Economic Value of Information.New York: Springer-Verlag, 1999.

Salop, S. C. “Evaluating Uncertain Evidence with Sir Thomas Bayes: A Note for Teachers,” Journal

of Economic Perspectives(Summer 1987): 155–160. Salop argues strongly for the application of probabili-

ties and statistical techniques in the evaluation of legal evidence.

Savage, S. L. Decision Making with Insight. Belmont, CA: Thomson Learning, 2003.

The following references present theory and evidence concerning optimal search.

Abrams, E., et al. “An Experimental Comparison of Two Search Models.” Economic Theory 16

(November 2000): 735–749.

DeGroot, M. Optimal Statistical Decisions. Chapter 13. New York: McGraw-Hill, 1970.

Diamond, P. “Search Theory.” In J. Eatwell, M. Milgate, and P. Newman (Eds.), The New Palgrave:

A Dictionary of Economics. New York: Macmillan, 1987, pp. 271–286.

Genesove, D. “Search at Wholesale Auto Auctions.” Quarterly Journal of Economics110 (February

1995): 23–49.

Online, one can find a Bayes’ theorem calculator for revising probabilities athttp://StatPages.org/

bayes.html. This is part of a comprehensive Web site for free statistical software athttp://statpages.org/

index.html.

CHECK STATION

ANSWERS

1. The joint probability table can be written as follows:
   For example, Pr(G&W) Pr(GƒW)Pr(W) (3/4)(.28)  .21. Thus,
   Pr(WƒG)  .21/.45  .47 and Pr(WƒB)  .07/.55  .13.

WD

G .21 .24 .45

B .07 .48 .55

Total .28 .72

2. With a good test, the partners drill and obtain E() (.47)(600) 
   (.53)(200) $176 thousand. If the test is bad, they do not drill and
   earn $0. Thus, their overall E() is (.45)(176) $79.2 thousand.
   Without the test, the E() from drilling is (.28)(600) (.72)(200) 
   $24 thousand. The value of the test is $55.2 thousand.


3. This test is valueless: Pr(WƒG)  .32/.8  .4, and Pr(WƒB)  .08/.2  .4.
   The test never causes a probability revision. It reports “good” 80 percent
   of the time, whether or not the site is wet: Pr(GƒW) Pr(GƒD)  .8.


4. If firm A offers $120 or $140, the buyer will accept (because the expected
   price from firm B is $155). Thus, the buyer’s expected profit of
   approaching A first is (.15)(120) (.25)(140) (.6)(155) $146. If the
   buyer approaches B first, it accepts $130 but rejects $180 (in which case,
   it faces A’s expected price of $152). The buyer’s expected profit is
   (.5)(130) (.5)(152) $141. Approaching B first is the best course of
   action.

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