Under a moderate market, which option yields the highest payoff?

• A. Large Plant
• B. Small Plant
• C. Subcontracting
• D. None

Answer: (B)

This question tests how capacity choices interact with market demand to influence payoff under uncertainty. In a moderate market, the demand is not so high that paying the fixed cost of a large plant pays off, because much of that extra capacity would sit idle and drag down profit. Subcontracting offers flexibility but usually comes with higher per-unit costs, which can erode margins when demand is moderate. Doing nothing yields zero payoff, which is never optimal if there’s any positive expected sales.

A small plant hits the sweet spot: it has lower fixed costs than a large plant while still providing enough capacity to meet the typical moderate demand. This balance tends to maximize expected profit in this scenario, making the small plant the best choice.