Which two states of nature are considered in the capacity expansion decision scenario?

• A. Favorable market and Moderate market
• B. Favorable market and Unfavorable market
• C. Growth and Decline
• D. High and Low Demand

Answer: (A)

In capacity expansion under uncertainty, a state of nature is a possible future market condition that changes how much cash flow or payoff you’ll get. The problem sets up two possible market conditions to compare: a favorable market and a moderate market. Under a favorable market, demand and profits are higher, while a moderate market represents a more typical, not-too-extreme level of demand. These two states let you evaluate how the expansion decision performs across a best-case and a more typical scenario, helping you decide whether to expand now, later, or not at all.

This pairing aligns with the scenario’s description, focusing on a strong but not extreme positive outcome and a standard outcome. The other options propose pairings that describe different notions of market strength (like high vs low or growth vs decline) that aren’t the two states defined in this problem.