Key West Fisheries

In March 1987, Harry Morgan, the founder and president of Key West Fisheries faced a difficult
decision. The company has been in the tuna fishing business for twelve years, operating a single
boat. Morgan has seen the company's fortunes rise and ebb, mainly depending upon the price of
tuna. When prices are high, tuna fishermen prosper. When prices fall, they face tough times. He is
uneasy about the company's future because of uncertainties about prices and the size of future
catches.
Earlier in the week, Morgan received a Fax from a Spanish tuna importer to whom he has sold
fish in the past. The importer is offering to make a one season contract with Key West Fisheńes to
deliver 150,000 pounds of tuna at a price of $1.10 per pound. The tuna is to be delivered by
October 31. Morgan has to decide in the next 10 days whether to accept or reject the Spanish
contract.
In consideńng this decision, Morgan has gathered the following information. The tuna season in
the south Atlantic runs from the beginning of April to the end of October. (Not all of this time can
be devoted to fishing; time in port or traveling to fishing grounds means lost fishing days.) At the
risk of some over-simplification, Morgan foresees two different types of seasons, good and bad.
(The type of season depends upon ocean currents, tuna migration patterns, the number of
competing boats, and so on.) In a good season, the total Atlantic catch will be large, and the
company can catch 300,000 pounds of tuna. In a bad season (small catches), Morgan will be able
to catch only 240,000 pounds. Before the beginning of the season, it is impossible to tell whether
it will be good or bad. Based on his past experience, Morgan sees good and bad seasons as
equally Iikely. However, after the first four weeks of the season, Morgan can discern the
prevailing pattern (large or small catches).
Tuna is caught not only in the Atlantic but also in the Pacific, primarily by li S, Russian, and
Japanese fishermen. Therefore, the price of Atlantic tuna depends not only on whether the
Atlantic catch is large or small but also on the size of the Pacific catch. The expected price of
tuna depends upon the catches in the respective oceans as follows:
Atlantic Large/Pacific Large: $.50 per pound
Atlantic Large/Pacific Small: $.80 per pound
Atlantic SmalUPacific Large: $.70 per pound
Atlantic Small/Pacific Small: $1.00 per pound
Morgan considers each of these four possibilities to be equally Iikely. (The type of Pacific
season is fifty-fifty, and the outcomes of the two seasons are independent of one another.) As
with the Atlantic catch, the size of the Pacific catch cannot be predicted prior to the season.
However, the type of Pacific season will be known after the first three or four weeks of
fishing.
If Morgan accepts the contract, there are two options for delivering the fish to Spain. He can
hire a commercial freighter to take all or part of the 150,000 pounds at a cost of $.44 per

1
pound. Alternatively, Morgan can use his own boat to deliver the fish. This would require two
round-tńps since his boat can carry only 75,000 pounds. (The cost difference between
operating the boat for shipping versus fishing is insignificant.) However, if the company
delivers the fish itself, it will lose about 1/3 of the available fishing days (meaning a 1/3
reduction in its total catch).
Revenues, Costs, and Assets. The company's revenues in the coming season consist of its
domestic sales (at uncertain prices) plus revenues from the importer (if the contract is
accepted). The company's total cost for the entire fishing season is $180,000 (the sum of
crew's wages, interest expenses, office rent, etc.) regardless of how much fish is caught.
Besides its boat, the company currently has $30,000 in liquid assets.
Morgan has decided to sketch a decision tree to help him determine whether to accept the
contract (and if so, how to deliver the fish). He has decided to measure outcomes in terms of
end-of-season liquid assets. For example, if he rejects the contract and there are large catches
in both oceans, his end-ofseason assets are: 30 + [($.50)(300) - 180] = $0 thousand. (The low
price results in a $30 thousand dollar loss reducing his assets to zero.) If he accepts the
contract, uses the freighter, and both catches are large, his assets are: 30 + [165 - 66 + 75 -
180] = $24 thousand, and so on.

Assuming Morgan is risk neutral, what is his best course of action?

Additional questions.
1. Suppose that Morgan is able to delay his contract decision until after the first of May
(when he will know the types of Atlantic and Pacific season). How much is this
postponement worth to him?
2. Suppose instead that Morgan can hire the services of a marine biologist who will be able
to ąive him a perfect forecast of the Pacific season (large or small) irnmediately. How much
is this forecast worth?
3. Morgan is risk averse. He has provided the following certainty equivalents for fifty-fifty
gambles. Sketch his utility curve, and use this to determine his preferred course of action:

50-50 Gamble Certainty Equivalent 50-50 Gamble Certainty Equivalent

a) $90,000 and $0 $24,000 d) $90,000 and $52,000 $69,000

b) $90,000 and $24,000 $52,000 e) $52,000 and $24,000 $35,000

c) $24,000 and $0 $6,000 f) $24,000 and $6,000 $13,000