5. To advertise or not to advertise Suppose that Fizzo and Pop Hop are the only

Question

5. To advertise or not to advertise Suppose that Fizzo and Pop Hop are the only two firms that sell orange soda. The following payoff matrix shows the profit (in millions of dollars) each company will earn depending on whether or not it advertises: Pop Hop Advertise Doesn't Advertise Advertise 8, 8 15, 2 Fizzo Doesn't Advertise 2,15 11,11 For example, the upper right cell shows that if Fizzo advertises and Pop Hop doesn't advertise, Fizzo will make a profit of $15 million, and Pop Hop will make a profit of $2 million. Assume this is a simultaneous game and that Fizzo and Pop Hop are both profit-maximizing firms. If Fizzo decides to advertise, it will earn a profit of $ million if Pop Hop advertises and a profit of$ million if Pop Hop does not advertise If Fizzo decides not to advertise, it will earn a profit of $ million if Pop Hop advertises and a profit of$ million if Pop Hop does not advertise If Pop Hop advertises, Fizzo makes a higher profit if it chooses to advertise If Pop Hop doesn't advertise, Fizzo makes a higher profit if it c not to advertise Suppose that both firms start off not advertising. If the firms a hat strategies will they end up choosing? Both firms will choose to advertise Fizzo will choose not to advertise and Pop Hop will choose to advertise Fizzo will choose to advertise and Pop Hop will choose not to advertise Both firms will choose not to advertise Again, suppose that both firms start off not advertising. If the firms decide to collude, what strategies will they end up choosing? Fizzo will choose to advertise and Pop Hop will choose not to advertise Both firms will choose to advertise Fizzo will choose not to advertise and Pop Hop will choose to advertise Both firms will choose not to advertise

Explanation / Answer

If Fizzo decides to advertise, it will earn a profit of $8 mn if Pop Hop advertises and a profit of $15 mn if Pop Hop does not advertise.

If Fizzo decides not to advertise, it will earn a profit of $2 mn if Pop Hop advertises and a profit of $11 mn if Pop Hop does not advertise.

If Pop Hop advertises, Fizzo makes a higher profit if it chooses to advertise.

If Pop Hop does not advertise, Fizzo makes a higher profit if it chooses to advertise.

Firms act independently:

- Both firms will choose to advertise. (Dominant strategy for both)

Firms decide to collude:

- Both firms will choose not to advertise. (Total profit is maximized)

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