Firm M and N compete for a market and decide independently how much to advertise

Question

Firm M and N compete for a market and decide independently how much to advertise. Each can spend either $10 million or $20 million on advertising. If the firms spend equal amounts, they split the $120 million market equally. (for instance, if both choose to spend $20, each firm's net profit is 60-20=$40 million.) If one firm spends $20 million and other $10 million, the former claims two-thirds of the market and the latter one third. Firm N's Advertising 10 million 20 million Firm M's Advertising 10 million ?,? ?,? 20 million ?,? 40,40 A)Fill in the profit entries in the payoff table. B)If the firms act independently, what advertising level should each choose? Explain. Is a prisoner's dilemma present? C)Could the firms profit by entering into an industry-wide agreement concerning the extend of advertising? Explain.

Explanation / Answer

There is a prisoner's dilemma. Each firm wants to maximize its profits. In order to do that, they will both want to spend 20M. However, if both firms spend 20M, they both end up with less than optimal solution.

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