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 Doesnt 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 s millon if Pop Hop advertises and a profit of s milion if Pop Hop does not advertise. If Pop Hop advertises, Fizzo makes a higher profit if it choosesY If Pop Hop doesn't advertise, Fizzo makes a higher profit if it chooses Suppose that both firms start off no t advertising. If the firms act independently, what strategies will they end up choosing?

Explanation / Answer

If Fizzo advertises it will earn profit of $ 8 if Pop advertises and profit of $15 if Pop does not advertise.

If Fizzo does not advertise it will earn profit of $ 2 if Pop advertises and profit of $11 if Pop does not advertise.

If Pop advertises Fizzo makes higher profit from Advertise.

If Pop does not advertise Fizzo makes higher profit from Advertise.

Both Firms will choose to Advertise. This is because (Advertise, Advertise) is a Nash equilibrium solution. Given the action of other each party is better off advertising. Hence, both will advertise.

Both Firms will choose not to Advertise. This is because (Not Advertise, Not Advertise) is a solution which provides higher payoffs to each firm. When they collude they can determine and set the outputs and their decisions as monopolists thereby giving them maximum returns.

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