Question

5. To advertise or not to advertise Suppose that Creamland and Dairy King are the only two firms that sell ice cream. The following payoff matrix shows the profit (in millions of dollars) each company will earn depending on whether or not it advertises: Dairy King Advertise Doesn't Advertise Advertise 10, 10 20, 3 Creamland Doesn't Advertise 3, 20 11, 11 For example, the upper right cell shows that if Creamland advertises and Dairy King doesn't advertise, Creamland will make a profit of $20 million, and Dairy King will make a profit of $3 million. Assume this is a simultaneous game and that Creamland and Dairy King are both profit-maximizing firms If Creamland decides to advertise, it will earn a profit of $ million if Dairy King advertises and a profit of$ million if Dairy King does not advertise If Creamland decides not to advertise, it will earn a profit of $ million if Dairy King advertises and a profit of million if Dairy King does not advertise If Dairy King advertises, Creamland makes a higher profit if it chooses to advertise If Dairy King doesn't advertise, Creamland makes a higher profit if it c not to advertise Suppose that both firms start off not advertising. If the firms act indep tegies will they end up choosing? Creamland will choose not to advertise and Dairy King will choose to advertise Both firms will choose not to advertise Creamland will choose to advertise and Dairy King will choose not to advertise

Answer 1

According to the payoff matrix :

If Creamland decides to advertise, it will earn a profit of $10 million if Dairy King advertises and a profit of $20 million if Dairy King does not advertise.

If Creamland decides not to advertise, it will earn a profit of $3 million if Dairy King advertise and a profit of $11 million if Dairy King does not advertise.

If Dairy King advertises then in that case Creamland can make profit of $10 million if it advertises or can make profit of $3 million if it chooses not to advertise. So, Creamland makes a higher profit if it chooses to advertise.

So, If Dairy King advertises, Creamland makes a higher profit if it chooses to advertise.

If Dairy King does not advertise that in that case Creamland can make profit of $20 million if it advertise or can make profit of $11 million if it chooses not to advertise. So, Creamland makes a higher profit if it chooses to advertise.

Thus, If Dairy King does not advertises, Creamland makes a higher profit if it chooses to advertise.

If the firms act independently, both firms will choose to advertise. (When creamland advertises, the profit of creamland will rise but Dairy King's profit will dip. This will induce Dairy King to advertise)

When the firms collude, both firms will choose not to advertise. ( when they both don't advertise the profit is higher as they dont hamper each other's market)