Question

Attempts: Keep the Highest: 16 11. 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 Creamland Doesn't Advertise 3,15 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 $15 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. million if Dairy King advertises and a profit of million if Dairy King does not If Creamland decides to advertise, it will earn a profit of advertise. million if Dairy King advertises and a profit of 3 If Cream and decides not to advertise, it will earn a profit of not advertise. million if Dairy King does If Dairy King advertises, Creamland makes a higher profit if it chooses If Dairy King doesn't advertise, Creamland makes a higher profit if it chooses

Answer 1

If Creamland decides to advertise, it will earn a profit of $9 million if Dairy King advertises, and a profit of $15 million if Dairy King does not advertise.

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

If Dairy King advertises, Creamland makes a higher profit if it advertises.

If Dairy King doesn't advertise, Creamland makes a higher profit if it advertises.

MCQ 1: If both firms start off with not advertising but choose to act independently, then both firms will choose to advertise eventually. This is because, for each firm, advertising always generates a larger payoff, irrespective of what the other firm does. In other words, advertising is the dominant strategy for each firm, and a dominant strategy equilibrium is where both firms advertise. So the last option is the correct option.

MCQ2: If the firms decide to collude, both firms will end up "not advertising". This is because, in a collusive structure, firms decide to maximise the total profits earned, and in this payoff structure, combined payoffs are largest($22 million) if the firms mutually decide to not advertise, than through any other possible combination.