Question

Suppose instead that advertising attracts new customers into the market, as illustrated by the payoffs in the second payoff matrix below. Each airline’s advertisements are different, so the effectiveness of each airline’s advertising campaign in attracting new customers to the market is different as well.

1. Do the firms have dominant strategies? If so, what are they?
2. What is the Nash equilibrium?
3. What is the Stackelberg equilibrium if American Airlines makes their advertising decision first?
4. What is the Stackelberg equilibrium if United Airlines makes their advertising decision first?

		American Airlines (A)
		Do Not Advertise	Advertise
United Airlines (U)	Do Not Advertise	A = 2 U = 2	A = 6 U = 6
	Advertise	A = 0 U = 6	A = 5 U = 5

Answer 1

If United Airlines choose the strategy to not advertise, American Airlines would choose to advertise.

If United Airlines choose the strategy to advertise, American Airlines would choose to advertise.

So, we can see that American Airline has the dominant strategy of advertising.

If American Airlines choose the strategy to not advertise, United Airlines would choose to advertise.

If American Airlines choose the strategy to advertise, United Airlines would choose not to advertise.

So, we can see that United Airline does not have a dominant strategy.

So, we can see that only United Airlines has a dominant strategy and the dominant strategy is to advertise.

We know that American Airlines will choose to advertise, irrespective of the strategy that united airlines chooses. And when American Airlines will choose to advertise, United Airlines would choose not to advertise. So the Nash equilibrium is American airlines choosing to Advertise and United Airlines not choosing to advertise.

In Stackelberg Equilibrium, the leader firm chooses the strategy and the other firms follow te same strategy.

Now, if American Airlines make their advertising decision first, they will choose to advertise, because they know that United Airlines will also choose to advertise and in this case, there will be a profit of 5 for both the firms. So, the Stackelberg equilibrium would be to advertise for both the firms.

Now, if United Airlines make their advertising decision first, they will choose to advertise, because they know that American Airlines will also choose to advertise and in this case, there will be a profit of 5 for both the firms. So, the Stackelberg equilibrium would be to advertise for both the firms.

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