Question

In: Economics

The following is a payoff matrix showing profit in millions of dollars when two companies simultaneously...

The following is a payoff matrix showing profit in millions of dollars when two companies simultaneously decide on various advertising budgets ($1 million, $2 million, or $3 million):

Blank for Formatting Pizza Hut Advertising Budget: $1 mill Pizza Hut Advertising Budget: $2 mill Pizza Hut Advertising Budget: $3 mill
Papa John's Advertising Budget: $1 mill $225/$175 $215/$185 $210/$180
Papa John's Advertising Budget: $2 mill 235/165 210/170 205/175
Papa John's Advertising Budget: $3 mill 215/155 205/160 200/165

QUESTION:

What would be the likely outcome of this simultaneous advertising decision (i.e. what ad budget would each company end up choosing)?

Select one:

a. Both would choose $3 mill.

b. Papa Johns would choose $2 mill; Pizza Hut would choose $1 mill.

c. Papa Johns would choose $3 mill; Pizza Hut would choose $2 mill.

d. Papa Johns would pick $1 mill; Pizza Hut would pick $2 mill.

Solutions

Expert Solution

Option (d).

When Pizza Hut chooses $1 million, Papa John's best strategy is to choose $2 million since payoff is highest (235 > 225 > 215).

When Pizza Hut chooses $2 million, Papa John's best strategy is to choose $1 million since payoff is highest (215 > 210 > 205).

When Pizza Hut chooses $3 million, Papa John's best strategy is to choose $1 million since payoff is highest (210 > 205 > 200).

When Papa John chooses $1 million, Pizza Hut's best strategy is to choose $2 million since payoff is highest (185 > 180 > 175).

When Papa John chooses $2 million, Pizza Hut's best strategy is to choose $3 million since payoff is highest (175 > 170 > 165).

When Papa John chooses $3 million, Pizza Hut's best strategy is to choose $3 million since payoff is highest (165 > 160 > 155).

Therefore, Nash equilibrium (best outcome) is: Papa John chooses $1 million, Pizza Hut chooses $2 million [See below].


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