Question

The table below shows two cigarette manufacturers (Firm A and Firm B) that are faced with lawsuits from states to recover the healthcare related expenses associated with cigarette smoking. Both cigarette firms have evidence that indicates that cigarette smoke causes lung cancer (and other related illnesses). State prosecutors do not have access to the same data used by cigarette manufacturers and thus will have difficulty recovering full costs without the help of at least one cigarette firm study. Each firm has been presented with an opportunity to lower its liability in the suit if it cooperates with attorneys representing the states.

		Firm B
		Concede that cigarette smoke causes lung cancer	Argue that there is no evidence that smoke causes cancer
Firm A	Concede that cigarette smoke causes lung cancer	Firm A profit = $–20 Firm B profit = $–15	Firm A profit = $–50 Firm B profit = $–5
	Argue that there is no evidence that smoke causes cancer	Firm A profit = $–5 Firm B profit = $–50	Firm A profit = $–10 Firm B profit = $–10

1. What is the dominant strategy for each firm? Explain.

2. When this game reaches a Nash equilibrium, what will the profits for Firm A and Firm B be? Explain.

Answer 1

Ans.-(A) Dominant strategy is (argue,argue) .
If firm A Concedes that cigarette
smoke causes lung cancer then firm B would Argue that there is no evidence that smoke causes cancer in order to maximize its profit.
If firm A Argue that there is no evidence that smoke causes cancer then firm B would Argue that there is no evidence that smoke causes cancer in order to maximize its profit. So, Argue that there is no evidence that smoke causes cancer is the dominant strategy for firm B.
Similarly, Argue that there is no evidence that smoke causes cancer is the dominant strategy for firm A.

Ans. (b)- Nash equilibrium is (argue,argue) and profit is -10 for each firm.
If both A and B Argue that there is no evidence that smoke causes cancer then there is no incentive for any firm to deviate to some other strategy and hence (argue,argue) is the nash equilibrium.

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