Question

 

5. To advertise or not to advertise 

Suppose that Fizzo and Pop Hop are the only two firms that sell orange soda. The following payoff matrix shows the profit (in millions of dollars) each company will earn depending on whether or not it advertises: 

For example, the upper right cell shows that if Fizzo advertises and Pop Hop doesn't advertise, Fizzo will make a profit of \(\$ 15\) million, and Pop Hop will make a profit of \(\$ 2\) million. Assume this is a simultaneous game and that Fizzo and Pop Hop are both profit-maximizing firms.

If Fizzo decides to advertise, it will earn a profit of \(\$\) million if Pop Hop advertises and a profit of \(\$\) million if Pop Hop does not advertise.

If Fizzo decides not to advertise, it will earn a profit of \(\$\) million if Pop Hop advertises and a profit of \(\$\) million if Pop Hop does not advertise.

If Pop Hop advertises, Fizzo makes a higher profit if it chooses

If Pop Hop doesn't advertise, Fizzo makes a higher profit if it chooses

 

Suppose that both firms start off not advertising. If the firms act independently, what strategies will they end up choosing? 

• Both firms will choose not to advertise. 

• Fizzo will choose to advertise and Pop Hop will choose not to advertise. 

• Both firms will choose to advertise. 

• Fizzo will choose not to advertise and Pop Hop will choose to advertise. 

 

Again, suppose that both firms start off not advertising. If the firms decide to collude, what strategies will they end up choosing? 

• Fizzo will choose not to advertise and Pop Hop will choose to advertise. 

• Both firms will choose not to advertise. 

• Both firms will choose to advertise. 

• Fizzo will choose to advertise and Pop Hop will choose not to advertise.

Answer 1

1. If Fizzo decides to advertise, it will earn a profit of $8 million if pop hop advertises and a profit of $15 million if pop hop does not advertise.

2. If Fizzo decides not to advertise, it will earn a profit of $2 million if pop hop advertises and a profit of $11 million if pop hop does not advertise.

3. If pop hop advertises, Fizzo makes a higher profit if it chooses to advertise.
  As can be seen from the matrix, when pop hop advertises, Fizzo will make a profit of 2 million if it doesnt advertise or of 8 million if it advertises.

4. If pop hop doesnt advertise , Fizzo makes a higher profit if it chooses to advertise.
  Again, as seen from matrix, when pop hop doesnt advertise, Fizzo will make a profit of 11 by not advertising and 15 by advertising.

5. Suppose that both firms start off not advertising. If the firms act independently, what strategies will they end up choosing?
We need to find the Nash Equilibria here. Since they are acting independently, one of the firms will move to advertising as it will increase the revenue to 15 million. It will also reduce the other firm's revenue to 2. Seeing this, the other firm will move to advertising as well, resulting in both earning 8 million dollars. This is the Nash Equilbria as neither firm has any move left that will make its situation better. The only option remaining is to not advertise, but that will reduce its profit to 2 million, lesser than the current 8.
Hence, the right answer is C- both firms will choose to advertise.

6. Again, suppose that both firms start not advertising. If the firms decide to collude, what strategies will they end up choosing?
Since the firms are colluding, the aim is to maximize total profit. Total profit gets maximized when both firms decide not to advertise, as the total profit there is 22 million- higher than any other combination.
Hence, the correct answer is B- both firms will choose not to advertise.