Question

Advertising: Two firms compete in the breakfast cereal industry producing Wheat Krinkles cereal (Firm A) and Rice Krinkles cereal (Firm B). Each manufacturer must decide whether to promote its product with a large or small advertising budget. The potential profits for these firms are as follows (in millions of dollars):

		Firm A's Actions
		Small Advertising Budget	Large Advertising Budget
Firm B's Actions	Small Advertising Budget	$50M $50M	$30M $150M
	Large Advertising Budget	$140M $20M	$150M $150M

(a) Do both firms have dominant strategies?

(b) What will be the most probable outcome of the game?

Answer 1

If Firm A goes for small advertising budget then Firm B will go for large advertising budget as pay-off is greater for Firm B in that case.

If Firm A goes for large advertising budget then Firm B will go for large advertising budget as well as pay-off is greater for Firm B in that case.

It can be seen that Firm B will always adopt strategy of large advertising budget whatever be the strategy adopetd by the Firm A.

So, Firm B has dominant strategy (large advertising budget).

If Firm B goes for small advertising budget then Firm A will go for large advertising budget as pay-off is greater for Firm A in that case.

If Firm B goes for large advertising budget then Firm A will go for large advertising budget as well as pay-off is greater for Firm A in that case.

It can be seen that Firm A will always adopt strategy of large advertising budget whatever be the strategy adopetd by the Firm B.

So, Firm A has dominant strategy (large advertising budget).

When both firms has dominant strategy then nash equilibrium is the combination of dominant strategies.

So, nash equilibrium is (large advertising strategy, large advertising strategy).

Thus,

(a)

Both firms have dominant strategy. The dominant strategy of each firm is to adopt large advertising budget.

(b)

The most probable outcome of this game is that both firms will adopt the strategy of promoting their product with large advertising budget.