Scenario 17-4.

Consider two cigarette companies, PM Inc. and Brown Inc. If neither company advertises, the two companies split the market and earn $50 million each. If they both advertise, they again split the market, but profits are lower by $10 million since each company must bear the cost of advertising. Yet if one company advertises while the other does not, the one that advertises attracts customers from the other. In this case, the company that advertises earns $60 million while the company that does not advertise earns only $30 million.
-Refer to Scenario 17-4. What will these two companies do if they behave as individual profit maximizers?
A)Neither company will advertise.
B)Both companies will advertise.
C)One company will advertise, the other will not.
D)There is no way of knowing without knowing how many customers are stolen through advertising.

Question

Scenario 17-4.
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Consider two cigarette companies, PM Inc. and Brown Inc. If neither company advertises, the two companies split the market and earn $50 million each. If they both advertise, they again split the market, but profits are lower by $10 million since each company must bear the cost of advertising. Yet if one company advertises while the other does not, the one that advertises attracts customers from the other. In this case, the company that advertises earns $60 million while the company that does not advertise earns only $30 million.
-Refer to Scenario 17-4. What will these two companies do if they behave as individual profit maximizers?
A)Neither company will advertise.
B)Both companies will advertise.
C)One company will advertise, the other will not.
D)There is no way of knowing without knowing how many customers are stolen through advertising.

Quizplus · Accepted Answer

Both companies will advertise because each company has an incentive to advertise to increase its own profit, leading to a Nash equilibrium where both advertise and earn $40 million each.

Scenario 17-4. ​

Scenario 17-4.