Table 17-28
Suppose that two firms determine that each could lower its costs and increase its profits if both reduced their advertising budgets. But in order for the plan to work, each firm must agree to refrain from advertising. Each firm believes that advertising works by increasing the demand for the firm's product, but each firm also believes that if neither firm advertises, the cost savings will outweigh the lost sales. The table below lists each firm's individual profits:
Firm A
Breaks agreement Maintains agreement
and advertises and does not advertise
-Refer to Table 17-28. Which of the following statements does not correctly characterize the outcome of this game?
A)There is a Nash equilibrium.
B)Both firms collectively would earn the highest joint profits by maintaining the agreement not to advertise.
C)Only one firm has a dominant strategy.
D)The game is an example of the Prisoners' Dilemma.

Question

Table 17-28
Suppose that two firms determine that each could lower its costs and increase its profits if both reduced their advertising budgets. But in order for the plan to work, each firm must agree to refrain from advertising. Each firm believes that advertising works by increasing the demand for the firm's product, but each firm also believes that if neither firm advertises, the cost savings will outweigh the lost sales. The table below lists each firm's individual profits:
Firm A
Breaks agreement Maintains agreement
and advertises and does not advertise 
-Refer to Table 17-28. Which of the following statements does not correctly characterize the outcome of this game?
A)There is a Nash equilibrium. 
B)Both firms collectively would earn the highest joint profits by maintaining the agreement not to advertise. 
C)Only one firm has a dominant strategy. 
D)The game is an example of the Prisoners' Dilemma.

Quizplus · Accepted Answer

Both firms have a dominant strategy of not advertising, as it results in higher profits regardless of the other firm's choice. Therefore, statement C is incorrect as both firms have a dominant strategy. The game is indeed an example of the Prisoners' Dilemma as both firms would collectively earn higher profits by maintaining the agreement, but each firm has a selfish incentive to break the agreement and advertise. There is a Nash equilibrium in which both firms choose not to advertise, as neither has an incentive to deviate from this strategy given the other's choice.

Table 17-28 Suppose That Two Firms Determine That Each Could Lower Its