Table 17-29
Suppose that two firms, Wild Willy's Wonderdrink (Firm W) and Hyper Hank's Hydration (Firm H), comprise the market for energy drinks. Each firm determines that it could lower its costs and increase its profits if both firms reduced their advertising budgets. But 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 energy drinks, 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 W
Breaks agreement Maintains agreement
and advertises and does not advertise
-Refer to Table 17-29. Which of the following statements does not correctly characterize the outcome of this game?
A)There is a Nash equilibrium.
B)Only one firm has a dominant strategy.
C)The game is an example of the Prisoners' Dilemma.
D)Both firms collectively would earn the highest joint profits by maintaining the agreement not to advertise.

Question

Table 17-29
Suppose that two firms, Wild Willy's Wonderdrink (Firm W) and Hyper Hank's Hydration (Firm H), comprise the market for energy drinks. Each firm determines that it could lower its costs and increase its profits if both firms reduced their advertising budgets. But 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 energy drinks, 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 W
Breaks agreement Maintains agreement
and advertises and does not advertise 
-Refer to Table 17-29. Which of the following statements does not correctly characterize the outcome of this game?
A)There is a Nash equilibrium. 
B)Only one firm has a dominant strategy. 
C)The game is an example of the Prisoners' Dilemma. 
D)Both firms collectively would earn the highest joint profits by maintaining the agreement not to advertise.

Quizplus · Accepted Answer

Both firms have the same payoff for either breaking or maintaining the agreement, so neither has a dominant strategy. It is a classic example of the Prisoners' Dilemma, where the Nash equilibrium is for both firms to break the agreement and advertise, resulting in lower overall profits. Therefore, D is the correct statement, as both firms could earn higher profits by maintaining the agreement, but this outcome is not reached in the Nash equilibrium.

Table 17-29 Suppose That Two Firms, Wild Willy's Wonderdrink (Firm W) and W)