Refer to the normal-form game of advertising shown below. Suppose there is a 50 percent chance that the advertising game depicted in Figure 10-17 will end next period. The collusive agreement {(not advertise, not advertise)} is: A) sustainable since $175 $50.

Question

Refer to the normal-form game of advertising shown below. Suppose there is a 50 percent chance that the advertising game depicted in Figure 10-17 will end next period. The collusive agreement {(not advertise, not advertise)} is: A) sustainable since $175 < $250. B) unsustainable since $175 < $25. C) sustainable since $20 > $50. D) unsustainable since $350 > $50.

Quizplus · Accepted Answer

The collusive agreement is {(not advertise, not advertise)}. If this agreement is followed, each firm earns a profit of $175.

If one firm deviates and advertises while the other does not, the firm that advertises earns a profit of $350 while the other earns $0.

If both firms advertise, they each earn a profit of $20.

Given that there is a 50 percent chance that the game ends next period, we need to consider the expected profits from each action.

If both firms follow the collusive agreement, their expected profits are:

(0.5)($175) + (0.5)($175) = $175

If one firm deviates and advertises while the other does not, the expected profits are:

(0.5)($0) + (0.5)($350) = $175

If both firms advertise, the expected profits are:

(0.5)($20) + (0.5)($20) = $20

Therefore, the collusive agreement is the best choice for both firms as it gives them the highest expected profit of $175.

Refer to the Normal-Form Game of Advertising Shown Below