Refer to the normal-form game of advertising shown below. Suppose there is a 90 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 90 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 < $138.89. B) unsustainable since $175 < $138.89. C) sustainable since $11.11 > $50. D) unsustainable since $11.11 > $50.

Quizplus · Accepted Answer

If the collusive agreement {(not advertise, not advertise)} is chosen in the current period, there is a 90% chance that the game will end next period. In the next period, if both players stick to the agreement, they will split the market and earn $50 each. Therefore, the expected payoff for each player from following the agreement is:
(0.9)($50) + (0.1)($400) = $91

However, if one player deviates from the agreement and advertises, they will capture the entire market and earn $175. The other player who sticks to the agreement will earn nothing. Therefore, the expected payoff from deviating is:
(0.9)($0) + (0.1)($175) = $17.5

Since $17.5 > $0, there is an incentive for both players to deviate from the agreement and advertise. Therefore, the collusive agreement is unsustainable and the best choice for each player is to advertise in this situation.

Refer to the Normal-Form Game of Advertising Shown Below