Consider the premier coffee industry, assuming Starbucks and Peet’s Coffee are t

Question

Consider the premier coffee industry, assuming Starbucks and Peet’s Coffee are the only two firms in the market. Both firms are contemplating the decision to advertise or not (for simplicity, assume the firms only decide whether or not to advertise, not how much to advertise). If neither firm advertises, they each earn profits of $1 million. However, if both firms advertise, each firm's demand will be unaffected although both firms will have to pay advertising costs and each will earn profits of $500,000. If one firm advertises and the other doesn't, the firm that advertises will attract customers from the other and the advertising firm's profits will jump to $2 million. The firm that doesn't advertise in this case loses so many customers that profits fall to $250,000. Use game theory to determine whether or not each firm will advertise. Explain your answer.

Explanation / Answer

It can be presented in game form as a matrix representing the payoffs to each of the firm

Firm1/Firm2 Advertize Not Advertize

Advertize $500,000,$500,000 $2,000,000 , $250,000

Not Advertize $250,000 , $2,000,000 $1,000,000 , $10,00,000

SO, THE NASH EQUILIBRIUM OF THIS GAME IS (ADVERTIZE,)

As the dominant strategy of both the firm is to advertize , which means given the stategy of other firm to Advertize, the firm's best stratgy will be to Advertize and given the strategy of other firm to not Advertize, the firm's best strategy is to Advertize. Hence regardless of other firm's strategy each firms best strategy is to Advertize and hence Nash Equilibrium is to Advertiz by both firms.

If you don't understand anything then comment, I'ill revert back on the same. :)

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