Suppose that Creamland and Dairy King are the only two firms

Suppose that Creamland and Dairy King are the only two firms that sell ice cream. The following payoff matrix shows the profit (in millions of dollars) each company will earn depending on whether or not it advertises: Dairy King Advertise Doesn\'t Advertise Advertise 10.10 18, 2 Creamland Doesn\'t Advertise 2,18 11, 11 For example, the upper right cell shows that if Creamland advertises and Dairy King doesn\'t advertise, Creamland will make a profit of $18 million, and Dairy King will make a profit of $2 million. Assume this is a simultaneous game and that Creamland and Dairy King are both profit-maximizing firms. If Creamland decides to advertise, it will earn a profit of $ million if Dairy King advertises and a profit of S million if Dairy King does not advertise If Creamland decides not to advertise, it will earn a profit of $ million if Dairy King advertises and a profit of $ million if Dairy King does not advertise. If Dairy King advertises, Creamland makes a higher profit if it chooses If Dairy King doesn\'t advertise, Creamland makes a higher profit if it chooses

Solution

Creamland advertise and Dairy King advertise - $ 10

Creamland advertise and Dairy King does not advertise - $ 18

Creamland does not advertise and Dairy King advertise - $ 2

Creamland does not advertise and Dairy King does not advertise - $ 11

If Dairy King advertises, Creamland makes higher profit if it chooses - Advertise

If Dairy King does not advertise, Creamland makes higher profit if it chooses - Advertise

If they act indpendently then they will end up choosing (Advertise, Advertise) because this is the Nash Equilibrium.

If they collude then they will end up choosing (Dosent Advertise, Dosent Advertise) because this action gives them the higher profits and they can agree to take the same action beneficial to both.

It might be easier to achieve the cooperative outcome if the payoffs of the game were doubled. This would ensure that by cheating no party will be better off than by cooperaing. Hence there will be no incentive to cheat.

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