Question

Consider two firms, Royal Flush Plumbing and Bottoms Up Plumbers, that are competing for customers in a small market. Each firm must decide whether to advertise heavily or to not advertise. Each firm prefers to advertise more than its competitor because this attracts customers. But each firm also prefers to save money. The table shows the possible outcomes for each decision combination. The numbers in each cell represent the firm’s profit of the outcome (in millions).

a) if Royal Flush decides to advertise, then what is Bottoms Up’s best response? b) if Royal Flush decides not to advertise, then what is Bottoms Up’s best response? c) if Bottoms Up decides to advertise, then what is Royal Flush’s best response? d) if Bottoms Up decides not to advertise, then what is Royal Flush’s best response? e) Does either firm have a dominant strategy? If so, what is(are) it(they)? f) If both firms could collude, what would they choose?

	Royal Flush: Advertise	Royal Flush: Not Advertise
Bottoms Up: Advertise	Bottoms Up: $2.5 Royal Flush: $2.5	Bottoms Up: $2.8 Royal Flush: $2.1
Bottoms Up: Not Advertise	Bottoms up: $2.1 Royal Flush: $2.8	Bottoms Up: $2.6 Royal Flush: $2.6

Answer 1

A) To advertise

B) To advertise

C) to advertise

D) to advertise

E) Both the firms have a dominant strategy to advertise.

F) If they collude they would choose not to advertise and both earn a payoff of $2.6