Question

Consider two cigarette companies, pm inc. and brown inc. if neither company advertises, the two companies split the market and earn $50 million each. if they both advertise, they again split the market, but profits are lower by $10 million since each company must bear the cost of advertising. yet if one company advertises while the other does not, the one that advertises attracts customers from the other. in this case, the company that advertises earns $60 million while the company that does not advertise earns only $30 million. refer to scenario 17-4. if these two companies collude and agree upon the best joint strategy,
a. neither company will advertise.

b. both companies will advertise.

c. pm inc. will advertise but brown inc. will not.

d. brown inc. will advertise but pm inc. will not.

Answer 1

To solve this problem, let us try to break down each scenario one by one. We must calculate the total earnings that the two companies receive for each scenario.

Scenario 1: Neither company advertise

Earning of PM Inc = $ 50 M

Earning of Brown Inc = $ 50 M

Total Earning = $ 100 M

 

Scenario 2: Both companies advertise

Earning of PM Inc = $ 40 M

Earning of Brown Inc = $ 40 M

Total Earning = $ 80 M

 

Scenario 3: One company advertise, let us say PM Inc is the company who advertise and Brown Inc does not

Earning of PM Inc = $ 60 M

Earning of Brown Inc = $ 30 M

Total Earning = $ 90 M

 

We can see that Scenario 1 has the largest total earnings of all scenarios. Therefore the best strategy is:

A. neither company will advertise