Question

Tobacco companies have often argued that they adver- ti se to attract more people who already smoke and not to persuade more people to begin smoking. Suppose there were just two cigarette manufacturers, Jones and Smith Each can either advertise or not advertise. If neither advertises, they each capture 50 percent of the market and each earns $10 million. If they both advertise, they again split the market evenly, but each spends $2 mil- lion on ads and so each earns just $8 million (remember advertising is not supposed to encourage more people to smoke). If one company advertises but the other does not, then the company that advertises attracts many of its rival's customers. As a result, the company that adver- tises earns $12 million and the company that does not earns just $6 million.
a. Show that advertising is a dominant strategy.

b. Suppose the government proposes a ban on cigarette ads. Should the two cigarette companies favor the ban or should they oppose the ban if advertising did not persuade some people to become smokers?

Answer 1

Answer: Please see below for answer

Explanation:

                                          Jones

                                 Advertise      NOT to  advertise

 Smith    Advertise         8,8                  12,6

           NOT to  advertise  6,12                  10,10

To show that advertising is a dominant strategy.

Here if smith advertises, the best option is for Jones to advertise too since Jones will be getting a high pay off of $8million. when Smithy fails to advertise, the best option is for Jones to stll advertise sinvehe will be getting a higher payoff of $12 million. The dominant strategy is for Jones to advertise.

In the same vein, if Jones advertises, the best option for smith is to advertise too since he will get a high pay off same with ones at $8million. and if Johns fails to advertise, Smith should still advertise since he will be getting a higher pay off of $12million than $6million making the dominant strategy for smith to be in favor of advertisement.

This shows that advertising is a dominant strategy as a higher payoff is guaranteed.

b) If the government places a ban on  cigarette ads, both firms will receive $10 million as neither of them will be able to advertise , than when both firms advertise with a pay off of $8million.  The two firms should favor the ban as they will receive a higher payoff if both do not advertise.