Question

There are two plant nurseries in a small town. They are called Tumbleweed and Native Roots. If neither advertises, Tumbleweed makes $80,000 a month in profits and Native Roots makes $95,000. Advertising would cost each firm $20,000 a month. If only one firm advertises, that firm increases sales by $50,000 a month whereas the nonadvertising firm loses out. If Tumbleweed doesn't advertise but Native Roots does, Tumbleweed loses $30.000 a month. If Native Roots doesn't advertise but Tumbleweed does, it loses $35,000 a month. If both advertise, they increase revenue by $15,000 each. Insofar as they grow their products from the ground, they don't have any increased costs when they have increased sales (that is, their marginal cost of production is $0).
Part 1 What is the amount of profit Tumbleweed makes when both advertise?
How much profit does Native Roots make when both advertise?
Part 2 What outcome is predicted (that is, the Nash equilibrium) for these two firms, given the figures above?
Choose one: •
A. Both firms advertise.
B. Tumbleweed advertises, but Native Roots doesn't.
C. Native Roots advertises, but Tumbleweed doesn't.
D. Neither firm advertises.

Answer 1

Answer:

1. a. $75,000

b. $90,000

c. A. Both firms advertise.

Explanation:

1. a.  Tumbleweed profits when both advertise.

When both advertise they get an increased revenue of $15,000 however they will pay $20,000 for adverts which means they will have a net gain from advertising of -$5,000.

Tumbleweed profits = Amount when non advertises + Gain from advertising

= 80,000 + ( - 5,000)

= $75,000

b.  Native Roots profit if both advertise;

= Amount when non advertises + Gain from advertising

= 95,000 + ( 15,000 - 20,000)

= $90,000

2. A. Both firms advertise.

The Nash Equilibrium is the strategy that either of the two plant nurseries will take and not have to worry about the actions of the other nursery because this strategy provides the highest payoff regardless of their competitors actions.

Both firms advertising will be that strategy because if neither advertise, one will then advertise and the other would make losses so will then advertise as well.