Consider two firms X and Y produce identically tasting cold drinks. In order to increase the demand for its cold drink, firm X increases its advertisement outlay. However the advertising doesn’t increase its demand in the long run. Explain why this must be the case.
use pd game theory and incorporate the following: How are the two firms producing soda similar to a classic PD game? Try setting up a game matrix where the two firms have the following choices- keep the same level of advertising or increase the level of advertising. Which choice will the firm always make, regardless of the actions of the other firm? The outcomes could be market share or profit.
please offer any insight as once again, i am extremely comfused and only can figure out that if one firm keeps the same level of advertising their will be equal profits as the demand reaches a equilibrium with the other firms profits. if the other advertsier increases the advertsing their profits will exceed the other firm.
*please, please help me to answer correctly. it is imperative that i get a more detail answer. thank you.
mary hornbeck
In this scenario, let's analyze the situation using game theory, specifically the concept of a Prisoner's Dilemma (PD) game. The PD game is often used to explain situations where individuals or firms are faced with a choice between cooperating or competing, and where the outcome depends on the choices made by all parties involved.
Let's consider the two firms, X and Y, and their choices regarding advertising. The choices can be represented as follows:
```
| X Keeps Advertising | X Increases Advertising |
-------------------------------------------------------------
Y Keeps Adv. | (a, b) | (c, d) |
-------------------------------------------------------------
Y Increases | (e, f) | (g, h) |
Advertising | | |
-------------------------------------------------------------
```
In this matrix, the payoffs represent the outcomes in terms of market share or profit. The specific values (a, b, c, d, e, f, g, h) would depend on the specific circumstances of the firms and the market.
Now, let's analyze the choices and possible outcomes:
1. If both firms keep the same level of advertising (top left cell): Suppose X and Y both decide to keep the same level of advertising. They both continue with their current advertising expenditure. This scenario results in some outcome (a, b) in terms of market share or profit. The payoffs could be equal or unequal, depending on the specific circumstances.
2. If firm X increases advertising and Y keeps the same level (top right cell): In this case, firm X increases its advertising expenditure while firm Y maintains its current level. Consequently, firm X may see an increase in its market share or profit, resulting in an outcome (c, d). However, since firm Y did not increase its advertising, it may not experience any negative consequences in terms of market share or profit.
3. If both firms increase advertising (bottom right cell): Suppose both firm X and firm Y decide to increase their advertising expenditure. This scenario can lead to a result (g, h) in terms of market share or profit for each firm. Again, the specific outcomes would depend on the specific circumstances.
Now, looking at the matrix, we can see that regardless of what choice firm Y makes, firm X has an incentive to increase its advertising expenditure. In all cases, X's payoffs for increasing advertising are either equal to or greater than its payoffs for keeping the same level of advertising (i.e., c >= a and g >= e, assuming profits or market share increase with increased advertising).
Therefore, firm X will always choose to increase its advertising expenditure, regardless of the actions of firm Y. This can lead to a situation where both firms end up increasing their advertising expenditure, as seen in the bottom right cell of the matrix.
However, it's important to note that in the long run, the additional advertising expenditure by firm X does not increase its demand. This could be due to various reasons, such as the market already reaching saturation with advertising, consumers not perceiving a significant difference between the two brands, or other factors beyond advertising affecting consumer preferences. As a result, firm X does not see a sustained increase in demand despite its increased advertising expenditure.
In order to explain why increasing advertising doesn't increase demand for firm X's cold drink in the long run, we can analyze the situation using game theory, specifically the Prisoner's Dilemma (PD) game.
In this scenario, firm X and firm Y are producing identically tasting cold drinks. They both have the choice to either keep the same level of advertising or increase their advertising expenditure.
Let's set up a game matrix to represent the choices and outcomes:
```
| Firm Y keeps same advertising | Firm Y increases advertising
-----------------------------------------------------------------
Firm X keeps | (a, b) | (c, d)
same level | |
of advertising| |
-----------------------------------------------------------------
Firm X | (e, f) | (g, h)
increases | |
advertising | |
```
In this matrix:
- The outcomes (a, b, c, d, e, f, g, h) represent the market share or profit levels for firm X and firm Y, depending on their choices.
- The letters (a, b, c, d, e, f, g, h) are just placeholders and can be any numbers that represent the respective outcomes.
To determine which choice each firm will always make, we need to examine the payoffs for different scenarios.
If firm Y keeps the same level of advertising, let's focus on firm X's decision. Regardless of the choice made by firm X, firm Y's payoffs will not change. Hence, firm X will choose the action that maximizes its own payoff, whether it keeps the same level of advertising or increases advertising.
If firm Y increases its advertising, again, firm X will choose the action that maximizes its own payoff, irrespective of the choice made by firm Y.
Now let's analyze the situation. If both firms keep the same level of advertising, a possible outcome could be that they both achieve a balanced market share or equal profits (a). This equilibrium is achieved as both firms are producing identical products with similar levels of advertising.
Consider the scenario where firm X increases its advertising while firm Y keeps the same level. In this case, firm X may attract more customers and achieve a higher market share or profit (e). However, as firm Y hasn't increased its advertising, it may not be able to compete effectively and may experience a decrease in market share or profit (f). Firm X gains an advantage in this situation.
But here is where the dilemma arises. If both firms independently decide to increase their advertising, the result may not be as favorable for both. They could end up in a situation where they both spend more on advertising (g) but don't gain a significant advantage in terms of market share or profit (h). In this scenario, both firms may end up worse off than if they had chosen to keep the same level of advertising.
This PD game matrix suggests that in the long run, increasing advertising expenditure may not necessarily lead to increased demand for firm X's cold drink. Both firms have an incentive to increase their advertising to gain a competitive advantage, but if both firms do so, it can lead to a suboptimal outcome for both.
Thus, firm X's increased advertising won't necessarily result in long-term increased demand, as it depends on the actions of firm Y and the overall dynamics of the market.