OMBA 6921 – Industrial Economics WB Spring 2022
Assignment 5 – 42 points - Due Sunday, April 24
XXXXXXXXXXGM and Chrysler both must decide whether to invest in a new process. Games 1 and 2 below show how their profits depend on the decision they might make.
GAME 1
GAME 2
Chrysle
Chrysle
Invest
Don’t
Invest
Invest
Don’t
Invest
Invest
5 for each
GM=12
Chrysler=4
Invest
GM=12
Chrysler=4
10 for each
GM
GM
Don’t
GM=4
Chrysler=12
10 for each
Don’t
5 for each
GM=4
Chrysler=12
Invest
Invest
a) (4) What is the Nash equili
ium from each game?
) (6) Which of the games above (1, 2, both or neither) represents a prisoner’s dilemma? Explain.
XXXXXXXXXXSuppose that two clothing manufacturers, Lands’ End and L.L. Bean, are deciding what price to charge for very similar field coats. The cost of producing these coats is $100. The coats are very close substitutes, so customers flock to the seller that offers the lowest price. If both firms offer identical prices, each receives half the customers. For simplicity, assume that the two firms have the choice of pricing at prices of $103, $102, or $101. The profit each firm would earn at various prices (Lands’ Ends Profit, LL Bean’s Profit) is shown in the payoff matrix below.
LL Bean
$103
$102
$101
$103
($150, $150)
($0, $220)
($0, $120)
Lands' End
$102
($220, $0)
($110, $110)
($0, $120)
$101
($120, $0)
($120, $0)
($60, $60)
a. (4) What is the Nash equili
ium and expected profits to LL Bean and Lands’ End of this game?
XXXXXXXXXXSuppose this is a mixed strategy game in which LL Bean has a 25% percent chance of choosing a price of $101, a 25% chance of choosing price of $102, and a 50% chance of choosing $103, while Lands End has a 1/3 chance of choosing each strategy. What’s the expected payoff to LL Bean?
c. (4) Suppose that in hopes of raising prices, L.L. Bean announces the price for its coat early in the summer (before Lands’ End announces their prices). Do you think this strategic move be successful for LL Bean? Explain.
XXXXXXXXXXSuppose you manage a large company’s marketing department and are responsible for deciding whether or not to advertise in the Super Bowl. Your team of analysts estimate that for each advertisement, your firm would generate $5 million in additional revenue for the company. It costs $6.5 million to run a 30-second advertisement. Therefore, your company would expect to lose $1.5 million in profit for each advertisement.
a) (3) Explain why it could still be worthwhile to purchase an advertisement, even though you know in advance that your company would lose $1.5 million in profit?
) (7) Depict this situation with a game theory payoff matrix. Your company (A) and a major competitor (B) have two potential strategies: to advertise or to not advertise during the Super Bowl. The payoffs in each cell represent the change in firm profits from advertising. Create payoffs in each cell such that the Nash equili
ium is that both firms advertise despite having a higher profit if neither firm advertised.
XXXXXXXXXXPrevious research suggests that many firms ‘over - invest’ in advertising - meaning spend beyond a point where advertising positively affects a firm’s bottom line (if interested see here: Advertising Effectiveness) . Game Theory can explain some of this, but not all. What else can explain why many firms over invest in advertising? Are there are any reasons for firms to advertise beyond wanting to increase profits? Note: two recent Freakonomics on this topic can be found here: https:
freakonomics.com/podcast/advertising-part-1 and https:
freakonomics.com/podcast/advertising-part-2 You don’t have to listen to both podcasts to answer the question but I recommend it anyway.