The managers of Alpha and Beta must make repeated advertising decisions simultaneously at the beginning of every month.They choose either low or high levels of advertising expenditure.They both employ a discount rate of 2.5 percent per month. If Beta decides not to cooperate,its undiscounted benefit from cheating for one month is

Question

The managers of Alpha and Beta must make repeated advertising decisions simultaneously at the beginning of every month.They choose either low or high levels of advertising expenditure.They both employ a discount rate of 2.5 percent per month.  If Beta decides not to cooperate,its undiscounted benefit from cheating for one month is

Quizplus · Accepted Answer

If Beta decides not to cooperate, it means choosing high advertising expenditure while Alpha chooses low advertising expenditure. In this scenario, Beta's benefit would be ($6,000 - $3,500) = $2,500. However, this benefit is undiscounted, and we need to discount it back to present value using the discount rate of 2.5% per month.

The present value of $2,500 for one month is calculated as follows:

PV = $2,500 / (1 + 0.025) = $2,439.02

Therefore, the undiscounted benefit from cheating for one month is $2,500, but the present value of this benefit is $2,439.02.

Now, let's look at the best choice(s) for the managers of Alpha and Beta. This is a simultaneous game, and there are multiple equilibria, but one possible equilibrium is both choosing high advertising expenditure every month.

The payoffs for this equilibrium are as follows:

- Alpha's payoff = $4,000 per month
- Beta's payoff = $3,000 per month

Both managers could potentially increase their payoffs by deviating from this equilibrium, but if one manager deviates while the other sticks to the equilibrium, the deviator would get a lower payoff.

Therefore, both managers are better off sticking to the equilibrium of high advertising expenditure every month.

The Managers of Alpha and Beta Must Make Repeated Advertising