Question

Company A and Company B are a duopoly, an oligopoly of only two firms. Neither company advertises its product and both firms earn $10 million in profits. Company A is considering increases to its advertising budget which would raise its profits to $12 million. Below is the payoff matrix for both companies and their decision as to whether to advertise or not.

Company A' Profits
Don't Adevertise Advertise
Don't Advertise A: $10 million A: $12 million
B: $10 million B: $6 million
Company B's Profits A: $6 million A: $8 million
B: $12 million B: $8 million
If Company A increases its advertising budget, Company B should:____.
A. Shut down.
B. Continue to not advertise.
C. Increase its advertising budget.
D. Increase the price it charges to increase profits.

Answer 1

Answer: C. Increase its advertising budget.

Step-by-step explanation:

If Company A advertises and Company B does not, Company B profits are $6 million compared to $12 million for Company A. If both company advertise, they both have a profit of $8 million.

It is therefore important that when A advertises, B should advertise as well. This is why B should increase its advertising budget when A does because it will lead to them having a better income than they would should A advertise more.