Game theory to determine whether or not firm will advertise

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Consider the premier coffee industry, assuming Starbucks and Peet’s Coffee are the only two firms in the market. Both firms are contemplating the decision to advertise or not (for simplicity, assume the firms only decide whether or not to advertise, not how much to advertise). If neither firm advertises, they each earn profits of $1 million. However, if both firms advertise, each firm's demand will be unaffected although both firms will have to pay advertising costs and each will earn profits of $500,000. If one firm advertises and the other doesn't, the firm that advertises will attract customers from the other and the advertising firm's profits will jump to $2 million. The firm that doesn't advertise in this case loses so many customers that profits fall to $250,000. Use game theory to determine whether or not each firm will advertise. Explain your answer.

Reference no: EM131102764

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