What is the economic intuition behind this result

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Imagine that two cigarette companies are competing in a market. They each charge the same constant price p < 2 (taken as given). In order to increase their market share, they must advertise. Let a1 denote the number of hours of advertisement from firm 1, and a2 denote the number of hours of advertisement from firm 2. We assume that the cost from each firm i ∈ {1, 2} from advertising ai hours is given by a 2 i . We assume that, if firm i advertises ai units and its rival advertises a−i units, then the quantity demanded from firm i will be given by (1 + (ai − a−i)). a) Assuming that both players choose a1 and a2 simultaneously, show that setting ai = p/2 is a strictly dominant strategy for both players. 1 b) If the government imposes a regulation that prohibits each firm from advertising whatsoever (i.e., that specifies that a1 = a2 = 0), then would the firms become better off or worse off? What is the economic intuition behind this result?

Reference no: EM13896948

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