Chapter 9: Economics of Strategy: Game Theory
FAVORING A GOVERNMENT BAN ON ADVERTISING
Discussion Question Answers:
1. The following hypothetical two-company game illustrates why cigarette companies might
favor a government ban on advertising. The payoffs in this game assume that the overall market
demand for cigarettes is not influenced by advertising. Advertising, however, does affect the
The payoffs in the game are based on the following underlying assumptions (students can
illustrate the same economic intuition through similar games using different hypothetical
payoffs). Total industry cigarette sales are fixed at $200 (million) independent of the amount of
The Nash Equilibrium (highlighted in the graph) is for both firms to advertise. This game is
similar in spirit to the prisoner’s dilemma. While the firms are better off jointly if they do not
advertise, they have strong private incentives to advertise. For example if one firm chooses not to
2. It is not correct to conclude that firms in all industries will favor bans on advertising. The
hypothetical game assumes that the industry demand is not affected by the amount of advertising.
In the resulting equilibrium, each firm advertises and gets ½ the market. This same gross sales
are obtained when both firms refrain from advertising. The government ban in effect forces each
firm to honor an agreement not to advertise. It is easy to envision situations where advertising
might affect overall industry demand and the firms are jointly better off if they advertise. For
example, drug companies might increase the industry demand for various categories of drugs by
The hypothetical example also assumes symmetry in payoffs between the two firms. It is easy to
envision situations where one firm such as an established incumbent might favor a ban on
advertising to limit competition from less well known competitors, while a less established
company might want to advertise to make customers aware of its products.
LET’S MAKE A DEAL
Discussion Question Answers:
Many people initially have trouble understanding the economic intuition for this result. They
argue that since there are two remaining doors that there is a ½ probability that it is behind Door
When you initially choose Door #1 there is a 1/3 chance that you have hit the jackpot. There is a
2/3 chance that you have not. After your initial choice the host shows you a door. He knows
which door has the $100,000. He will never open that door. If you choose Door #1 and the
The key idea is that the host’s choice of which door to show you is not random. Rather he
You have chosen Door 1 at Node 1. The host subsequently makes a choice at Node 2. There is a
1/3 chance that your choice, Door #1 contains the grand prize. There is a 2/3 chance that the
$100,000 is behind either Door #2 or Door #3. Whenever the big money is behind one of these
Try playing the game with a friend who acts as the host if you have trouble understanding the
intuition. Take three cards from a deck and designate one as the $100,000 prize (e.g., the ace of
spades). Move first by choosing one of the cards at random. Set the card aside without looking to
see if you have selected the grand prize. Have your friend play the role of the host. He should
3. One of the major lessons you should learn from the game show example is that it is very
useful to put yourself in the other person’s shoes in strategic settings and to analyze the problem
from their perspective. This type of reasoning can often give you important insights into what
actions you should take. Another lesson is that negotiators often have private information. For
example, similar to the game show host, the current owner of an asset will often have better
HOLLAND SWEETNER VERSUS MONSANTO
Discussion Question Answers:
1. The Nash equilibrium is for both firms to price low. Pricing low is a weakly dominant
strategy for Holland Sweetner. It loses $25 million in all situations unless Monsanto prices high
2. No. They will lose $25 million if they enter and zero if they stay out.
3. Ex post it appears to have been a mistake. Entry, however, may have been a reasonable
business decision ex ante given the information available at that time. Managers work with
imperfect information. The managers at Holland Sweetener may have made some faulty
4. They may have been acting strategically to reduce Monsanto’s power to extract a high price
5. Monsanto, by moving first was able to gain consumer acceptance. At equal prices the soft
drink companies would rather deal with Monsanto than a new supplier. This gave them an
advantage in the marketplace. Many would-be competitors may have realized that it was
6. They were able to use the threat of shifting to Holland Sweetener to negotiate a lower price
with Monsanto. Monsanto may have made some profits on the deal because of their consumer