Micro Business Economics Philip Morris

Question: Discuss about the Micro Business Economics by Philip Morris. Answer: (1) Cigarette Advertising The profit (payoff) of Philip Morris = $1 * 4 billion * [AP / (AP + AR)] AP The profit (payoff) of R. J. Reynolds = $1 * 4 billion * [AR / (AP + AR)] AR There are 4 levels of advertising: $200 million, $400 million, $600 million and $800 million. (a) The payoff matrix for this advertising game is: Reynolds Philip $200 million $400 million $600 million $800 million $200 million 1800 , 1800 1133.3 , 2266.7 800 , 2400 600 , 2400 $400 million 2266.67 , 1133.33 1600 , 1600 1200 , 1800 933.33 , 1866.67 $600 million 2400 , 800 1800 , 1200 1400 , 1400 1114.29 , 1485.71 $800 million 2400 , 600 1866.67 , 933.33 1485.71 , 1114.29 1200 , 1200 In the payoff matrix, the first component of each cell represents the payoff of Philip Morris and the second component represents the payoff of R.J. Reynolds. The payoffs are in terms of million dollars. (Varian, 2009) (b) There is only one Nash equilibria in the advertising game. It is when both Philip Morris and R.J. Reynolds are spending $800 million dollar each on advertising. It is the only outcome which is mutually beneficial to both and is hence Nash equilibria. The payoff to each is $1200 million under the Nash Equilibria. (Pindyck and Rubinfeld, 2009) (c) When it becomes infeasible for the cigarette companies to spend $800 million on advertising due to the government ban, the maximum advertising expense will be $600 million. The resulting payoff matrix is shown as follows: Reynolds Philip $200 million $400 million $600 million $200 million 1800 , 1800 1133.3 , 2266.7 800 , 2400 $400 million 2266.67 , 1133.33 1600 , 1600 1200 , 1800 $600 million 2400 , 800 1800 , 1200 1400 , 1400 The Nash equilibrium in the new advertising game is generated when both Philip Morris and R.J Reynolds spend $600 million on advertising. The payoff to each will be $1400 million. (Varian, 2009) Under the ban, the payoff of both Philip Morris and R.J Reynold is $1400 million. Hence, their payoff is increasing due to the ban. Thus, they are both better off from the ban. References: Pindyck, R. and Rubinfeld, D. (2009). Micreconomics. 7th ed. New Jersey: Prentice Hall. Varian, H. (2009). Intermediate Microeconomics: A Modern Approach. 8th ed. New York: W. W. Norton Company.