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# Trigger Strategies and Collusive Level of Advertising

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At a time when demand for ready-to-eat cereal was stagnant, a spokesperson for the cereal maker Kellogg's was quoted as saying, " . . . for the past several years, our individual company growth has come out of the other fellow's hide." Kellogg's has been producing cereal since 1906 and continues to implement strategies that make it a leader in the cereal industry. Suppose that when Kellogg's and its largest rival advertise, each company earns \$3 billion in profits. When neither company advertises, each company earns profits of \$15 billion.

If one company advertises and the other does not, the company that advertises earns \$54 billion and the company that does not advertise loses \$3 billion. For what range of interest rates could these firms use trigger strategies to support the collusive level of advertising?

Instruction: Enter your answer as a percentage rounded to the nearest whole number

#### Solution Preview

To find the Nash equilibrium, we determine whether a firm can increase its profits by choosing a different action, given the actions of the other firm. In this case we can see that with both firms advertising, neither firm can increase their payoffs by not advertising. If neither ...

#### Solution Summary

This solution explains how rival companies use a trigger strategy to initiate collusion in advertising. It discusses the Nash equilibrium, profit, interest rate and the percentage rounded to nearest whole number.

\$2.19

## Under what conditions could trigger strategies be used by these firms to support the collusive level of advertising? Identify the costs that are relevant for your decision, and then determine whether Gear Net should produce 250 hubs or 500 hubs.

15. At a time when demand for ready-to-eat cereal was stagnant, a spokesperson for the cereal maker Kellogg's was quoted as saying, "... for the past several years, our individual company growth has come out of the other fellow's hide." Kellogg's has been producing cereal since 1906 and continues to implement strategies that make it a leader in the cereal industry. Suppose that when Kellogg's and its largest rival advertise, each company earns \$0 billion in profits. When neither company advertises, each company earns profits of \$8 billion. If one company advertises and the other does not, the company that advertises earns \$48 billion and the company that does not advertise loses \$1 billion. Under what conditions could trigger strategies be used by these firms to support the collusive level of advertising?

16. You are the manager of GearNet and must decide how many Internet hubs to produce to maximize your firm's profit. GearNet and its only rival (NetWorks) sell dual speed Internet hubs that are identical from consumer's perspectives. The market price for hubs depends on the total quantity produced by the two firms. A survey reveals that the market price of hubs depends on total market output as follows:

Combined Hub Protection of GearNet and NetWorks Market Price of Hubs (Per Unit)
500 units \$120

750 units 100
1000 units 90

GearNet and NetWorks each use labor, materials, and machines to produce output. Gear Net purchases labor and materials on an as-needed basis; its machines were purchased three years ago and are being depreciated according to the straight-line method. GearNet's accounting department has provided the following data about its unit production costs: GearNet's Unit Cost for an Output of:
Item 250 units 500 units
Direct Labor \$40 \$40
Direct materials 30 30
Depreciation charge 80 40
Reports from industry experts suggest that NetWork's cost structure is similar to GearNet's cost structure and that technological constraints require each firm to produce either 250 hubs or 500 hubs. Identify the costs that are relevant for your decision, and then determine whether Gear Net should produce 250 hubs or 500 hubs.

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