Question

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 $2 billion in profits. When neither company advertises, each company earns profits of $10 billion.

If one company advertises and the other does not, the company that advertises earns $40 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 response as a percentage rounded to the nearest whole number.

i ≤ __ percent

Answer 1

If interest rate is r,

​​​​=1/(1+r)

We know for a collusion to be sustainable

PV(collude) greater than PV(cheat).

Here both firms colluding will result in both firms not advertising since maximum profits are made by this for both firms

Where cheating occurs when one firm advertises and other doesn't.

In trigger strategy we use non cooperative repetitive game

PV=P+P+P....

PV(collude)=+++..

=10+(10÷r)

PV(cheat)=40+++....

=40+(1/r)

For collusion to be successful PV(collude)PV(cheat)

10+40+

r30%

Therefore r should be less than 30% for collusive advertising