Question

4. Wilson has been producing tennis racquets since 1948 and continues to implement strategies that make it a leader in the tennis racquet industry. Suppose that when Wilson and its largest rival, Head, 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 collusion be profitable?

Answer 1

According to the given scenario, the normal form of this game is

		Follower firm
Leader firm		Advertise	Not advertise
	Advertise	0,0	48,-1
	Not advertise	-1,48	8,8

if both firm do not advertise total profit is 8+8 = $16

If both the firm advertise total profit is 0 + 0= $0

If one advertise and other do not advertise profit is 48 + (-1) =$47

So profit is maximum when one advertise.

So collusion is possible when the advertising firm compensate the other firm so that it do not advertise. This way the total profit will not fall to $0.