Game Theory and Strategic Behavior
1. Suppose that GE is trying to prevent Maytag from entering the market for high-efficiency clothes dryers. Even though high-efficiency dryers are more costly to produce, they are also more profitable as they command sufficiently higher prices from consumers. The following payoffs table shows the annual profits for GE and Maytag for the advertising spending and entry decisions that they are facing.
Advertising = $12m
Advertising = $0.7m
$ 1m, $20m
Based on this information, can GE successfully prevent Maytag from entering this market by increasing its advertising levels? What is the equilibrium outcome in this game?
Suppose that an analyst at GE is convinced that just a little bit more advertising by GE, say another $2m, would be sufficient to deter enough customers from buying Maytag, thus, yield less than $0 profits for Maytag in the event it enters. Suppose that spending an extra $2m on advertising by GE will reduce its expected profits by $1.5 m, regardless of whether Maytag enters or stays out. Would this additional spending on advertising achieve the effect of deterring Maytag from entering? Should GE pursue this option?
If GE maintains its advertising expenditure to $12M and Maytag stays out of the market, then GE’s profit will be $30M. If it enters the market, then Maytag’s profit will be $1M while GE’s profit will be $20M. This results in a loss of $10M due to Maytag entry to the market. Whereas, if GE maintains its’ advertising expenditure to $700,000 and Maytag stays out of the market, then GE’s profit will be $35M. Now, if it enters the market, then Maytag profits will be $12M while GE’s profit will be $15M. Now, this will result in a loss of $20M due to Maytag entry to the market.
In business it’s a 50 percent chance that advertising works, knowing your competition knowing what to communicate to the public and knowing your profit is very important factors. In this situation putting more money in the advertisement wouldn’t be the best idea for GE due to the profit that they will receive if Maytag enters the market. that GE may not be able to prevent Maytag from entering the market. Maytag may also anticipate that GE will increase advertising may not be able to prevent Maytag from entering the market. it may not be wise for GE to put more money in the advertisement due to the profit that they will receive if Maytag enters into the market. Also a great example, Winn-Dixie was never the same, even though they spent all that money on advertisement, they lost all of the business. GE may not be able to prevent Maytag from entering the market. Maytag may also anticipate that GE will increase advertising may not be able to prevent Maytag from entering the market.
Maytag may also anticipate that GE will increase advertising It would deter Maytag to enter the business even as the net profitability will be hit as the equilibrium has not been established. it would not be a good idea for GE to spend more money on advertising, due to the profit that they will receive if Maytag enters into the market.
I found that Game Theory is a very interesting topic within economics. In this case, we don’t know if Maytag will enter the market but GE feels that there is a threat that they will which will take away market share and profits from the company. According to Douglas, 2012, “a game is a situation in which two or more players choose strategies to compete for a reward or payoff.” In this situation, GE is trying to determine the strategy of increasing advertising to keep Maytag from entering the market for high efficiency clothes dryers.
According to the profit numbers and advertising expense we were given, GE can deter Maytag from entering the market by choosing the equilibrium outcome of increasing advertising to 12M. Although GE will lose profits of 15M in doing so, they still maintain profits and maintain a large market share. If they don’t increase from $700,000, it will allow Maytag to enter the market and lose 20M in profits and lose a large amount of their market share. They need to find the strategy that deters Magtag from entering the market and still maintain profits and market share.
I don’t feel that GE needs to increase their advertising by an additional 2M over the 12M. In doing so, GE will lose additional profits over the equilibrium. We need to remember the subject, Game Theory. Maytag probably will not enter the market and invest 12M in advertising to gain a profit of 1m and an extremely small market share. We also have to consider that GE has been through the process of creating efficiencies in the production of the product that Maytag will learn at a cost. We also need to consider the case of a false threat. If GE talks about adding the additional 2M, it may be enough of a threat to Maytag to keep them out of the game.
At first, I thought it could be beneficial to spend the extra 2M to guarantee total market share, but then I started to consider the prisoner’s dilemma. This would create a worse case outcome for GE through additional profit lose. Their greed takes them to a solution that is not optimal for the company. If this was a repetitive game, where Maytag continues to make claims to enter the market, then it might be necessary to increase the advertising spending by the addition 2M in order to pursue Maytag to stay out of the game.
Douglas, E. (2012) Managerial Economics (1st ed.) [Electronic version]. Retrieved November 10, 2019, from https://content.ashford.edu/