Behavioral Game Theory Paper

Throughout life, we are constantly bombarded by advertisements. The average modern person is exposed to around 5,000 advertisements every day. How can this possibly maximize profit for the firms in a market? In a broad context, the advertising efforts of one company dictates the efforts other companies must produce . It is obvious that if they cooperate and do not advertise, total profits would increase. The problem arises where one firm benefits greatly from advertising, and the other firms suffer for cooperating. This behavior leads to the phenomenon we observe today.

This paper presents a prisoners dilemma modeled simultaneous game that describes how the cost of advertising and sales revenue create uncooperation between companies in the same market. My model suggests that the decision to advertise was optimal given the other strategies available to Companies One and Two. The constructed model is a two participant game in which there are only two companies that are given to one decision. This model would expand as more companies begin to join the market.

This approach can be used to better understand why advertising comprises such a large portion of a firm’s expenditures. If all companies chose to abstain from advertising, sales would stay roughly the same, but costs would go down. Therefore, it would be optimal for all companies to cooperate, but that is not what we observe in the market.

Cooperate Advertise

The setup of the game is set as a prisoners dilemma simultaneous game with two players. It is implied that both companies receive no other benefits or penalties associated with their choice, other than the payoffs themselves.

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The prisoner’s dilemma is a classic example of behavior analyzed in game theory that shows why two rational individuals might not cooperate, even if it maximizes payoffs to do so. In this situation, both companies are given a decision, and a payout at the end. This model would apply to the revenue each company receives, based on if they chose to advertise or cooperate. They can either both decide to cooperate, both decide to advertise, or a mix of cooperate and advertise respective to each participant. From this model, we can see that both players cooperating results in an equal payoff for each player. If both firms decide to advertise, the payoffs are still evenly divided, but the cost of advertising has brought total profits down. Both firms would benefit from a reduction in advertising. However, should Company Two choose not to advertise, Company One could benefit greatly by advertising, thus the dilemma is born.

Similar to many other models based on the prisoners dilemma, this game has two Nash Equilibriums. The first being for both companies to advertise, expecting the other to as well. Although this outcome is not pareto efficient, it protects both firms from potentially losing profits and market share to the other. The second is for both to cooperate. Ideally, this would be the best choice seeing as how the overall goal is to maximize profit, and the best way to do this consistently would be to cooperate.

This model has many more applications than just the prisoners dilemma or advertising in the market. This same model could be used in environmental studies, politics, or even sports. Blood doping in sports has been used as an example of a prisoners dilemma simultaneous game. Two athletes have to option to blood dope to enhance their performance. If both dope or choose to abstain, then neither gains the advantage. But if one competitor does dope, then they gain an advantage over the other. Although not associated with advertisement in the market, the scope of the simultaneous game is vast.