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 in profits. When neither company advertises, each company earns profits of $12 billion. If one company advertises and the other does not, the company that advertises earns $52 billion and the company that does not advertise loses $4 billion. Under what conditions could these firms use trigger strategies to support the collusive level of advertising?
- Demonstrate the static result by using a standard form payoff matrix and explain the result.
- To sustain a collusive solution using a trigger strategy, what must the discount/interest rate be in order to make collusion profitable?
- In order to sustain the collusive solution, what must firms be able to observe about rivals?