Tobacco companies have often argued that they advertise to attract more existing smokers and not to persuade more people to smoke. Suppose there were just two cigarette manufacturers, Jones and Smith. Each can either advertise or not advertise. If neither advertises, they each capture 50% of the market and each earns $10 million. If they both advertise, they again split the market evenly, but each spends $2 million on ads and so each earns just $8 million (remember, advertising is not supposed to encourage more people to smoke). If one company advertises but the other does not, then the company that advertises attracts many of its rival’s customers. As a result, the company that advertises earns $12 million and the company that does not earns just $6 million.
a. Show that advertising is a dominant strategy.
b. Suppose the government proposes a ban on cigarette ads. Should the two cigarette companies favor the ban or should they oppose the ban?