Consider the following demand system for two differentiated products:
q1 = θ - bp1 + dp2 + z A1 q2 = θ - bp2 + dp1 - w A1
where A1 is advertising expenditure by firm 1. The parameters b, d, and z are all positive.
(a) Firm 1 chooses a level of advertising in period 1; then the firms play a Nash price game in period 2. Is the period 2 game one of strategic substitutes or strategic complements?
(b) If w = 0, will investment in advertising make you tough or soft?
(c) In an accommodation game, what kind of strategic game is this (in terms of puppy dogs, etc.)? Will there be over- or underinvestment in advertising?
(d) Suppose firm 1 wished to deter firm 2 from entering-what type of strategy (under the same classification system) would it pursue now? Would it require over- or underinvestment in advertising?
(e) Now suppose that w > 0. What additional types of strategic effects have been introduced into the game?
(f) In a reaction function diagram show the different strategic effects of advertising and describe the final equilibrium.