FINAL PROJECT: APPLIED MATHEMATICS FOR THE SOCIAL SCIENCES

TAKREEM RIWAN SIDDIQUI

Genetic Algorithm for Optimization: Advertising in Mature Markets through Repeated Chicken Games
Section 1) Statement and Overview
This model will study the features of optimum profit maximizing advertising strategies used by
duopolists in a mature market. Duopolists advertising in mature markets can be thought of as players in
a game of chicken. By using genetic algorithms over multiple generations, we can study the strategies
that persist and thrive and thus find the features that set them apart from random or sub-optimal
strategies. The output from our model is will not give us a clean cut set of instructions. Instead, it will let
us analyze common features that we can identify in the best performing strategies to maximize profits,
similar to the analysis by Axelrod to identify features of optimum strategies in prisoners dilemma games.
First, we will discuss the nature of advertising in mature markets. Next, we will describe the game of
chicken and show how it is a good framework for analyzing advertising in mature duopolists markets.
The last section of the introduction will discuss the variables and assumptions behind the choice of our
model. Section 2 will describe the model in greater detail, with the appendix giving precise
mathematical descriptions of the algorithm.
Industrial organization theory models advertising acting on sales through three channels. Let us
consider the consequences of advertising for a hypothetical Firm A. First, advertising by Firm A increases
the size of the entire market by luring new consumers into it. Thus, all else equal, this increases Firm As
revenues. Second, advertising lures customers away from Firm As competitors and so increases Firm As
market share. Thirdly, Firm As advertising causes rivals to advertise too to maintain market share: this
may cause Firm A to not gain as many customers from the advertising campaign or lose out if other
firms put out more effective advertisements. However, for mature markets, such as the market for soft
drinks in the United States, the market is already saturated with consumers. Nearly all potential
consumers of soft drinks are already consuming soft drinks and there is no reason to believe they will
dramatically change their attitudes towards soft drinks in the near future. Thus, the overall soft drinks
market can be assumed to grow at the same rate as population growth, which is too slow in the
developed world to dramatically affect profits. Thus the key factor that will determine the impact of
advertising is how other firms respond to Firm As advertising and their relative market share dynamics.
In a duopoly, the payoffs from advertising can be analyzed by modeling as a game of chicken. Suppose
there are two firms, Coke and Pepsi. A hypothetical game and profit payoffs are described in Figure 1 in
the appendix. The firms are thought to have two choices- heavy advertising (H) and low advertising (L).
These reflect their levels of relative expenditure on advertising. If both firms choose a low level of
advertising expenditure, they do not infringe upon each others market share and they get equal,
medium level payouts. If Coke decides to pursue high advertising while Pepsi has low advertising
expenditures, Coke will steal away a significant portion of Pepsis market share resulting in a far higher
payout for Coke than for Pepsi. The opposite will occur if Pepsi pursues a strategy of high advertising
expenses while Coke spends low amounts on advertising. The worst outcome for both occurs if they
both pursue high advertising expenditures. They will exhaust significant resources on advertising, and
thus they will incur high costs. But, as their rivals are also spending heavily, they will not make any
inroads in terms of market share. Thus they will both make low profits- a disaster outcome that is
characteristic of the Chicken game. Note that though the figures in Appendix I Figure 1 are hypothetical,
they could be set at any level as long as they have the features described above: both agents choosing
high advertising has to lead to the worse outcome; one agent choosing high while the other chooses low
gives the agent choosing high a sizable advantage, and both choosing low gives equal medium level
profits. Furthermore, mature markets with duopolies may have smaller competitors, but they often do
not have the scale to significantly affect the dominant firms. There are a variety of sodas in the United
States, but none can challenge Coke and Pepsi in scale. In addition, Coke and Pepsi are large and
entrenched and are thus likely to remain so. It is unlikely that one or the other will go bankrupt or
become irrelevant overnight. Thus we can view their choices as a repeated game that goes on over
multiple, but finite terms. They cannot be infinite, because if nothing else, the Sun swallowing the earth
or the Rapture will finally send them out of business simultaneously.
To summarize, we will model the interactions of advertising expenses in a duopoly. Our optimizing
agents are duopolists, henceforth known as Coke and Pepsi. They will have two choice variables, high
advertising and low advertising and will simultaneously choose strategies. They will play repeated games
and the payoffs from each round can be modeled as a game of Chicken. We will investigate what
strategies allow firms to optimize the variable of interest: profits. We assume that this occurs in a
mature duopoly. This is underpinned by two assumptions: first, no other firms advertising expenditures
affect the duopolists and that due to maturity, their advertising does not lure new customers to increase
the overall size of the market. Our last assumption is that there is no event that makes the firms go out
of business within a finite timespan, so they will stay in business and play the game against each other
over a set finite number of turns. Our model will not give us a direct output showing an optimization
strategy. Rather, it will show us the features of successful strategies.
Section 2) Model Description
As mentioned, there are two agents, Coke and Pepsi who play Chicken against one another by
selecting the choice variable: high advertising or low advertising for each round. They try to optimize the
amount of profit from the game over 5 periods by choosing the best strategy over those periods. They
can only recall the results and choices from the last 2 rounds. We can use the genetic algorithms
approach to analyze features of effective strategies.
First, let us analyze the actions of Pepsi. Each turn it has to choose H or L. Pepsis choice will be
determined by the outcome of the last two rounds (c
1,
c
2
), (d
1,
d
2
)

Appendix II has details on what these
vectors specify. As there are 4 possible arrangements of strategies over two rounds, we see that there
are 16 possible histories, each of which will lead to Pepsi choosing one strategy should that history have
occurred. We can show Pepsis range of strategies as bits on a binary string. The bits take values of H or
L based on what history precedes it. Note that the string for Coke would be identical. This is described in
Appendix II.
We start with a population of 5 strings in our first generation. To begin our analysis, generate two
rounds of games for each bit in each string, where of the 16 possible histories are equally likely. This
process is described in Appendix II, (ii). For each bit in each string, randomly assign H or L so that both
are equally likely by the procedure outlined in Appendix II, (iii). This gives us our initial population of 5
strings.
We need to assign fitness values to each string. The process of how this is carried out is described in
Appendix III. Each string is played against all other strings in the population 5 times. After each round, it
carries out strategies encoded in its string and receives payouts described in Appendix I based on the
actions of its opponent. Each strings score across the 20 games is summed up and assigned to it as a
fitness value, f
i
. We sum across the five values of f
i
to generate T. We can now calculate fraction of total
fitness for each string i, measured by f
i
/T. We set up a procedure to select 5 parents to reproduce by the
method outlined in Appendix IV. Each parent is chosen with a probability equal to their fraction of total
fitness.
Each of the strings selected for reproduction are considered for crossover. This is described by
Appendix V(i). Each string has a probability of 0.20 of being selected for crossover. Each string is
considered in turn. If a certain string is considered for crossover, a partner string is generated from the
remaining 4 strings with probability . Once the parents are specified, we select the site of crossover.
This process is shown in Appendix V(ii). Each site has an equally likely chance of being selected. Once
selected, the bits from before the site on i, our initial parent, is followed by those from the generated
parent. The remaining genetic material from i and the generated parent is irrelevant, we can consider it
discarded. However, we just obtained a new string with crossed over genetic material.
Finally, we carry out the mutation operation. Each bit on each string has an equally likely chance to
mutate with a probability 0.001. This process is described in Appendix VI. After carrying out the
mutation operation, we finally obtain 5 strings that are the second generation of offspring.
To recap the algorithm, we initially generated 5 random strings with 16 pre-described histories
encoding 16 bits denoting strategies. Fitness values were assigned and strings were randomly with a
probability corresponding to their proportion of total fitness. The strings underwent crossover and
mutation with fixed probabilities. This gave us a new generation of strings. This process is repeated 1000
times. As the process is repeated, we note what features or patterns in strings are lost as the
generations progressed and which patterns tend to persist. Finally, we analyze the patterns present on
our 1001
st
generation. We note what strategy strings kept repeating in the previous rounds to note that
they are optimal strategies. At the end of our exercise, we should be able to outline what strategy
patterns allow duopolists to maximize profits.