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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 1
Managerial Economics in a Global Economy, 5th Edition
byDominick Salvatore
Chapter 10
Game Theory andStrategic Behavior
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 2
Strategic Behavior
• Decisions that take into account the predicted reactions of rival firms– Interdependence of outcomes
• Game Theory– Players– Strategies– Payoff matrix
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 3
Strategic Behavior
• Types of Games– Zero-sum games– Nonzero-sum games
• Nash Equilibrium– Each player chooses a strategy that is
optimal given the strategy of the other player
– A strategy is dominant if it is optimal regardless of what the other player does
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 4
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 5
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
What is the optimal strategy for Firm A if Firm B chooses to advertise?
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 6
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
What is the optimal strategy for Firm A if Firm B chooses to advertise?
If Firm A chooses to advertise, the payoff is 4. Otherwise, the payoff is 2. The optimal strategy is to advertise.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 7
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
What is the optimal strategy for Firm A if Firm B chooses not to advertise?
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 8
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
What is the optimal strategy for Firm A if Firm B chooses not to advertise?
If Firm A chooses to advertise, the payoff is 5. Otherwise, the payoff is 3. Again, the optimal strategy is to advertise.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 9
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
Regardless of what Firm B decides to do, the optimal strategy for Firm A is to advertise. The dominant strategy for Firm A is to advertise.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 10
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
What is the optimal strategy for Firm B if Firm A chooses to advertise?
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 11
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
What is the optimal strategy for Firm B if Firm A chooses to advertise?
If Firm B chooses to advertise, the payoff is 3. Otherwise, the payoff is 1. The optimal strategy is to advertise.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 12
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
What is the optimal strategy for Firm B if Firm A chooses not to advertise?
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 13
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
What is the optimal strategy for Firm B if Firm A chooses not to advertise?
If Firm B chooses to advertise, the payoff is 5. Otherwise, the payoff is 2. Again, the optimal strategy is to advertise.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 14
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
Regardless of what Firm A decides to do, the optimal strategy for Firm B is to advertise. The dominant strategy for Firm B is to advertise.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 15
Advertising Example 1
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
The dominant strategy for Firm A is to advertise and the dominant strategy for Firm B is to advertise. The Nash equilibrium is for both firms to advertise.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 16
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
Advertising Example 2
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 17
Advertising Example 2What is the optimal strategy for Firm A if Firm B chooses to advertise?
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 18
Advertising Example 2What is the optimal strategy for Firm A if Firm B chooses to advertise?
If Firm A chooses to advertise, the payoff is 4. Otherwise, the payoff is 2. The optimal strategy is to advertise.
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 19
Advertising Example 2What is the optimal strategy for Firm A if Firm B chooses not to advertise?
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 20
Advertising Example 2What is the optimal strategy for Firm A if Firm B chooses not to advertise?
If Firm A chooses to advertise, the payoff is 5. Otherwise, the payoff is 6. In this case, the optimal strategy is not to advertise.
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 21
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
Advertising Example 2The optimal strategy for Firm A depends on which strategy is chosen by Firms B. Firm A does not have a dominant strategy.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 22
Advertising Example 2What is the optimal strategy for Firm B if Firm A chooses to advertise?
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 23
Advertising Example 2What is the optimal strategy for Firm B if Firm A chooses to advertise?
If Firm B chooses to advertise, the payoff is 3. Otherwise, the payoff is 1. The optimal strategy is to advertise.
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 24
Advertising Example 2What is the optimal strategy for Firm B if Firm A chooses not to advertise?
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 25
Advertising Example 2What is the optimal strategy for Firm B if Firm A chooses not to advertise?
If Firm B chooses to advertise, the payoff is 5. Otherwise, the payoff is 2. Again, the optimal strategy is to advertise.
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 26
Advertising Example 2Regardless of what Firm A decides to do, the optimal strategy for Firm B is to advertise. The dominant strategy for Firm B is to advertise.
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (6, 2)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 27
Advertising Example 2
Advertise Don't AdvertiseAdvertise (4, 3) (5, 1)
Don't Advertise (2, 5) (3, 2)
Firm B
Firm A
The dominant strategy for Firm B is to advertise. If Firm B chooses to advertise, then the optimal strategy for Firm A is to advertise. The Nash equilibrium is for both firms to advertise.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 28
Prisoners’ Dilemma
Two suspects are arrested for armed robbery. They are immediately separated. If convicted, they will get a term of 10 years in prison. However, the evidence is not sufficient to convict them of more than the crime of possessing stolen goods, which carries a sentence of only 1 year.
The suspects are told the following: If you confess and your accomplice does not, you will go free. If you do not confess and your accomplice does, you will get 10 years in prison. If you both confess, you will both get 5 years in prison.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 29
Prisoners’ Dilemma
Confess Don't ConfessConfess (5, 5) (0, 10)
Don't Confess (10, 0) (1, 1)
Individual B
Individual A
Payoff Matrix (negative values)
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 30
Prisoners’ Dilemma
Confess Don't ConfessConfess (5, 5) (0, 10)
Don't Confess (10, 0) (1, 1)
Individual B
Individual A
Dominant StrategyBoth Individuals Confess
(Nash Equilibrium)
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 31
Low Price High PriceLow Price (2, 2) (5, 1)High Price (1, 5) (3, 3)
Firm B
Firm A
Prisoners’ Dilemma
Application: Price Competition
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 32
Low Price High PriceLow Price (2, 2) (5, 1)High Price (1, 5) (3, 3)
Firm B
Firm A
Prisoners’ Dilemma
Application: Price Competition
Dominant Strategy: Low Price
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 33
Advertise Don't AdvertiseAdvertise (2, 2) (5, 1)
Don't Advertise (1, 5) (3, 3)
Firm B
Firm A
Prisoners’ Dilemma
Application: Nonprice Competition
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 34
Prisoners’ Dilemma
Application: Nonprice Competition
Dominant Strategy: Advertise
Advertise Don't AdvertiseAdvertise (2, 2) (5, 1)
Don't Advertise (1, 5) (3, 3)
Firm B
Firm A
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 35
Cheat Don't CheatCheat (2, 2) (5, 1)
Don't Cheat (1, 5) (3, 3)
Firm B
Firm A
Prisoners’ Dilemma
Application: Cartel Cheating
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 36
Cheat Don't CheatCheat (2, 2) (5, 1)
Don't Cheat (1, 5) (3, 3)
Firm B
Firm A
Prisoners’ Dilemma
Application: Cartel Cheating
Dominant Strategy: Cheat
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 37
Extensions of Game Theory
• Repeated Games– Many consecutive moves and
countermoves by each player
• Tit-For-Tat Strategy– Do to your opponent what your
opponent has just done to you
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 38
Extensions of Game Theory
• Tit-For-Tat Strategy– Stable set of players– Small number of players– Easy detection of cheating– Stable demand and cost conditions– Game repeated a large and
uncertain number of times
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 39
Extensions of Game Theory
• Threat Strategies– Credibility– Reputation– Commitment– Example: Entry deterrence
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 40
Entry Deterrence
Enter Do Not EnterLow Price (4, -2) (6, 0)High Price (7, 2) (10, 0)
Firm B
Firm A
Enter Do Not EnterLow Price (4, -2) (6, 0)High Price (3, 2) (8, 0)
Firm B
Firm A
Credible Entry Deterrence
No Credible Entry Deterrence
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 41
Entry Deterrence
Enter Do Not EnterLow Price (4, -2) (6, 0)High Price (7, 2) (10, 0)
Firm B
Firm A
Enter Do Not EnterLow Price (4, -2) (6, 0)High Price (3, 2) (8, 0)
Firm B
Firm A
Credible Entry Deterrence
No Credible Entry Deterrence
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 42
International Competition
Produce Don't ProductProduce (-10, -10) (100, 0)
Don't Produce (0, 100) (0, 0)
Airbus
Boeing
Boeing Versus Airbus Industries
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 43
Sequential Games
• Sequence of moves by rivals
• Payoffs depend on entire sequence
• Decision trees– Decision nodes– Branches (alternatives)
• Solution by reverse induction– From final decision to first decision
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 44
High-price, Low-priceStrategy Game
A
B
B
High Price
High Price
Low Price
Low Price
$100 $100
$130 $50
$180 $80
$150 $120
Firm A Firm B
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 45
High-price, Low-priceStrategy Game
A
B
B
High Price
High Price
Low Price
Low Price
$100 $100
$130 $50
$180 $80
$150 $120
Firm A Firm B
X
X
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 46
High-price, Low-priceStrategy Game
A
B
B
High Price
High Price
Low Price
Low Price
$100 $100
$130 $50
$180 $80
$150 $120
Firm A Firm B
X
XXSolution:Both firmschoose lowprice.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 47
Airbus and Boeing
A
B
B
Jumbo Jet
Jumbo Jet
Sonic Cruiser
Sonic Cruiser
$50 $50
$120 $100
$0 $150
$0 $200
Airbus Boeing
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 48
Airbus and Boeing
A
B
B
Jumbo Jet
Jumbo Jet
Sonic Cruiser
Sonic Cruiser
$50 $50
$120 $100
$0 $150
$0 $200
Airbus Boeing
X
X
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 49
Airbus and Boeing
A
B
B
Jumbo Jet
Jumbo Jet
Sonic Cruiser
Sonic Cruiser
$50 $50
$120 $100
$0 $150
$0 $200
Airbus Boeing
X
XX
Solution:Airbus buildsA380 andBoeing buildsSonic Cruiser.
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Prepared by Robert F. Brooker, Ph.D. Copyright ©2004 by South-Western, a division of Thomson Learning. All rights reserved. Slide 50
IntegratingCase Study
A
B
B
A
A
A
A
Advertise
Not Advertise
Low Price
Low Price
High Price
High Price
Hig
h Pr
ice
Low Price
60 70
100 50
40 60
75 70
70 50
90 40
80 50
60 30
Firm A Firm B
Advertise
Not Advertise
Advertise
Not Advertise
Advertise
Not Advertise