Question

Suppose that the price of sugar, a major input for making Coca – Cola (Coke), decreased. Using two separate competitive supply/demand diagrams for Coke market, and Pepsi market, illustrate and briefly explain the probable effects of the decrease in the price of sugar: on equilibrium price, and equilibrium quantities, in the Coke and Pepsi market (assume Pepsi uses sweetener instead of sugar). What happens to the revenues of Coke, and Pepsi producers/sellers? [Hint: Coke and Pepsi are substitutes]. You may just explain in detail what happens to the demand/supply curves for Coca – Cola market and Pepsi market as well as corresponding equilibrium price and quantity

Answer 1

As coke and pepsi are substitutes of each other, their price would not be much different or roughly the same to attract more customers. Assume the price of Coke is Pc, quantity sold at this price is Qc. Price of Pepsi is Pp, quantity sold at this price is Qp.

There is decline in price of sugar, an input for making coca - cola, it will reduce the overall cost of producing coke. Reduction in overall cost will induce prdoucers to supply more coke in the market such that they can earn maximum profit. Rise in supply from supply to new supply curve will reduce its price to P1 and raise quantity sold to Q1. We can see that change in quantity is more than change in price because many customers of Pepsi will shift to Coke as there is no reduction in cost of production of Pepsi. We can see that there is rise in revenue of Coke.

As consumers shift to Coke, there will be reduction in demand of Pepsi which will shift its demand curve from demand to new demand and reducing its price from Pp to Pp1 while quantity demanded of Pepsi fall from Qp to Qp1.