Question

In the soda market we know that Pepsi Cola and Coca Cola are substitutes; suppose that the demand for Pepsi Cola increases and, at the same time, the supply of the Coca Cola decreases significantly. Other things being equal, what would be the expectation of change in the Coca Cola market, if any?

Question 15 options:

	The equilibrium quantity is expected to increase while the direction of the change in the equilibrium price is ambiguous.
	The equilibrium quantity is expected to decrease while the direction of the change in the equilibrium price is ambiguous.
	The equilibrium price is expected to increase while the direction of the change in the equilibrium quantity is ambiguous.
	The equilibrium price is expected to decrease while the direction of the change in the equilibrium quantity is ambiguous.

Answer 1

Option C i.e. The equilibrium price is expected to increase while the direction of the change in the equilibrium quantity is ambiguous.

When the demand of Pepsi Cola increases, the demand curve for Pepsi will shift rightward. Assuming the supply remains constant, quantity demanded will be more than quantity supplied. As a result a shortage will be created. This shortage will put upward pressure on price and hence Equilibrium Price of Pepsi Cola will rise. With the rise in price the quantity demanded for Pepsi Cola will reduce. This happens due to law of demand which states that with the rise in price, quantity demanded falls and with fall in price, quantity demanded rises.

As a result the demand for Coca Cola, which is a substitute will increase. The demand curve for Coca Cola will shift rightward. Also, as given the supply of Coca Cola has reduced. This will result in shifting the supply curve of Coca Cola towards left. Both new demand curve and supply curve of Coca Cola will intersect at new Equilibrium Point. At this Equilibrium Point, the Equilibrium Price will definitely rise but effect on Equilibrium Quantity will be uncertain. In this case demand for Coca Cola increases and supply of Coca Cola reduces. As a result, at a given price quantity demanded excceds quantity supplied. As a result, a Shortage is created, which put upward pressure on price and hence, Equilibrium Price of Coca Cola will certainly increase. The impact on equilibrium quantity of Coca Cola is uncertain. It may increase, decrease or even remain same. It depends upon the magnitude of the shift of demand and supply. If increase in demand is equal to decrease in supply then equilibrium quantity will remain same. If increase in demnad is more than decrease in supply then equilibrium quantity will increase. If increase in demand is less than decrease in supply then equilibrium quantity will decrease.