Question

3.Suppose there are two firms that sell slightly different formulations of a perfectly safe sugar substitute. You are the manager of one such firm that produces a product called Ultrasweet. Your competitor produces a product called Sweet and Healthy.

1. Discuss the direct effects of a reduction in the price of Sweet and Healthy, your competitor's product, on a typical consumer's consumption of Ultrasweet. Assume the consumer considers them both normal goods and that they are reasonably close substitutes since they are usually blended into other products like coffee or ice cream. Include in your discussion an assessment of the substitution effect and the income effect on Ultrasweet consumer quantity demanded.
   
2. Suppose both firms have a ½ price sale. Discuss the direct effects of the price cuts on a typical consumer’s consumption of Ultrasweet. Answer this question in you discussion: Which effect is unchanged in this situation, the substitution effect or the income effect?

Answer 1

ANSWER:

(a) If the price of sweet and healthy decreases then it will have a negative impact on ultra sweet as both of them are close substitute of each other. decrease in price of sweet and healthy will decrease the demand for ultra sweet and increase the demand for sweet and healthy. the income effect will cause a increase in demand for the sweet and healthy product and the substitute effect will increase the demand because the other substitute is relatively costlier now.the same income and substitution effect will cause

A decrease in the demand for ultra sweet as well. the income effect will make the consumer left with less ultra sweet because of the price reduce in substitute good, and the substitution effect will make the consumer buy sweet and healthy and there by reduce the demand for ultra sweet.

(b) If both firm have a 50% sale then there will be no change in the substitution effect and only the income effect will make the consumers feel richer and there by consumption of both the good will increase.

consumption of ultra sweet will definitely increase.