Question

A large Coca Cola vendor recently hired some economic analysts to assess the effect of a price increase in its 16 ounce bottles from $1.25 to $2.25. The analysts determined that, on average, the vendor’s customers spend about $14.00 on soda (Coke and all other brands) each week, and the average price for other 16-ounce soda bottles is $1.25. The analysts also utilized some focus groups to determine the preferences of the vendor’s customers. They used this analysis to build the following graph: Suppose X0 = 7 and X1 = 5. Should the vendor expect to sell 5, more than 5, or less than 5 bottles of Coke after raising the price to $2.25 if Coke is an inferior good? The vendor should expect to sell 5 bottles of Coke. The vendor should expect to sell more than 5 bottles of Coke. The vendor should expect to sell less than 5 bottles of Coke.

Answer 1

When the price of Coke rises, two effects come into picture:

a) Substitution effect: this says Coke is now relatively expensive so decrease the number of cokes demanded and substitute it for the other commodity.

b) Income effect: As the price of the Coke increases, the real income has decreased, so reduce the quantity of Coke (in case of normal good). But incase of inferior goods, income effect in negative. This means as the price of Coke increase, more amount of Coke is demanded.

Therefore, The vendor should expect to sell more than 5 bottles of Coke is the correct answer becaue coke is an inferior good.