Question

You have been analyzing the soft drink market for some time now. Your boss is the chief operating officer of Frosty Cola soft drink, a caffeinated soft drink selling in the same market as Coca-Cola, Pepsi Cola, and many other brands. You have made the following notes that you are about to present to him in your next meeting:

            Percentage change in quantity demanded of Frosty Cola = -6 percent

            Percentage change in price per bottle of Frosty Cola = +5 percent

            a) What can you conclude about the responsiveness of Frosty Cola to its own price? How do you know?

            b) Given the data you’ve researched, what pricing strategy would you recommend to the COO of Frosty Cola in order to improve the company’s revenue picture? Explain.

Answer 1

a. The price elasticity of Frosty Cola will be percentage change in quantity demanded of Frosty Cola divided by the percentage change in its price. The price elasticity thus is -6/5= -1.2. Since the absolute value of elasticity is greater than 1, thus the Frosty Cola is elastic which means that the quantity responds to the change in its price by more than the change in price.

b. When the demand of good is price elastic, the decline in the price of the good cause a rise in its revenue as the percentage change in the quantity demanded is more than the percentage change in price. Thus, in this case, the Frosty Cola must not increase its price if it wants to increase its revenue. The decline in price will cause more than the proportionate rise in the quantity demanded and thus higher revenues in total. Lowering the prices will also help the company to gain a competitive advantage over Coca Cola in the market.