Question

You are the manager of Coca-Cola. The price of a can of Coke is the same price as a can of Pepsi. The manager of PepsiCo has decided to decrease the price of a can of Pepsi by 20%. Assume that the consumer’s income is constant and the price of Coke stays the same. Based on economic theory, explain the changes in consumer equilibrium and draw a graph. Does this affect Coca-Cola revenues?

Answer 1

Coke and Pepsi are perfect substitutes.

When price of a can of Pepsi decreases, more people will be willing to substitute pepsi for coke since the price of coke stays same and consumer income is constant. Thus, the demand for coke decreases.

Supply on the other hand remains same.

The change in consumer equilibrium can be seen in the following graph:

DECREASE IN DEMAND Price Supply P1 P2 New Demand Demand 02 Q1 Ouantity

Hence both equilibrium quantity and equilibrium price decrease. This is so because both firms need to have same price in the market to achieve equilibrium, thus price for Coke decreases. In the process, Pepsi attracts more number of consumers till prices are equalized. Thus, equilibrium quantity decreases as well.

Revenues of the Coca cola = Price * Quantity.

Since both equilibrium quantity and equilibrium price decrease, thus revenues for Coca cola decreases too.