Question

Assume two goods: Coca-Cola and Pepsi Cola, which buyers assume to be substitute goods. (Note:  if we have two goods, that means we need two graphs!)  In the market for Coca-Cola, the number of firms producing it has decreased. Draw a supply and demand diagram.  Also, write WHY the curve (or curves) is (are) shifting based on the shift factors for demand and supply.  What is happening to the equilibrium price and quantity? Remember the concept of ceteris paribus.  

Answer 1

In each of the following graphs, price (P) and quantity (Q) are measured vertically and horizontally respectively. D0 and S0 are initial demand and supply curves intersecting at point A with initial price P0 and quantity Q0.

(1) Coca-Cola market

When number of firms decreases, this is a negative supply shock and supply decreases, shifting supply curve leftward, which increases price and decreases quantity of Coca-Cola. In following graph, when S0 shifts left to S1, it intersects D0 at point B with higher price P1 and lower quantity Q1.

(2) Pepsi-Cola Market

Since Coke and Pepsi are substitutes, higher price of Coca-Cola (described above) will lead to an increase in the demand for Pepsi Cola, shifting its demand curve rightward, increasing both price and quantity. In following graph, when D0 shifts right to D1, it intersects S0 at point B with higher price P1 and higher quantity Q1.