Question

Assume that you graduated from the MBA program at MSU last fall and were hired as

manager of Coca-Cola. The price of a can of Coke is the same price as the can of Pepsi.

However, 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 (draw a

graph). Does this affect Coca-Cola revenues?

Answer 1

Coca-Cola and Pepsi are substitutes in consumption. Therefore, lower price of Pepsi will increase the quantity demanded of Pepsi, and decrease the demand for Coca-Cola. Its demand curve will shift leftward, decreasing both price and quantity of Coca-Cola. Since price and quantity both fall for Coca-Cola, its revenue (= Price x Quantity) will decrease.

In following graph, Price (P) and Quantity (Q) of Coca-Cola are measured vertically and horizontally respectively. D0 & S0 are initial demand and supply curves of Coca-Cola, intersecting at point A with initial price P0 and quantity Q0. A fall in demand will shift D0 to D1, intersecting S0 at point B with lower price P1 and lower quantity Q1.