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Income & Substitution Effects of Pepsi and Coca-Cola Pricing

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What would be the consumer buying response to Coca-Cola if the price of Pepsi doubled?

If the prices of Coca-Cola and Pepsi remained constant, what would be the consumer's typical buying response to these products if their income was reduced by 30%?

Suppose all carbonated beverages tripled in price. How would the concepts of utility, income, and substitution predict consumer behavior based on the rise in the cost of carbonated beverages?

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Solution Preview

Please see attachment for graphical analysis.

If we assume Coca Cola and Pepsi are perfect substitutes, then the pricing strategy of one affects the demand for the other. This correlates to an indifference curve (for Coke and Pepsi) that would be a straight line with equal slopes across all points.

When Pepsi doubles the its price, there will be a decrease in the demand and consumption of its product. This can be seen in the price elasticity of demand for Pepsi:

The new higher price of Pepsi, P2, results in a lower consumption, Q2 of the good. Because Pepsi and Coke are perfect substitutes, a decrease in consumption of Pepsi results in a proportionate ...

Solution Summary

The solution analyses these questions on the effects of price fluctuation, looking at what would happen if Pepsi's price doubles and other hypothetical situations, in 448 words with graphs attached in Word to support their arguments.