Business Economics

The demand for Coca Cola is elastic, which is mostly due to the fact that there are numerous soft drinks that Coca Cola can be substituted with. If the price for Coca Cola decreases, many people will choose to go for the substitute. We anticipate the demand for Coca Cola to increase significantly. In general, where a product has several substitutes, its demand will assume elastic nature. Where a product has few substitutes, the demand for it will be less elastic (Hardy).

The price elasticity of demand is defined as the measure of the level of the effect of change in a price of a commodity on the quantity demanded. When the price of goods is increased, there is an inclination for the quantity demanded of the commodity to decrease. Equally, when the price of goods is low, the demand for a normal product or service will tend to increase. Nevertheless, the extent to which this is applicable varies from one commodity to another. The relationship between the price and demand for commodity, referred to as price elasticity of demand is mathematically calculated using the formula below.

Elasticity of demand = (Percentage change in demand) / (Percentage change in price)

Commodities that are considered to be secondary needs, in the sense that they do not meet the essential needs, and their consumption can be delayed without negative impact on the line of the consumers, tend to have elastic demand. On the other hand, there are goods that fulfill essential needs, and they tend to have inelastic demand.         

Coca Cola is a normal product which has a wide variety of substitutes. Therefore, a decrease in the price of Coca Cola will result in an increase in the quantity demanded the brand. The change in price causes tremendous changes in the quantity demanded. This is attributed to the fact that there are substitute products, such as Pepsi (Miller).

Complimentary goods are referred as the different goods that are related to the product under consideration, in this case Coca Cola. There are some other goods that are considered to be substitutes; they are different products that compete with Coca Cola. Coca Cola and Pepsi Cola are considered as substitutes just as it is the case with margarine vs butter, or Japanese cars vs American cars. There is a high possibility that the demand for Coca Cola would change if the price of Pepsi Cola would rise or fall. This relationship is as such: as the price of a substitute product (Pepsi) falls, the demand for Coca Cola rises. The knowledge of this trend is important, though it is not sufficient. The level of changes in the demand for Coca Cola as affected by the price of Pepsi should be known. This will shed more light to the concept of making an adjustment remain relevant in the market. The knowledge of the percentage change in the demand for a product as it is affected by the percentage change in the price of another commodity. The amount of these changes explained in terms of percentage is referred to as the cross elasticity of demand. This is calculated using the formula (Gaughan):

(Percentage Change in the demand for Coca Cola)/ (Percentage Change in the price of Pepsi)

The resulting number measures the extent by which the demand for Coca Cola responds to the change in the price of Pepsi. In case the resulting number is positive, then the goods substitute each other (if the price for Coca Cola rises, the demand for Pepsi will rise as well, since Coca Cola consumers will tend to look for an alternative product to replace a rather expensive Coke). The cross elasticity of demand for Coca Cola is greater than +1, which indicates that the two products are from the same industry. The implication for this is that a 10% rise in the price of Coke would translate to increase in demand for Pepsi with an equal magnitude or more (Sherman).

If Pepsi reduces its retail price to $1.49 to gain an advantage over Coca Cola and result in an increase in sale to 1500 units, it may fail in this strategy. The projected increase in sale would only be possible if Coca Cola, which is in the same industry as Pepsi, did not react to change in Pepsi’s price cut. Conversely, Coke will match the price reduction by Pepsi to fight for its share of the market. Because of the reduced prices by both Coke and Pepsi there is a likelihood of increased sales for both competitors, this competition being detrimental to smaller-sized companies in the same industry. In the light of this competition, it is important to realize that the standard prices tend to be maintained.  Neither Coke nor Pepsi will be willing to raise the price since this would result in loss of sales and their market share to their competitors who would maintain or even lower their prices. At the same time, neither of the firms will be inclined to lower the prices and engage in a price war, given that the outcome would be a lowered profit for both firms (Landsburg).

Income elasticity of demand

The income elasticity of demand is used in measuring how quantity demanded respond to changes in income. It might be expected that when incomes are increased, more of a commodity or services would be demanded; though this is not always the case. Assuming there are two products which are substitutes, and they are Pepsi Cola and Coca Cola. In case the price of Coca Cola rises, it is to be expected that amount of commodity demanded would decrease, while the demand for Pepsi would increase. Presupposing that Coca Cola and Pepsi are perfect substitutes, when the price of Coke increases by 10% and this translate to a 10% increase in the demand for Pepsi, the elasticity is +1 (Arnold).

Income Effects

Income is one of the most important factors that affect the demand for a commodity.

Income effects and substitution effects are two non-price determinants of demand. Changes to the income level of customers in a market shift the position of the demand curve for a product (in contrast to a movement along the demand curve or to a change in quantity demanded.) An overall increase in the level of income, for a normal product, will transpose the demand curve to the right. That is, at any price on the original demand curve, more of the product will be demanded after the increase in income, as reflected by the new demand curve (William Boyes).

A normal product or service are any commodity for which a rise in income relates to a rise in its demand. The opposite for normal goods are inferior goods. In the case of Coca Cola, demand for a can of Coca Cola will increase with the increase in income (McEachern). The more an individual earns, the higher the possibility is that they will tend to take more soda.  As buyers’ incomes increase, the demand curves for a normal commodity, such as Coca Cola, tend to move to the right, while the demand curves for the inferior products tends to move to the left. Providing there are no changes in the prices of a commodity, the buyers’ income increase will result in changes of the budget constraint.  When an individual’s income increases, there will be a shifting of the budget constraints to the right, providing more of the commodity will be bought. In case of a change in the level of income of the buyers, there is always a change in the amount demanded of a product, considering that all the other factors remain constant. The income elasticity of demand is defined; the ratio percentage alteration in the quantity of demanded goods (David Besanko).

In general, when there is a rise in income, consumers will desire to purchase more of a commodity than they previously did, but this will not be applicable to inferior goods. Normally, since the change in income affects demand positively, the income elasticity of demand will also be positive. In case the changes in income do not reflect any changes in demand, the elasticity is said to be zero. The elasticity is negative in case an increase in income leads to lowered purchases. It is worth noting that for an individual seller, the demand for the commodity on a large scale may be inelastic. If the seller will consider lowering the price, as compared with their competitors, the seller infinitely increases the demand for the commodity. It is this form of competition between Coca Cola and Pepsi that has been an advantage to the consumers. Since no one will accept lowering or increasing the price significantly in the fear of losing market share and revenue (Sexton).