South-Western EconNews: Cola Prices Pop Up

Cola Prices Pop Up

Subject

Assumptions, strategy, and equilibrium

Topic

Oligopoly

Key Words

Price, marketing, strategy, profitability, volume, consumers, demand, consolidation

News Story

PepsiCo is following Coca-Cola in raising the price of concentrate to bottlers by 7 percent in 2000. This is double the normal increase. However, PepsiCo will give greater marketing support payments to bottlers.

This strategy is new. Recently, the companies have been foregoing profit to increase volume. Now they are trying to increase profitability, but also volume. The price of a can of Pepsi is expected to rise by a penny on average, although supermarkets may raise the price of a twelve-pack from as low as $1.99 to $2.49 or $2.79. The question is how will consumers react? Coke and Pepsi both experienced a fall in demand in the spring of 1999 when retailers raised prices, although demand has since bounced back. What happens in 2000 will depend much on the marketing program.

Some believe that the higher concentrate prices may cause some bottlers to sell their businesses. The industry could well become more consolidated.

(Updated January 1, 2000)

Questions

1.	a) Why is the cola industry oligopolistic? Refer to the assumptions on which oligopoly theory is based.
	b) Is there any evidence of interdependence between the primary producers?
2.	a) Why do you think that PepsiCo emulated Coca-Cola's pricing strategy?
	b) What would have happened had Pepsi kept its price lower and competed with Coke? Why?
3.	The actions of PepsiCo and Coca-Cola indicate that joint profit maximization may be occurring.
	a) Draw a diagram with prices and costs on the vertical axis and the output of cola on the horizontal axis. Show the demand and marginal revenue curves and the marginal and average total cost curves of the joint-profit-maximizing firms. What other kind of product market diagram does it resemble? Why?
	b) Show the effect of the increased marketing payments on the cost curves assuming that they bear at least some relation to the output of cola. Justify why you moved the curve(s) you did.
	c) Why is it imperative that the marketing program work? Refer to what happens to the equilibrium price and output due to the cost of the program, and what might occur if it were successful.

Source

Constance L. Hays, "Following Coke, Pepsi Will Raise Prices," The New York Times, November 22, 1999.