Answer to Question #165708 in Macroeconomics for Cephas

Question

You are the country manager of a firm that produces and markets a generic type of soft 

drink in a competitive market in Ghana. In addition to the large number of generic products 

in your market, you also compete against major brands such as Coca-Cola and Pepsi. 

Suppose that, due to the successful lobbying efforts of sugar producers in Ghana, 

Parliament levies a ȼ1.20 per pound tariff on all imported raw sugar: the primary input for 

your product. In addition, Coke and Pepsi launches an aggressive advertising campaign 

designed to persuade consumers that their branded products are superior to generic soft 

drinks. How will these events impact the market outcomes of generic soft drinks if effect of 

the tariff is larger the effect of advertising of Coke and Pepsi on the generic type of soft 

drink? [Explain with an appropriate graph]

Answer 1

You are dealing with two separate affects. First, the sugar tariff will decrease your supply curve and the industry supply curve. This means that price increases and quantity decreases. However, since you are a small firm, you will be hurt particularly bad because your variable cost is a larger portion of your total cost due to increasing economies of scale in manufacturing soft drinks. If your cost increases cause you to increase your prices enough, Coca-Cola and Pepsi may actually benefit from the tariff because they are harmed relatively less by the tariff and benefit when small competitors increase prices.

The second effect is that Coke and Pepsi increase product-specific advertising. This will decrease your demand curve. This will lower the price and lower the quantity.

Now, as the given graph;

 

 

Initially, the demand and supply for the generic drinks will be at equilibrium point "a". The price would be P and quantity sold will be Q. Due to an increase in the price of the sugar which is an important input the price of the generic drink will increase. And this will shift the supply curve to the left. The new equilibrium will be at point "b" at a higher price P1 and lower quantity Q1. The supply curve will shift to S2 from S1.

After the Ad campaign by the big brand, the demand for the generic drinks will decrease even further. The new quantity demanded will be Q2 and price will be lower at P2. The equilibrium will be at point "C". The demand curve will shift from D1 to D2.