A large Coca Cola vendor recently hired some economic analysts to assess the eff

Question

A large Coca Cola vendor recently hired some economic analysts to assess the effect of a price increase in its 16 ounce bottles from $1.75 to $2.25. The analysts determined that, on average, the vendor’s customers spend about $18.00 on soda (Coke and all other brands) each week, and the average price for other 16-ounce soda bottles is $1.75. The analysts also utilized some focus groups to determine the preferences of the vendor’s customers. They used this analysis to build the following graph:

(A)The vendor should expect to sell less than 4 bottles of Coke. (B)The vendor should expect to sell 4 bottles of Coke. (C)The vendor should expect to sell more than 4 bottles of Coke.
Budget Line before Price Increase Budget Line after Price Increase Bottles of Coke

Explanation / Answer

Ans C.

Coke is an inferior good, so with rise in income the demand for coke will fall. When the price of coke increases from $1.75 to $2.25, real income of consumer decreases. The consumer is hypothetically given an income, which brings him to initial indifference curve. The movement from xo to x1 shows his substitution effect due to price change. Since income effect is negative, with fall of real income consumer will buy more goods of coke. Therefore, bottles of coke purchased by consumer will lie between x1xo.

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