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

Question

You are the manager of a firm that produces and markets a generic type of soft drink in a competitive market. In addition to the large number of generic products in your market, you also compete against major brands suh as Coca-Cola and Pepsi. Suppose that, due to the successful lobbying efforts of sugar producers in the US, Congress is going to levya $.50 pern pound tariff on all imported rall sugar-- the primary input for yur product. In addition, Coke and Pepsi nplan to launch an aggressive advertising campaign designed to persuade cosumers that their branded product are superior to generics soft drinks. How will these events impact the equilibriumn price nand quantity of generic soft drinks?

Explanation / Answer

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. As a result of both changes, we know that quantity decreases because both events decrease quantity. However, the change in price is unknown because the tariff increases price while competitor advertising decreases price. In order to know what happens to the price, we would have to know the relative size of the price changes as a result of each event. But that information is not given in the problem.

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