MICROECONOMICS (BUS1604/ ECN60104) INDIVIDUAL ASSIGNMENT (30%) -The Coca-Cola Company

I. Introduction

The Coca-Cola Company is an American multinational beverage company, with its headquarters in Atlanta, Georgia. The first company that conducted its operation in the soft drink industry was Coca-Cola. It is the world’s largest non-alcoholic beverage company serving more than 1.8 billion consumers daily in more than 200 countries. It has a portfolio of more than 3,500 (more than 800 no or low calorie) products. However, the company is best known for its flagship product Coca-Cola which was originally intended to be a patented medicine was invented in 1886 by pharmacist John Stith Pemberton in Columbus, Georgia. The Coca-Cola formula was sold to Atlanta businessman, Asa Griggs Candler, who incorporated The Coca-Cola Company in 1892. The company has generated a net operating revenue of $48 billion and an operating income of nearly $11 billion in 2012; this is despite the lingering economic headwinds. The Coca-Cola products can be termed as normal goods, that is, goods whose demand increase as consumer incomes increases.

II. Demand 

The demand curve of Coca-Cola as any other normal goods’ demand curve is downward slopping from left to right, showing the inverse relationship between the price of Coca-Cola and the quantity demanded of Coca-Cola over a given time period. This relationship can be explained by the law of demand which states that as price of a good increases (or decreases), the quantity demanded of that good falls (or rises), all other things being equal (ceteris paribus).

The demand curve demonstrates how many items of a product or service a consumer would like to purchase at different prices. Therefore, the lower the price of Coca-Cola, the more a consumer is likely to buy. Hence, it can be concluded that price is major determinant of demand. The effect of a change in price is illustrated by a movement along the demand curve and is referred to as a change in quantity demanded.

It can be seen from Figure 1 that when the price of Coca-Cola falls from $2.00 to $1.50, the quantity of Coca-Cola bottles demanded rises from 4 to 6.

However, price is not the only factor that determines how much of a good people will buy. There are other factors affecting demand and any change in any other determinants other than price causes a change in demand and a shift in the demand curve.

Figure 2: Shifts in the Demand Curve

Figure 2 shows how any change in one of the other determinants causes demand to rise or to fall by shifting the whole curve to the right or the left. It also shows that at each price on the demand curve D2 (or D3), more (or less) will be demanded than what was demanded on the original demand curve D1.

The other determinants of demand are:

1. Income: For Coca-Cola, there is a positive (direct) relationship between a consumer's income and the amount of the Coca-Cola that person is willing and able to buy. This is because Coca-Cola is a normal good. Therefore, when income rises the demand for Coca-Cola will increase; and vice-versa.

2. The number and price of substitutes products: Coca-Cola has numerous substitutes available on the market, Pepsi being its almost perfect substitute. Therefore, if the price of Coca-Cola increases, this may make Pepsi relatively more attractive to the consumers. The Law of Demand tells us that fewer people will buy Coke; some of these people may decide to switch to Pepsi instead. Hence, it can be concluded that there is a positive relationship between the price of one good, Coca-Cola in this case and the demand for the other good, Pepsi.

3. The number and price of complementary goods: Coca-Cola is often complementary to various fast foods such as KFC or McDonald. Hence, if the price of these fast foods increases, the Law of Demand tells us that fewer people will be willing and able to buy fast foods and hence, causing a decrease in the demand for Coca-Cola as well. Therefore, it can be concluded that there is an inverse relationship between the price of one complement, the fast food products in this case and the demand of the other complementary goods, Coca-Cola here.

4. Tastes and consumer preferences: It is logical that the more a product is found desirable by the people, the more the product will be demanded. Consumer preferences are highly influenced by advertising, fashion and by observing other consumers. Coca-Cola had understood this right from the beginning, which is why it used advertising extensively. Coca-Cola made full use of slogans in advertising so that it does not reflect the brand only but also the time, the people, the fashion trends, the celebrity craze, traditions but also the need for newness, freedom and uniqueness. One such example would be when the 1906 slogan, "The Great National Temperance Beverage”. It reflected a time period where the United States was trying to veer away from alcoholic beverages and Coca-Cola provided a nice alternative.

III. Supply

Like its demand curve, the supply curve of Coca-Cola is that of a normal good which slopes upwards from left to right, showing the relationship between the price of Coca-Cola and the quantity of Coca-Cola supplied over a given period of time. The effect of a change in price is illustrated by a movement along the supply curve which is often referred as a change in quantity demanded.

Figure 3: Movement along the Supply Curve

Figure 3 illustrates the movement along the supply curve as price rises from $ 2.00 to $2.50, the quantity supplied increased from 3 to 4 bottles.

Similar to the demand curve, supply is not only determined by price. The other factors influencing the supply of a product causes a shift in the supply curve leading to a change in supply.

Figure 4: Shifts in the Supply Curve

The principle here is the same as with demand curves; any change in the other determinants will cause the whole supply curve to shift.

The other determinants of supply are:

1. Cost of Production: An increase in the input prices such as the prices of basic commodity ingredients such as color, flavor, caffeine or sugar is likely to cause a rise in the cost of production of Coca-Cola. An increase in its production cost will cause the supplier less willing to supply at each quantity level.

2. Technology: Any improvement in the techniques of production used by Coca-Cola would lead to a decrease in its cost of production and hence suppliers would be willing to supply more.

3. The number of consumers: Coca-Cola has a large number of consumers and high level of brand loyalty, as a result suppliers are willing to supply more to cater for the need of its customers.

V. Price Elasticities

When the price of a good rises, the quantity demanded falls, however, by how much does it fall? To know by how much quantity demanded falls, we have to calculate the price elasticity of demand, that is, calculate how responsive demand is to a rise in price. Similarly, the price elasticity of supply measures the responsiveness of quantity supplied to a change in price.

Both the price elasticity of demand and the price elasticity of supply of Coca-Cola are elastic, that is, the value of elasticity is greater than 1 and hence a change in price causes a proportionately larger change in demand. Normally goods which have many substitutes have an elastic demand and supply curves. Coca-Cola and Pepsi are perfect substitutes Therefore, when Coca-Cola increases its price; most of its customers being highly sensitive to price will shift their consumption from Coca-Cola to other substitutes, most likely to Pepsi due to the similarity of the taste. However, Coca-Cola has very high level of brand loyalty; part of its customers is willing to pay more for Coca-Cola because they placed Coke as their only preference. The blind test game between Coca-Cola and Pepsi conducted by Pepsi was used to determine the preferences of cola drinkers. “The results shows most of the participants preferred the taste of Pepsi but they still argued that Coke is their brand of choices” (Tanner, 2012). This experience showed that Coca-Cola consumers are highly loyal. However, a rise in price will still make some of them shift to other substitutes. The high number of substitutes also explains why the demand for Coca-Cola is elastic while the demand for soft drinks itself is inelastic.

VI. Oligopoly

The Coca-Cola Company may pride itself on being the “world’s largest beverage company” and the “No. 1 provider of sparkling beverages, ready-to-drink coffees, and juices and juice drinks” but it is still operating in an oligopoly. “Oligopoly occurs when just a few firms between them share a large proportion of the industry” (Sloman, Wride, Garratt, 2012). Coca-Cola and Pepsi are the two dominant players in the beverage market with a total market share of 72%; Coca-Cola’s market share is 42% and Pepsi’s 30% (Russell, 2012).

They follow the two crucial features that distinguish them as oligopolies:

1. Barriers to entry

Due to the high market share owned by each individual industry, each of them are large enough to serve and dominate the market and yet when a new rival enter the industry they will both collude to take it down. Coca cola and Pepsi have signed a cartel contract. Cartel is a formal collusive contract among the firms with the aim of limiting cost, raising price and increasing profit. The two firms will become a cartel to prevent other firms from entering this industry because it will decrease their economic profit.

2. Interdependence of firms

In an oligopolistic industry, firms are mutual interdependence, where the profit gained is depending not only on the prices but on the other firms (McConnell et al., 2009). They are selling virtually identical product; drinks with similar taste and color, therefore they are perfect substitutes. The pricing and production decisions (strategies) of any one firm will affect overall industry price and production levels. Coca-Cola and Pepsi, each have to consider the reaction of each other before one of them decides to make a move on increasing or lowering price. When one of them cut its price, the other tends to follow.

VI. Conclusion

The Coca-Cola Company is truly global. It has been a success story for over 127 years. The objective of this report was to apply the microeconomics concept in the real world. The demand of Coca-Cola is highly influenced by factors such as income, relative goods and consumer preference. While its supply is determined by its cost of production, the technology used and then amount of consumer. Both of these curves are elastic, despite the fact that it has high brand loyalty. Coca-Cola belongs to an oligopolistic market as it dominates the industry with a 42% share market.

Reference

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Pangpal, N. (2010) Price War Analysis- Coke Pepsi [online]. Available at: http://www.slideshare.net/natarajpangpal/price-war-analysis-coke-pepsi [Accessed 7 January 2014]



McConelle, C., Brue, S. and Flynn, S. (2009) Economics: Principles, Problems, and Policies. 18th ed. United States of America: McGraw-Hill

Kumar, A. (2011) Demand-supply-of-Coca-Cola (1) [blog]. 02 September. Available from: http://www.slideshare.net/abhishekkumar1105/demandsupplyelasticityofcocacola-1 [Accessed 7 January 2014]



Chew, C. (2013) The Cola Oligopoly [blog]. 7 June. Available from: http://carmenchewyimin.blogspot.com/2013/06/the-cola-oligopoly.html [Accessed 7 January 2014].

Sloman, J., Wride, A., and Garratt, D. (2012) Economics 8th ed. Pearson.