Question

You are the manager of a firm that produces and markets a generic soft drink in a competitive market. In addition to the large number of generic products in your market, you also compete against major brands, such as Coke and Pepsi. Your production process is capital-intensive, relying on automation to produce your generic soft drinks. You have outsourced the transportation and delivery services to an outside firm and have a multi-year firm fixed priced contract that shields your firm from variation in transport and delivery costs. Due to a successful lobbying effort, you have managed to insert a provision in the new tax bill that allows you to immediately deduct the cost of new capital investment.

a. All else remaining equal, what will be the impact of immediate expensing of capital investments on market equilibrium price and quantity?

b. You have just received an email that several consumer groups are launching an anti-soda campaign. Normally, you would ignore these campaigns, however, the groups are proposing to tax soda by value (an ad valorem tax) and to use the funds for public health campaign that enjoys wide support. The proposed ad valorem tax would be 2 cents on each $1 dollar of value and, as such, proponents of the tax argue that it would not impact sales at all. Note that you have previously received data to suggest that the tax-price elasticity of demand for generic soda is -1.25. What is the potential impact of the proposed tax on the industry and what might be a reasonable argument against the proposed tax?

c. An economic consultant that you recently hired arrives to inform you that Coke and Pepsi are competitors and that the cross-price elasticity of demand of your product with Coke and Pepsi are 2.5 and 1.75, respectively. Coke has recently announced a price increase of three (3) percent while Pepsi is holding price steady. If all else remains equal, what would be the impact on the quantity demanded of generic soda?

Answer 1

Ans....

a) The impact of immediate expensing of capital investments on market equilibrium price and quantity are all  else remains the same immediate expensing of the capital investment will reduce the demand and price of the capital equipment reducing its quantity too. People will demand less of capital equipment because expensing will make it costlier.

If capital equipment is exempt from taxing then the price and quantity both ill increase due to increased demand.

b) The proposed tax will reduce the demand for the Soda because the demand for soda is highly elastic i.e. more than 1 which means an increase in the price will affect the demand more than the percentage of price increased.

c) The demand for Generic Soda will increase rapidly because the demand for generic soda is highly elastic to the price of the other two competitors.