Strategic Behavior in a Soft-Drink Market :

F.Gasini, Q.Voung and J.J.Laffont (Econometric analysis of collusive behaviour in a soft- drink market, Journal of Economics and Management Strategy, 1992:277-311), estimate demand functions and marginal cost functions for Coca-Cola and Pepsi. It is found that Coca-Colas marginal cost is constant at 5 and Pepsis marginal cost is constant at 4.

For Coca-Cola the demand is: QCOKE = 63 4PCOKE + 2PPEPSI (1)

For Pepsi the demand is QPEPSI = 50 5PPEPSI + PCOKE (2)

a) Assume that the two firms set prices simultaneously in a one shot game. Derive the two companies best response functions. Find the Nash equilibrium prices.

b) Assume that Coca-Cola is forced to set its price before Pepsi. Find the prices for both companies. Would this lead to a higher price of Pepsi in the equilibrium than the one in a)? Use a formal argument. Is Coca Colas profit higher or lower than in a)?

c) Assume that Coca-Cola and Pepsi set quantities (rather than prices) simultaneously. Find the equilibrium in quantities. Provide an argument for why the Nash equilib- rium profits of the two companies would be higher in a quantity setting situation than in a).