The market for energy drinks is dominated by two major producers: Red Monster and Bull.

Knowing that their products are weakly differentiated, the companies have found a way to

sustain prices well above their marginal costs through tacit collusion. While the marginal

costs equal $4 for a 12-pack for either company, the companies have been charging $20 for a

12-pack in the recent years.

a. Suppose that the price that the two companies chose, $20, is the price that maximizes the

industry's profits (i.e., the price that a monopoly company would choose if it had the

same cost structure). What does

this

tell you about elasticity of demand for energy

drinks?

Knowing the importance of a healthy energy drink to students and faculty alike, Kellogg

graduates of 2020 started a company that would produce a new energy drink from organic

ingredients using traditional recipes from world cultures. The marginal cost of the new drink

is going to be $7 per 12-pack (which is understandably higher than that of the major

competitors, both due to a smaller scale and higher quality ingredients). The new company

(and the drink itself) is named Brave Purple (BP). Through market research,

you

established

that demand for the new drink in Evanston is well-described by the following formula:

=

150

10

+

6

,

where

is Brave Purple's price,

is the price

charged

by Red Monster and Bull (they

charge the same price due to tacit collusion),

is the quantity demanded, in units per day.

Since Red Monster and Bull are national brands and Brave Purple is a small local competitor,

you have reason to believe that Brave Purple's pricing decisions will either be unnoticed by

the two major companies, or in any case they

would

not be a sufficient reason to upend the

tacit collusion and risk a price war.

b. How would you price the new product? What quantity would you produce and what

would be your profit?

The remainder of this question posits different scenarios and asks for your recommendations.

IMPORTANT: Consider each of the following scenarios independently, unless stated

otherwise.

Explicit calculations are not required

(or even possible). However, please clearly

explain your reasoning. Use diagrams wherever appropriate.

c. Red Monster airs a negative ad about Bull products, triggering a price war between the

two brands. Should you increase the price or decrease the price of Brave Purple? Would

you produce less or more? What would happen to your profits?

d. To prevent energy drinks from being used at parties, the city of Evanston attempts to

prohibit the sale of energy drinks after hours. Specifically, it bans the sale of drinks that

contain taurine after 8pm. Fortunately for you, while Red Monster and Bull contain

taurine, Brave Purple does not. Would you recommend to adjust the price of Brave

Purple? If so, how? (Hint: the tacit collusion has not broken down!)

e. A trade war with Russia and China begins and pine nuts, an essential ingredient in Brave

Purple, increase in price considerably. What would be your recommendation?

f. Brave Purple, consistent with its name, put big letters B and P on the cans. A London-

based gas company that uses the same letters as part of their brand sent Brave Purple a

cease-and-desist letter. After some negotiation, they reached a settlement that allows

Brave Purple to keep using the letters on energy drinks in exchange for a one-time

payment of $100,000. How would you recommend that Brave Purple change their pricing

policy?

g. Red Monster and Bull merge, and the resulting economies of scale reduce the marginal

cost of the merged firms' products by 10%, from $4 to $3.60 per 12-pack. Do you expect

them to increase the price, decrease it, or keep it constant? What would you recommend

Brave Purple to do? (Hint: Remember $20 was the optimal monopoly price in part a.)

h. Shortly after the merger in part (g), while shopping in a local supermarket, you notice

that the price of Red Monster is no longer at the monopoly level as in (g) - in fact, it is

exactly equal to the price of Brave Purple. The price of Bull, however, stays the same.

After some research, you figure out that this is true in other local supermarkets as well,

but not in supermarkets elsewhere in the country where both prices remain at the

monopoly level. What would you do? Explain.