Suppose that Coke and Pepsi are the only two producers of cola drinks, making them duopolists. Both companies have zero marginal cost and a fixed cost of

$100,000.

a. Assume first that consumers regard Coke and Pepsi as perfect substitutes.

Currently both are sold for $0.20 per can, and at that price each company sells 4 million cans per day. i. How large is Pepsi’s profit? ii. If Pepsi were to raise its price to $0.30 per can, and Coke did not respond, what would happen to Pepsi’s profit?

b. Now suppose that each company advertises to differentiate its product from the other company’s. As a result of advertising, Pepsi realizes that if it raises or lowers its price, it will sell less or more of its product, as shown by the demand schedule in the accompanying table.

If Pepsi now were to raise its price to $0.30 per can, what would happen to its profit?

c. Comparing your answer to part a(i) and to part

b, what is the maximum amount Pepsi would be willing to spend on advertising?