Friday, April 1, 2011

Pepsi and Input Prices

Pepsi announced in 2011 that oil and agricultural product prices are increasing. Since oil and agricultural products are inputs (or resources) used in the production of Pepsi's output, this is an example of a variety of topics from Principles of Microeconomics.

First we see that as the price of inputs (or resources) are increasing this should shift the supply curve to the left (if Pepsi's output is in a competitive market) or shift's Pepsi's marginal cost curve to the left (which is the case if Pepsi's output is competitive or not competitive). As the supply curve or marginal cost curve shifts to the left, Pepsi will produce less output and if Pepsi is able to set their own prices (which seems reasonable) this leads to an increase in the price of Pepsi products.

Secondly, as the article mentions, Pepsi is going to pass on some of the costs, (but not all of the costs), which shows that the supply curve for Pepsi's products is not perfectly inelastic - it probably is relatively elastic since there a number of good substitutes for Pepsi's products, and hence if the supply curve is not perfectly elastic, then some of the increases in Pepsi's costs will be passed on to the final customers, and some of Pepsi's increased costs will be paid by Pepsi in the form of lower marginal profits. Speaking of profits...

Finally, this reduces Pepsi's profits, which is stated in the article. Higher marginal costs and average variable costs will lead to lower total profits if the increase in the average variable cost (in dollars) is greater than the increase in price (in dollars).

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