Final answer:
Coke and Pepsi are substitutes, which means a price decrease in Pepsi will lead to a decrease in demand for Coke due to the substitution and income effects. These concepts are integral parts of the law of demand and supply, explaining market dynamics and consumer behaviors.
Step-by-step explanation:
Because Coke and Pepsi are substitutes, a decrease in the price of Pepsi will cause the demand for Coke to decrease. In economics, elasticity refers to how much the quantity demanded of a good responds to a change in price. Goods that are substitutes have a high cross-price elasticity, meaning that if the price of one goes down, the demand for the other will likely decrease, because consumers will switch to the cheaper option.
Substitution effect and income effect are two reasons why this trend is seen. The substitution effect means that consumers will tend to buy more of the cheaper product and less of the more expensive one. The income effect implies that after a price decrease for Pepsi, for example, consumers have more purchasing power and could afford to buy more Pepsi even if they continue buying other goods as before.
Therefore, when Pepsi's price drops, people tend to substitute Coke for Pepsi, leading to a decrease in Coke's demand. This concept is foundational in understanding market dynamics and consumer behavior patterns as outlined by the law of demand and the law of supply. A clear grasp of this helps explain how market equilibriums are disrupted and subsequently restored.