Question

8. Substitutes, complements, or unrelated?

You work for a marketing firm that has just landed a contract with Run-of-the-Mills to help them promote three of their products: penguin patties, flopsicles, and cannies. All of these products have been on the market for some time, but, to entice better sales, Run-of-the-Mills wants to try a new advertisement that will market two of the products that consumers will likely consume together. As a former economics student, you know that complements are typically consumed together while substitutes can take the place of other goods.

Run-of-the-Mills provides your marketing firm with the following data: When the price of penguin patties decreases by 4%, the quantity of flopsicles sold decreases by 4% and the quantity of cannies sold increases by 3%. Your job is to use the cross-price elasticity between penguin patties and the other goods to determine which goods your marketing firm should advertise together.

Complete the first column of the following table by computing the cross-price elasticity between penguin patties and flopsicles, and then between penguin patties and cannies. In the second column, determine if penguin patties are a complement to or a substitute for each of the goods listed. Finally, complete the final column by indicating which good you should recommend marketing with penguin patties.

Answer 1

Using the formula for cross-price elasticity as:

E = % change in Q1/% change in P2

Thus, cross price elasticity of demand of Flopsicles = -4%/-4% = 1

Since elasticity is positive, the goods are substitutes

So, it is recommended not to advertise with patties.

Similarly, cross price elasticity of demand of Cannies = 3%/-4% = -0.75

Since elasticity is negative, the goods are complements.

So, it is recommended to advertise with patties.