Question

4. Assume that the demand for a product X is heavily influenced by the price of another product Y (Py), and the income of consumers (I). The cross-price elasticity of X with respect to Y is ex 1.25, and the income elasticity is e 2. (1) Are X and Y complements or substitutes? Why? (2) Is X a normal or inferior good? (3) Suppose now Py decreases by 5%, and consumer income decreases by 1%. will the quantity demanded of X increase or decrease? By what percent?

Answer 1

1) X and Y are substitutes because when cross price elasticity is a positive number then it is said to be substitutes.

2) X is a normal good because income elasticity is 2 which means change in income leads to change in quantity demanded of a product. Income elasticity is a positive number depicting quantity demanded is changing with rise in income. So it is a normal good as for inferior goods rise in income leads to fall in demand of inferior goods.

3) The quantity demanded for X will fall with fall in price of Y by 4%.