Question

2. A Calculate the cross-price elasticity of demand between bread and butter where a 20 percent decrease in the price of bread results in a 50 percent increase in the quantity of butter demanded. Explain your answer. B. Calculate the income elasticity of demand for sweaters where a 10 percent increase in income leads to a 25 percent decrease in the quantity of sweaters demanded at a given price. What type of a good is a sweater? Why?

Answer 1

2. A.

Cross price elasticity of demand is defined as the % change in the quantity of good A due to % change in the price of good B.

Particularly it is given by the following formula-

$CPED = \frac{ \Delta \%Q_A }{ \Delta \%P_B}$

In our example, CPED = +50 / -20 = -2.5

Negative cross price elasticity means that the goods are complement to each other. Thus a decrease in price of bread increases it consumption and this also leads to increase in the demand for butter due to the complementary nature of the goods.

B.

Income elasticity of demand is defined as the % change in the quantity of good due to % change in the income of the consumer.

Particularly it is given by the following formula-

$IED = \frac{ \Delta \%Q }{ \Delta \%I}$

In our example, IED = -25 / +10 = -2.5

Negative income elasticity of demand means that the good considered is inferior good. That is to say that an increase in income will lead to a fall in the demand of the good and may lead to changes to more luxurious substitutes.