Question

Please help with these questions:

1. Explain cross elasticity of demand.
2. How is it is used to determine substitute or complementary products?
3. Explain why a negative sign refers to a complimentary good.
4. Explain why a positive sign refers to a substitute good.
5. Explain what a cross-price elasticity of -5.50 means.
6. Explain what a cross-price elasticity of 0.50 means.

Answer 1

1. Cross price elasticity of demand refers to the responsiveness of the quantity demanded of one good for a change in price in another good. Cross price elasticity of demand = % change in quantity demanded of good A/ % change in the price of good B.

2. In the case of complementary goods, the quantity demanded of one good decreases with the increase in the price of the other good. In the case of substitute goods, the quantity demanded of one good increases with the increase in the price of the other good. Therefore, the cross-price elasticity of demand of two complementary goods is negative and the cross-price elasticity of demand of two substitute goods is positive.

3. In the case of complementary goods, the quantity demanded of one good decreases with the increase in the price of the other good. Therefore, the quantity demanded of one goods moves in the opposite direction of the price change of the other good. So, the cross price elasticity of demand of two complementary goods is negative.

4. In the case of substitute goods, the quantity demanded of one good increases with the increase in the price of the other good. Therefore, the quantity demanded of one goods moves in the same direction of the price change of the other good. So, the cross price elasticity of demand of two substitute goods is positive.

5. Cross-Price elasticity of -5.50 means that the two goods are complementary goods and the demand for one good would fall by 5.5% for a 1% increase in the price of the other good.

6. Cross-Price elasticity of 0.50 means that the two goods are substitute goods and the demand for one good would rise by 0.5% for a 1% increase in the price of the other good.