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Chapter 6: Problem 1

Define the cross-price elasticity of demand. What does it mean if the cross- price elasticity of demand is negative? What does it mean if the cross-price elasticity of demand is positive?

Short Answer

Expert verified
Cross-price elasticity of demand measures how demand for one good changes when the price of another good changes. It is calculated as the percentage change in quantity demanded of Good B divided by the percent change in price of Good A. A negative cross-price elasticity indicates the goods are complements, as an increase in price of one decreases demand for the other. A positive cross-price elasticity suggests the goods are substitutes, as an increase in price of one increases demand for the other.

Step by step solution

01

Defining Cross-Price Elasticity of Demand

Cross-price elasticity of demand measures how the quantity demanded of one good (let’s call it Good B) changes in response to a change in the price of another good (Good A). This is often used to see how closely related two goods are in the market. Cross-price elasticity of demand is calculated using the following formula: \( Cross-Price\, Elasticity = \frac{%Change\, in\, Quantity\, Demanded\, of\, Good\, B}{%Change\, in\, Price\, of\, Good\, A} \)
02

Negative Cross-Price Elasticity

If the cross-price elasticity of demand is negative, it means the two goods are complements. In other words, as the price of Good A increases, the quantity demanded of Good B decreases, and vice versa. This is because the goods are used together. For example, if the price of coffee increases (Good A), the demand for sugar, a complement, might decrease (Good B).
03

Positive Cross-Price Elasticity

If the cross-price elasticity of demand is positive, it means the two goods are substitutes. That is, as the price of Good A increases, the quantity demanded of Good B also increases, and vice versa. This is because the two goods can replace each other. For example, if the price of butter (referenced as Good A) goes up, the demand for margarine (Good B), a substitute, may increase.

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Most popular questions from this chapter

The publisher of a magazine gives her staff the following information: $$ \begin{array}{l|l} \hline \text { Current price } & \$ 2 \text { per issue } \\ \hline \text { Current sales } & 150,000 \text { copies per month } \\ \hline \text { Current total costs } & \$ 450,000 \text { per month } \\ \hline \end{array} $$ The publisher tells the staff, “Our costs are currently \(\$ 150,000\) more than our revenues each month. I propose to eliminate this problem by raising the price of the magazine to \(\$ 3\) per issue. This will result in our revenue being exactly equal to our cost." Do you agree with the publisher's analysis? Explain. (Hint: Remember that a firm's revenue is calculated by multiplying the price of the product by the quantity sold.)

Write the formula for the price elasticity of supply. If an increase of 10 percent in the price of frozen pizzas results in a 9 percent increase in the quantity of frozen pizzas supplied, what is the price elasticity of supply for frozen pizzas? Is the supply of pizzas elastic or inelastic?

A study of the consumption of beverages in Mexico found that "overall, for soft drinks a \(10 \%\) price increase decreases the quantity consumed by \(10.6 \%\)." Given this information, calculate the price elasticity of demand for soda in Mexico. Is demand price elastic or price inelastic? Briefly explain. Source: M. A. Colchero, et al. "Price Elasticity of the Demand for Sugar Sweetened Beverages and Soft Drinks in Mexico," Economics and Human Biology," Vol. 19, December 2015, pp. \(129-137\).

When San Francisco and other cities in California adopted soda taxes, an opinion column in the New York Times observed, "Often, the taxes don't even pinch the budgets of low-income families, because they respond by drinking less soda." What does the columnist mean when he writes that soda taxes don't "pinch the budgets" of low-income families? Shouldn't an increase in the price of soda resulting from a tax always increase the amount that families have to spend to buy soda? Briefly explain.

Are the cross-price elasticities of demand between the following pairs of products likely to be positive or negative? Briefly explain. a. Iced coffee and iced tea b. French fries and ketchup c. Steak and chicken d. Blu-ray players and Blu-ray discs
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