Question

The accompanying table lists the cross-price elasticities of demand for several goods, where the ­percent quantity change is measured for the first good of the pair, and the percent price change is measured for the second good.

Good                                                                                        Cross-price elasticities of demand

Apple and orange                                                                                +0.95

Shirt and trousers                                                                                -2.55

Explain the sign of each of the cross-price elasticities. What does it imply about the relationship between the two goods in question?

b.

Which of the following goods are likely to have elastic demand, and which are likely to have inelastic demand? Justify you answers.

Egg

Restaurant meal

Answer 1

(a) In case of Apple and orange, they are substitute goods as both of them are fruits. These two goods posses a direct relationship. If the price of the orange increases, it will lead to an increase in demand for apples, and hence the quantity demanded for apples will increase, hence cross-price elasticity of demand is positive.

Shirt and Trousers are complementary goods. They have an inverse relationship. If the price of trousers decreases, the quantity demanded for shirts will increase since people can make pair of clothes at a cheaper price, hence the sign of cross-price elasticity of demand is negative.

(b) Elastic demand occurs when the price of the product has a huge effect on the quantity demanded by the customers.

Inelastic demand occurs when the price of the product has no effect on the quantity demanded by the customers.

In the case of the egg, since it has no substitutes, an increase in price will not change the quantity demanded as there are no substitutes available, hence it has an inelastic demand.

Whereas in case of a restaurant meal, since there are substitutes available, it will have elastic demand. If the price of a restaurant meal increase, people will chose to eat some other meal as they have multiple options/ Subsitutues available.