Question

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Q.a) What does the cross-elasticity of factor demand measure and how is it defined?

b) When is the cross-elasticity of factor demand positive and when negative? Explain why.

c) Show graphically how the demand curve for input i changes, when the price of input j is increasing and input j is a substitute. Explain in one sentence why this is the case.

Answer 1

Ans-

a) Cross elasticity of factor demand - It is an economic term which measures the responsiveness of change in quantity demanded in factor input towards the change in price of other factor.

E.g. When a and b are two input substitutes, the cross elasticity of factor demand measures when how much change in price of input A will be responsible for change in demanded quantity of input b.

b) Positive and Negative cross elasticity of factor demand:

1) Positive cross elasticity- This value indicates that the two factor inputs are substitutes. Eg. When the price of input a increases, the demand for b also increases. This is known as positive cross elasticity.

2) Negative cross elasticity of factor demand - When two goods are complementary to each other, it shows negative cross elasticity. Eg. When a and b are complementary goods, when price of factor input a increases, the demand for factor input b decreases and vice versa.

c) Solution for this is attached below.