Question 1 a. Consider your two favorite soft drinks. Suppose the price of a two-liter bottle...

Question 1

a. Consider your two favorite soft drinks. Suppose the price of a two-liter bottle of your second choice falls. How much of a price decrease would it take to induce you to substitute the second for your first choice? Estimate the cross elasticity of demand for the drinks. Are they part of the same market?

b. Suppose a market becomes more competitive over time. What happens to the elasticity of demand for a particular firm's good as its market becomes more competitive?

Solutions

Expert Solution

1.a. Cross elasticity of demand measures the responsiveness in the quantity demanded of one good when the price for another good changes.

Two soft drinks may be Coke and Pepsi. If the price of my second choice i.e. Pepsi falls, there must be at least $1 decrease in price of Pepsi so that I can substitute Pepsi for coke.

To find cross price elasticity we can take following example- b. As we know that the elasticity measures the responsiveness of demand for a product due to change in its price. Now if the market becomes more competitive, this means that there must be many substitutes for a good in that market. So in this type of market when there is increase in price of a particular good than there is sharp decrease in its demand and vice-versa. This is because when there is increase in price of one product than people substitute it with other.

So it shows that when the market becomes more competitive the elasticity of demand for a particular firms good will become more elastic.

Rahul Sunny answered 1 year ago

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