Question

If you were an executive of a cereal company and if you had a research report that showed your firm’s cereal had a cross-price elasticity of negative -0.9 with milk, then what does this mean?

• Milk is a necessity

• Milk is a substitute product

• Milk is a complimentary product

• Milk is an inferior good

Answer 1

Two goods are considered to be complementary if increase in price of one results in decrease in demand of other and Two goods are considered to be substitutes if increase in price of one results in increase in demand of other.

Cross price elasticity of demand of X and Y = % change in demand of X / % change in price of Y.

So, If two are complements then increase in price of Y will result in decrease in demand of Y and thus % change in demand of X / % change in price of Y is negative.

Similarly if Cross price elasticity is positive then this means that X and Y are substitutes.

Here Cross price elasticity of demand is negative implies that Milk is a complementary of Cereals.

Thus option (c) is correct answer (b) is incorrect.

In order to check whether milk is inferior or luxury we need effect of income on demand of Milk and as there is no such information. Thus (a) and (c) are incorrect.

Hence, the correct answer is (c) Milk is a complimentary product.