Question

You work for a marketing firm that has just landed a contract with Run-of-the-Mills to help them promote three of their products: splishy splashies, flopsicles, and mookies. All of these products have been on the market for some time, but, to entice better sales, Run-of-the-Mills wants to try a new advertisement that will market two of the products that consumers will likely consume together. As a former economics student, you know that complements are typically consumed together while substitutes can take the place of other goods.

Run-of-the-Mills provides your marketing firm with the following data: When the price of splishy splashies decreases by 20%, the quantity of flopsicles sold decreases by 22% and the quantity of mookies sold increases by 7%. Your job is to use the cross-price elasticity between splishy splashies and the other goods to determine which goods your marketing firm should advertise together.

Complete the first column of the following table by computing the cross-price elasticity between splishy splashies and flopsicles, and then between splishy splashies and mookies. In the second column, determine if splishy splashies are a complement to or a substitute for each of the goods listed. Finally, complete the final column by indicating which good you should recommend marketing with splishy splashies.

	Relative to Splishy Splashies		Recommend Marketing with Splishy Splashies
	Cross-Price Elasticity of Demand	Complement or Substitute
Flopsicles
Mookies

Answer 1

The cost price elasticity of substitutes are always positive since the price increase of one good leads to increased demand for the other good.

The cost price elasticity of complements is always negative since the price increase of one good leads to decreased demand for the other good.

Splishy spalshies and flopsicles are complements.

Splishy splashies and mookies are substitutes.

cost price elasticity of Splishy spalshies and flopsicles complements = -0.22/0.07 = -3.14

cost price elasticity of Splishy splashies and mookies substitutes = 0.20/0.22 = 0.909