Question

The following table lists the cross elasticity of demand for several goods, where the percentage quantity change is measured for the first good of the pair, and the percentage price change is measured for the second good.

Good Cross elasticity of demand

Air-conditioning units and kilowatts of electricity -0.34

Coke and Pepsi 0.63

High-fuel-consuming SUVs and gasoline -0.28

McDonald’s burgers and Harvey burgers 0.82

Butter and Margarine 1.54

1.Explain the sign of each of the cross elasticities. What does it imply about relationship between the two goods in questions.

2. Compare the absolute value of the cross elasticities and explain their magnitudes. For example, why is the cross elasticity of demand of McDonald’s burgers and Harvey’s burgers less than cross elasticity of butter and margarine?

3. Use the information in the table to calculate how a 5% increase in the price of Pepsi affects the quantity of Coke demanded.

4. Use the information in the table to calculate how a 10% decrease in the price of gasoline affects the quantity of SUVs demanded

Answer 1

a) Positive cross price elasticity of demand says that two goods are substitutes to each other while negative cross price elasticity of demand says that goods are complements to each other.

Goods that are substitute to each other are:

• Coke and Pepsi
• McDonald’s burgers and Harvey burgers
• Butter and Margarine

Goods that are complements to each other are:

• Air-conditioning units and kilowatts of electricity
• High-fuel-consuming SUVs and gasoline

b) McDonald’s burgers and Harvey burgers as well as Butter and Margarine are substitutes to each other but higher value of cross price elasticity of demand of Butter and Margarine says that they are close substitutes of each other than McDonald’s burgers and Harvey burgers.

c) %change in price of pepsi = 5%

Cross price elasticity of demand between coke and pepsi = 0.63

0.63 = %change in quantity demanded of coke / %change in price of pepsi

0.63 * 5% = %change in quantity demanded of coke

%change in quantity demanded of coke = 3.15%

Quantity demanded of coke will increase by 3.15%

d) %change in price of gasoline = -10%

Cross price elasticity of demand between gasoline and SUV = -0.28

-0.28 = %change in quantity demanded of SUV / %change in price of gasoline

-0.28 * -10% = %change in quantity demanded of SUV

%change in quantity demanded of SUV = 2.8%

Quantity demanded of SUV will increase by 2.8%