Question

8. Substitutes, complements, or unrelated?

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: penguin patties, flopsicles, and kipples. 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 penguin patties increases by 4%, the quantity of flopsicles sold decreases by 5% and the quantity of kipples sold increases by 3%. Your job is to use the cross-price elasticity between penguin patties 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 penguin patties and flopsicles, and then between penguin patties and kipples. In the second column, determine if penguin patties 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 penguin patties.

	Relative to Penguin Patties		Recommend Marketing with Penguin Patties
	Cross-Price Elasticity of Demand	Complement or Substitute
Flopsicles
Kipples

Answer 1

Change in price of penguin patties=4%

Change in demand for flopsicles=-5%

Cross price elasticity of flopsicles relative to penguin patties=Change in demand for flopsicles/Change in price of penguin patties=-5%/4%=-1.25

We can see that cross price elasticity of demand is negative in this case. It means that penguin patties and flopsicles are complements. These products are consumed together.

Change in price of penguin patties=4%

Change in demand for kipples=3%

Cross price elasticity of kipples relative to penguin patties=Change in demand for kipples/Change in price of penguin patties=3%/4%=0.75

We can see that cross price elasticity of demand is positive in this case. It means that penguin patties and kipples are substitutes. These products are not consumed together.

	Relative to Penguin Patties		Recommend Marketing with Penguin Patties
	Cross-Price Elasticity of Demand	Complement or Substitute
Flopsicles	-1.25	Complement	Yes
Kipples	0.75	Substitute	No