Question

a. Good X has a cross elasticity coefficient with good Y equal to 2.5 for good Y. Is it likely that good X is peanut butter and good Y is jelly? Why or why not?

b. Good Z has an income elasticity coefficient equal to 0.5. Is it likely that good Z is a new Ferrari? Explain.

c. Give a definition for the Law of Increasing Costs. How does this law impact the opportunity cost of goods along a production possibilities frontier.

Answer 1

The rate of change in demand with respect to change in price of the related goods is known as cross elasticity coefficient, in case the goods are not related to each other thier cross elasticity is zero,in case of complimentary goods it is likely to be negative while in the case of substitute goods it is postive

For example, if the price of tea increases more consumer will shift towards it substitute coffee, hence resulting in the demand of the substitute

1) In the above example the cross elasticity of good X with Y is 2.5 , which means they can be substitute goods , so it is highly likely that they are peanut butter and jelly as both can be used as a substitute of another.

Income elasticity coefficient is percenatge change in quantity demanded over percentage change in income, the elasticity coefficient is based on the nature of the product whether it is a normal , inferior or luxurious goods.

In case of normal goods when the income of the consumer increses the the demand also increases and the coefiicient is positive , the coefficient generally lies between 0 to 1 for basic necesities.(food, medicine , milk etc)

In case of inferior goods with an increse in income people tend to switch to normal goods more which leads to decrease in demand so they have negative coefiicient

The coefficient of luxury goods is very high income elastic and it can vary form person to person

2) From the given example that the Income elasticity coefficient is 0.5 it could not be a Ferrari as it is a luxurious goods , it might be a good of normal necessity

3) Law of increasing cost states that the other factors of production i.e land , labour and  capital are used at its best , producing extra units will cost more than the average cost and this is the point where marginal cost also starts rising following the law of returns .

The term opportunity cost arrives when we have choice between two or more , we choose for the best possible as the the resources are scarce, from the point of incresing cost producer will stop producing that commodity and look for its best alternative that can be produced within the production possibility curve for the best marginal cost under the average cost .