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

1 - The negative sign before the cross price elasticity denotes that the goods are complemetary goods and positive cross price elasticity denotes that goods are substitute goods.

2 - Coke and pepsi are close substitutes hence their cross price elasticity is positive.

AC and electricity used are complements. Gretaer the use of AC , more will be electricity used , hence cross price elasticity is negative.

SUV and gasoline are complements showing negative cross price elasticity.

Mc Donald and Harvy burgers can be called as less perfect subtitutes that margariane and butter which have greater cross price elasticity

3 - % change in quantity of coke demanded

= 0.63*5

=3.15 %

Hence demand will rise by 3.15 %

4 - change in demand = -0.28 * 10

= -2.8 %

Hence demand will fall by 2.8 %