Question

a) Using the percentage change method, calculate the cross elasticity if the price of margarine falls from $2 to $1.60 and the quantity of butter demanded falls from 500 to 450. Are these two products substitutes or complements? b) If the income elasticity of a product is 2, how much would income need to change for quantity to increase by 20%? Is this a normal or inferior good?

Answer 1

Cross price elasticity is measured by CPED = % change in Qd / % change in P = (450 - 500)*100/500 divided by (1.60 - 2.00)*100/2.00 = -10%/-20%. = 0.5. Since price fall causes quantity demanded to fall, the two products are positively related so these are substitutes

Income elasticity = % change in Q/ % change in income

2 = 20%/% change in income

% change in income = 20/2 = 10%. Income should increase by 10%. SInce income elasticity is positive it is a normal good.