Question

b) When the price of Good A is $27, the quantity demanded of Good B is 1,200 units. When the price of Good A falls to $23 the quantity demanded of Good B falls to 800 units. i. Calculate the cross elasticity of demand ii. Are the goods substitutes or complements? Explain your choice. c. Explain how cross elasticity of demand is used. d. Explain how income elasticity of demand is used.

Answer 1

1) Cross elasticity

= [800-1200/(800+1200/2)] / [23-27/(23+27/2)]

= [-400/1000] / [-4/25]

= -0.4/-0.16

= 2.5

2) The goods are substitutes because the cross-price elasticity is positive

3) Cross price elasticity is used to determine the elasticity between the related goods such as complementary and substitutes

It gives the firm a clear idea where a change in price will either increase or decrease the demand and how it will affect the revenue so they can set a price accordingly.Positive elasticity means that the goods are substitutes such as tea and coffee and negative elasticity means that the goods are complements such as printer and ink.

4) income elasticity measures the change in quantity demanded with respect to the change in income. A positive income elasticity means that the goods are normal whose demand increases with income and a negative elasticity means that the goods are inferior whose demand decreases with an increase in income so it helps to set the price of the goods.