Question

Economists estimated that the cross - price elasticity of demand for beer and wine is - 0.83 and the income elasticity of wine is 5.03. This means that

A. beer and wine are complements and wine is a luxury good

B. beer and wine are substitutes and wine is a luxury good.

C. beer and wine are complements and wine is an inferior good.

D. beer and wine are substitutes and wine is an inferior good.

Can someone please explain?

I am confused. Are beer and wine complements OR substitutes? I also just don’t get what the -0.83 and wine income elasticity of 5.03 mean.

Answer 1

Solution-

Economists estimated that the cross - price elasticity of demand for beer and wine is - 0.83 and the income elasticity of wine is 5.03. This means that beer and wine are complements and wine is a luxury good

The correct answer is A. beer and wine are complements and wine is a luxury good

Reason-

The cross price elasticity means the measure of percentage change in one good and percentage change in another good.When cross price elasticity of demand is negative then goods are complement goods.Hence,beer and wine are complements goods because the cross price elasticity of demand is -0.83.When income elasticity of demand is greater than 1 then good is luxury good hence wine is luxury good because the income elasticity is 5.03.

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