Question

Suppose the cross-price elasticity of demand between Coke and Pepsi is 0.5. If the price of Pepsi is projected to go up 10%, how much will the demand for Coke change?

Answer 1

The first point to note is that since the cross-price elasticity of demand between Coke and Pepsi is 0.5, the two products are substitutes. In other words, if the price of Pepsi is projected to go up, the demand for coke will increase.

Further,

Cross Price Elasticity of Demand = % Change in Quantity Demanded for Good X ( Coke) / % Change in Price of Good Y (Pepsi)

Or,

0.5 = % Change in Quantity Demanded for Good X ( Coke) / 10

% Change in Quantity Demanded for Good X ( Coke) = 10 * 0.5

% Change in Quantity Demanded for Good X ( Coke) = 5%

Therefore, if the price of Pepsi is projected to go up 10%, the demand for Coke will increase by 5%.