Question

Suppose you consider the market for t-shirts and pants. Both t-shirts and pants are normal goods. You observe that a 20% increase the price of t-shirts causes a 10% decline in the quantity demanded for pants. Your friend Selma wants to know what the coefficient of cross elasticity of demand is. You tell here that it is   A. All of the other answers are incorrect    B. positive and therefore these goods are substitutes.    C. positive and therefore these goods are complements.    D. negative and therefore these goods are complements.    E. negative and therefore these goods are substitutes.

Answer 1

Coefficient of Cross Price Elasticity of demand= Percentage Change in the Quantity Demanded for pants/Percentage Change in the price t-shirt.

Coefficient of Cross Price Elasticity of Demand= –10/20= –0.5

The coefficient of cross price elasticity of demand is Negative.

The the meaning of the coefficient of cross price elasticity of demand being negative is that there is negative relationship between the price of T-shirt and the quantity demanded for pants. Therefore, t-shirt and pants are Complements.

So I tell Salma that the coefficient of cross price Elasticity of demand is Negative and therefore, these goods are complements.

Hence, Option D is correct.