The Cross-Price Elasticity of Demand Between Product A and Product B

What is the cross-price elasticity of demand between product A and product B, and what type of goods are they?

The price of product A is cut by 30%. As a result, the quantity demanded of product B rises by 40%. The options are:

  • 1.25; complements
  • -1.25; complements
  • -0.75; substitutes
  • 1.33; complements

Answer:

The cross-price elasticity of demand between product A and product B is 1.33. The cross-price elasticity of demand measures the responsiveness of the quantity demanded of one product to a change in the price of another product.

The price of product A being cut by 30% and resulting in a 40% rise in the quantity demanded of product B indicates that product A and product B are complements. When two products are complements, a decrease in the price of one product leads to an increase in the demand for the other product.

To calculate the cross-price elasticity of demand between product A and product B, we use the formula:

% change in quantity demanded of B / % change in price of A

Substituting the values given in the question, we get:

40% / 30% = 1.33

Therefore, the cross-price elasticity of demand between product A and product B is 1.33, indicating that they are complements. A cross-price elasticity greater than 1 suggests that the products are substitutes, while a cross-price elasticity less than 1 indicates that they are complements.

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