Question

The cross-price elasticity of the demand for cell phones and DVDs is 1.2. Explain. The cross-price elasticity of the demand for the iPod and DVDs is -1.4. Explain.

Short answer

Answer: Positive cross-price elasticity values indicate that the goods are substitutes, meaning their demand moves in the same direction when the price of one changes. In this case, cell phones and DVDs are substitutes with a positive value of 1.2. Negative cross-price elasticity values indicate that the goods are complements, meaning their demand moves in opposite directions when the price of one changes. For iPods and DVDs, a negative value of -1.4 indicates that they are complements.

Step-by-step solution

Understanding Cross-Price Elasticity of Demand

Cross-price elasticity of demand is the measure of the percentage change in the quantity demanded of one good (A) in response to a percentage change in the price of another good (B). It is calculated using the formula: Cross-price elasticity of demand = (% change in quantity demanded of A) / (% change in price of B)

Interpreting Positive and Negative Values

A positive cross-price elasticity value indicates that the two goods are substitutes – When the price of one good increases, the demand for the other good increases too. In contrast, a negative value suggests that the two goods are complements – When the price of one good increases, the demand for the other good decreases.

Explaining the Cross-Price Elasticity of Cell Phones and DVDs

Given the cross-price elasticity of demand for cell phones and DVDs as 1.2, we can interpret that as the price of DVDs increases by 1%, the quantity demanded for cell phones will increase by 1.2%. This positive value suggests that cell phones and DVDs are substitutes for each other, meaning that consumers tend to buy more cell phones when the price of DVDs increases.

Explaining the Cross-Price Elasticity of iPods and DVDs

The cross-price elasticity of demand for iPods and DVDs is given as -1.4. This means that when the price of DVDs increases by 1%, the quantity demanded for iPods will decrease by 1.4%. The negative value indicates that iPods and DVDs are complements – they are usually purchased or consumed together, so when the price of DVDs increases, the demand for iPods decreases. In conclusion, the cross-price elasticity values given reveal the relationships between the products. Cell phones and DVDs act as substitutes, with their demand moving in the same direction when one's price changes. Conversely, iPods and DVDs act as complements, with their demand moving in opposite directions when one's price changes.