Question

Are the following pairs of goods substitutes or complements? Indicate whether their cross-price elasticities are negative or positive. a. Bread and butter b. Bread and potatoes c. Socks and shoes d. Tennis rackets and golf clubs e. Bicycles and automobiles f. Foreign investments and domestic investments g. Cars made in Japan and cars made in the United States

Short answer

Question: Determine whether the pairs of goods are substitutes or complements and the sign of their cross-price elasticities. a. Bread and butter b. Bread and potatoes c. Socks and shoes d. Tennis rackets and golf clubs e. Bicycles and automobiles f. Foreign investments and domestic investments g. Cars made in Japan and cars made in the United States Answer: a. Complements, negative cross-price elasticity b. Substitutes, positive cross-price elasticity c. Complements, negative cross-price elasticity d. Substitutes, positive cross-price elasticity e. Substitutes, positive cross-price elasticity f. Substitutes, positive cross-price elasticity g. Substitutes, positive cross-price elasticity

Step-by-step solution

Understanding Substitutes and Complements

Substitute goods are goods that can replace each other, so when the price of one good increases, the demand for the substitute good also increases. Complementary goods are goods that are used together, so when the price of one good increases, the demand for the complementary good decreases.

Understanding Cross-price Elasticity

Cross-price elasticity measures the responsiveness of demand for a good to changes in the price of another good. It is calculated as the percent change in demand of one good divided by the percent change in price of another good. If the cross-price elasticity is positive, it means the goods are substitutes, and if it is negative, it means the goods are complements.

Analyzing the Pairs of Goods

a. Bread and butter: These goods are complements because they are typically consumed together. The cross-price elasticity would be negative. b. Bread and potatoes: These goods are substitutes since they can both be consumed as staple carbohydrates in a meal. The cross-price elasticity would be positive. c. Socks and shoes: These goods are complements because they are typically used together. The cross-price elasticity would be negative. d. Tennis rackets and golf clubs: These goods are substitutes because they are both leisure sports equipment and can replace each other in the interest of a user. The cross-price elasticity would be positive. e. Bicycles and automobiles: These goods are substitutes as they both serve as forms of transportation. The cross-price elasticity would be positive. f. Foreign investments and domestic investments: These goods are substitutes since they are both types of investments, and investors may choose to invest in one market instead of another. The cross-price elasticity would be positive. g. Cars made in Japan and cars made in the United States: These goods are substitutes because they are both types of automobiles, and consumers may choose between Japanese and American cars based on price or other factors. The cross-price elasticity would be positive.

Key concepts

Substitute goods

Substitute goods are essential concepts in the world of economics. They represent goods that can serve as replacements for one another. If the price of one good goes up, consumers tend to buy more of its substitute, because the substitute is now relatively cheaper.
For example, consider bread and potatoes. These are often seen as substitute goods because you can vary your choice of staple in a meal. If the price of bread rises, you might opt for more potatoes instead.
In economic terms, when we talk about substitute goods, we often discuss cross-price elasticity. In the case of substitutes, the cross-price elasticity is positive. This means as the price of one good increases, the demand for its substitute increases as well.
Overall, substitute goods are critical in understanding consumer choice and market dynamics.

Complementary goods

Complementary goods go hand-in-hand, quite literally! These are goods that are usually consumed together. When the price of one goes up, the demand for the other tends to fall. A classic example is bread and butter. If bread becomes more expensive, the likelihood of buying butter also decreases since they are often used together.
In terms of cross-price elasticity, complementary goods have a negative elasticity. This means if the price of one of the goods rises, the demand for its complement will decrease.
You can think of complementarity in daily items like socks and shoes. You don’t typically wear one without the other. Thus, understanding complementary goods helps explain consumption trends and can guide companies in joint marketing or bundling strategies.

Demand responsiveness

Demand responsiveness, or how sensitive consumer demand is to price changes, is a key concept in any economic analysis. Often assessed using concepts like cross-price elasticity, demand responsiveness can indicate whether goods are substitutes or complements.
For substitutes, demand is responsive to price changes of related goods. For instance, if the price of automobiles goes up, the demand for bicycles might increase, showing high responsiveness since those goods can serve similar purposes.
On the other hand, complementary goods like tennis rackets and tennis balls show different responsiveness. If the price of rackets goes up, demand for balls might drop, showing they are less independent of each other.
In conclusion, understanding demand responsiveness allows economists and businesses to predict how changes in the market conditions might affect consumer behavior.

Economic analysis

Economic analysis involves evaluating how economic principles play out in the real world, affecting consumer choice, company strategy, and policy-making. Examining the relationships between substitute and complementary goods is a fundamental aspect.
Cross-price elasticity is a tool used in economic analysis that helps gauge these relationships. Positive cross-price elasticity indicates substitution between goods, influencing market competition and pricing strategies.
Conversely, negative cross-price elasticity points towards complementarity, which might guide strategic alliances or joint ventures between companies.
In essence, studying these dynamics through economic analysis helps in making informed decisions at both microeconomic and macroeconomic levels, ensuring resources are allocated efficiently.