Question

Suppose the cross clasticity of demand for products \(\Lambda\) and \(B\) is +3.6 and for products \(C\) and \(D\) is \(-5.4 .\) What can you conclude about how products \(A\) and \(B\) are related? Products C and D?

Short answer

Products \( A \) and \( B \) are substitutes; products \( C \) and \( D \) are complements.

Step-by-step solution

Understanding Cross Elasticity of Demand

Cross elasticity of demand measures how the quantity demanded of one good changes in response to a price change of another good. It is calculated as the percentage change in quantity demanded of one good divided by the percentage change in price of the other good.

Analyzing Cross Elasticity for Products A and B

For products \( A \) and \( B \), the cross elasticity of demand is +3.6. A positive cross elasticity indicates that as the price of one good increases, the demand for the other good also increases. This implies that products \( A \) and \( B \) are substitutes.

Analyzing Cross Elasticity for Products C and D

For products \( C \) and \( D \), the cross elasticity of demand is -5.4. A negative cross elasticity shows that as the price of one product increases, the demand for the other decreases. This implies that products \( C \) and \( D \) are complements.

Key concepts

Substitute Goods

Substitute goods are products that can replace each other in consumption due to their similar nature. When the price of one good rises, consumers tend to switch to its substitute, increasing the demand for the latter. Think of products like coffee and tea; if the price of coffee goes up, many may opt for tea instead.
Tied together by the idea of cross elasticity of demand, substitute goods have a positive cross elasticity. This means that if the price of one good increases, the demand for the other goes up proportionally. A real-world example includes Apple and Samsung smartphones; as the price of an iPhone rises, more people might consider purchasing a Samsung phone.

Complementary Goods

Complementary goods are items that are often used together, so when the price of one goes up, the demand for the other tends to fall. Picture gasoline and cars; if fuel prices soar, people might drive less, resulting in lower car usage.
In economic terms, complementary goods demonstrate a negative cross elasticity of demand. This negative value means that the increase in the price of one good results in a decrease in the demand of its complement. An example in the tech world could be printers and ink cartridges. If printers become more expensive, fewer people buy them, reducing the demand for ink.

Quantity Demanded

Quantity demanded refers to the total amount of a good or service that consumers are willing and able to purchase at a given price. It's a key concept in understanding market dynamics. The relationship between price and quantity demanded is typically inverse; as one increases, the other declines, which is described by the law of demand.
In the context of cross elasticity, quantity demanded is sensitive to changes in the price of related goods, such as substitutes or complements. For instance, if the price of a substitute good falls, the quantity demanded of the original product might decrease because consumers find the substitute more attractive at lower prices. Similarly, an increase in the price of a complementary good might reduce the quantity demanded of its partner product.

Price Changes

Price changes are a fundamental aspect of economic principles that affect consumer behavior and market dynamics. When prices of goods fluctuate, this results in corresponding changes in consumer demand, influenced by the types of relationships between products.
Cross elasticity of demand reveals how price changes in one product influence the demand for another. With substitute goods, higher prices can lead consumers to favor competing products, boosting their demand. In contrast, for complementary goods, a price hike can reduce interest in associated products, lessening their demand. Understanding these dynamics helps businesses and economists predict market behaviors and set pricing strategies effectively.