Question

Although we could describe both the cross-price elasticity of demand between paper coffee cups and plastic coffee lids and the cross-price elasticity of demand between sugar and artificial sweeteners as highly elastic, the first cross-price elasticity is negative and the second is positive. What is the reason for this?

Short answer

The negative elasticity between cups and lids is due to complementarity, while the positive elasticity between sugar and sweeteners is due to their substitute nature.

Step-by-step solution

Understand Cross-Price Elasticity

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

Identify Relationships Between Goods

Determine the types of relationships: if two goods are complements, an increase in the price of one leads to a decrease in the demand for the other, resulting in a negative cross-price elasticity. For substitutes, an increase in the price of one good increases the demand for the other, leading to a positive cross-price elasticity.

Apply to Paper Cups and Plastic Lids

Paper coffee cups and plastic coffee lids are complementary goods. If the price of paper cups rises, the demand for plastic lids falls, which explains the negative cross-price elasticity between them.

Apply to Sugar and Artificial Sweeteners

Sugar and artificial sweeteners are substitute goods. When the price of sugar rises, consumers switch to artificial sweeteners, increasing their demand, which accounts for the positive cross-price elasticity between them.

Key concepts

Complementary Goods

Complementary goods are products that are often consumed together. Think of items like peanut butter and jelly, or in our case, paper coffee cups and plastic lids. The essentials of these goods are interlinked in such a way that the usage of one frequently depends on the usage of the other. When you buy a paper coffee cup, you usually need a lid too, right?

This strong connection between complementary goods plays a vital role in shaping their economic relationship. When the price of one good goes up, the demand for its complement tends to decrease. This is due to the fact that as one becomes more expensive, the overall cost of consuming both increases. For example, if paper coffee cups become pricier, you might decide to brewing coffee at home, resulting in less need for plastic lids.

• Complementary goods require each other for full utilization.
• Their consumption is often seen as a bundle.
• A price rise in one leads to a demand decrease in the other, causing a negative cross-price elasticity.

Substitute Goods

Unlike complementary goods, substitute goods can replace each other in consumption. This relationship is seen in products like butter and margarine or, in our exercise, sugar and artificial sweeteners. The essence of substitute goods lies in their ability to satisfy the same need or desire, making them interchangeable in the eyes of the consumer.

When the price of one substitute rises, people are likely to switch to the other. The primary reason is that the alternative provides a similar satisfaction or utility, often at a lower cost. For instance, if sugar prices spike, numerous consumers might opt for artificial sweeteners instead, raising the demand for the latter.

• Substitute goods serve as viable alternatives to each other.
• They satisfy the same consumer needs.
• A price increase in one usually boosts the demand for the substitute, resulting in a positive cross-price elasticity.

Economic Relationships

The relationships between goods are fundamental concepts in economics that affect consumer behavior and market dynamics. By understanding these relationships, we can predict how changes in the price of one good might influence the demand for another.

Cross-price elasticity of demand is a powerful tool to explore these interactions. It quantifies how reactive the quantity demanded of one good is when the price of another changes.

• If the cross-price elasticity is negative, the goods are typically complements, indicating a strong economic relationship of dependency.
• If it is positive, the goods are likely substitutes, signifying a relationship of interchangeability.

In our example, this economic measurement explains why paper coffee cups and lids demonstrate a negative elasticity while sugar and sweeteners exhibit a positive one.