Answer to Question #266962 in Economics of Enterprise for vachan

Question

Two goods have a cross-price elasticity of demand of +1.2 (a) would you describe the goods as substitutes or complements? (b) If the price of one of the goods rises by 5 per cent, what will happen to the demand for the other good, holding other factors constant? 

Answer 1

(a)

The goods are substitutes because their cross price elasticity of demand is positive.

(b)

When the price of one of the substitutes is increased by 5%, the good will be replaced by its substitute whose demand will rise. The increase in the quantity demanded of the other good will be: $=1.2\times 5=6$ %.