Question

Through the use of an example(s) and correctly labelled diagrams, explain how a change in relative prices affects:
i) relative profits and
ii) resource allocation

Answer 1

i) A change in relative prices can either increase or decrease profits depending on if the goods are substitutes or complements, so we need to measure cross-price elasticity of demand.

ii) Resources can shift from production of more expensive products to production of less expensive ones.