Answer to Question #195584 in Microeconomics for belinda

Question

1. Explain the difference between substitutes and complements in terms of cross elasticity of demand. use examples to illustrate your answer.
2. A baker calculates the income elasticity of bread as 0.25, interpret the elasticity co-efficient and explain what can be deducted about bread based on this value.

Answer 1

1.

Complementary goods are those goods that have negative cross-price elasticity. The price of one good inversely affects the demand for the other good. This means that as the price of one good increases, the demand for the other good decreases and vice versa. Also, an increase in demand for one good lead to an increase in demand for the other good. An example of complement goods is Cars and fuel. as the price of fuel decreases, the demand for cars increases. On the other hand, substitute goods have a positive cross-price elasticity, which means that when the price of one good increases, so does the demand for the other. If the price of coffee rises, for example, customers will buy less coffee and more tea. When the price of another good is decreased, demand for a substitute good decreases.

2.

The elasticity coefficient value, in this case, is <1. This indicates that the demand for bread is inelastic. It implies that the quantity demanded is unaffected by changes in bread prices. In other words, price fluctuations have a smaller impact on the quantity demanded. Therefore, an increase in the price of bread will have less impact on the revenue.

What can be deducted from this value is the percentage change in quantity demanded.