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Which of the following options is correct? If the demand for product A displays high and positive cross-price elasticity with respect to the price of product B, then a
Which of the following options is correct?
If the demand for product A displays high and positive cross-price elasticity with respect to the price of product B, then
a. the demand for product A is likely to have a high price elasticity.
b. products A and B are substitutes.
c. A and B are complements.
d. the demand for product B is likely to have a low price elasticity.
Expert Solution
The correct answer to the given question is option b. products A and B are substitutes.
The cross-price elasticity of a good is determined by dividing the percentage change in its quantity demanded when there is a unit percentage change in the price of a related good which could be a substitute or a complement.
If the related good is a substitute, a unit percentage increase in its price usually leads to a decrease in its quantity demanded and an increase in the quantity demanded for the good being considered. Hence, in such cases, the cross-price elasticity for the good being considered will be highly positive.
On the other hand, if the related good is a complement, a unit percentage increase in its price usually causes a decrease in its quantity demanded and also a decrease in the quantity demanded for the good being considered. Hence, the cross-price elasticity in such cases will be negative.
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