Assume that a 2 percent increase in the price of bologna causes a 5 percent decrease in the demand for cheese. What is the cross-price elasticity of demand between the two goods, and how are these goods related? aCross-price elasticity of demand equals −0.4 , and these goods are complements. bCross-price elasticity of demand equals +0.4 , and these goods are substitutes. cCross-price elasticity of demand equals −2.5 , and these goods are complements. dCross-price elasticity of demand equals +2.5 , and these goods are substitutes. eCross-price elasticity of demand equals −0.4 , and these goods are substitutes.
Question
Assume that a 2 percent increase in the price of bologna causes a 5 percent decrease in the demand for cheese. What is the cross-price elasticity of demand between the two goods, and how are these goods related? aCross-price elasticity of demand equals −0.4 , and these goods are complements. bCross-price elasticity of demand equals +0.4 , and these goods are substitutes. cCross-price elasticity of demand equals −2.5 , and these goods are complements. dCross-price elasticity of demand equals +2.5 , and these goods are substitutes. eCross-price elasticity of demand equals −0.4 , and these goods are substitutes.
Solution
The cross-price elasticity of demand is calculated as the percentage change in quantity demanded for one good divided by the percentage change in price of another good. In this case, the percentage change in quantity demanded for cheese is -5% and the percentage change in price for bologna is 2%.
So, the cross-price elasticity of demand would be -5% / 2% = -2.5.
This negative value indicates that the two goods are complements, because an increase in the price of one good (bologna) leads to a decrease in demand for the other good (cheese).
So, the correct answer is c) Cross-price elasticity of demand equals -2.5, and these goods are complements.
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