Recall that the cross price elasticity is a measure of how demand
for one good changes when the price of some other related good changes. By related we mean either a complement or a substitute;
therefore, only (d) or (e) could be correct.
2. The cross price elasticity
between two products is found to be -1/2. From this you know that
the two products are:
- normal. Normal goods are those with income elasticities that are positive.
Whether a good is normal or inferior has nothing to do with cross
price elasticity.
- inferior. Inferior goods are those with income elasticities that are negative.
Whether a good is normal or inferior has nothing to do with cross
price elasticity.
- necessities. Necessities are goods with income elasticities that are positive,
but less than one. Again, having nothing to do with cross price
elasticity.
- complements. If the price of a good increases, sales fall for goods that are
considered complements (goods that are consumed together); implying
a negative cross price elasticity.
- substitutes. If the price of a good increases, sales increase for goods that
are considered substitutes; implying a positive cross price elasticity.
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