Cross-price elasticity of demand is:
A. Positive for complementary goods
B. Positive for substitute goods
C. Unitary for inferior goods
D. Positive for inferior goods
The correct answer and explanation is:
Correct Answer: B. Positive for substitute goods
Explanation:
Cross-price elasticity of demand measures how the quantity demanded of one good changes in response to a change in the price of another good. It is calculated using the following formula:
Cross-price elasticity of demand (Exy) = (% change in quantity demanded of good X) / (% change in price of good Y)
This concept helps determine whether two goods are substitutes or complements.
For substitute goods, an increase in the price of one leads to an increase in the demand for the other. For example, if the price of tea goes up, people may buy more coffee instead. This results in a positive cross-price elasticity, because both the numerator (change in quantity demanded) and the denominator (change in price) are either positive or negative together, resulting in a positive ratio.
For complementary goods, an increase in the price of one good causes a decrease in the demand for its complement. For example, if the price of printers rises, the demand for ink cartridges may fall. This gives a negative cross-price elasticity, since the change in price is positive while the change in demand is negative, or vice versa.
Options C and D mention inferior goods, which relate to income elasticity of demand, not cross-price elasticity. Inferior goods are those whose demand decreases as income rises. Their elasticity is negative with respect to income but is unrelated to how demand reacts to the price of another good.
Therefore, the correct choice is B, because substitute goods always have a positive cross-price elasticity of demand, indicating a direct relationship between the price of one and the demand for another.