Question

Suppose that a 20 percent increase in the price of normal good Y causes a 10 percent decline in the quantity demanded of normal good X. The coefficient of cross elasticity of demand is:

A. negative and therefore these goods are substitutes.
B. negative and therefore these goods are complements.
C. positive and therefore these goods are substitutes.
D. positive and therefore these goods are complements.

Answer 1

The correct answer is B: The coefficient of cross elasticity of demand is negative and therefore these goods are complements. A 20 percent increase in the price of good Y causes a 10 percent decline in the quantity demanded of good X, which means that X and Y are complements.

Step-by-step explanation:

The cross-price elasticity of demand is a measure that shows the responsiveness of the quantity demanded for one good when the price of another good changes. If there is a 20 percent increase in the price of normal good Y and it causes a 10 percent decline in the quantity demanded of normal good X, this indicates that the two goods are complements. To calculate the cross-price elasticity of demand we use the formula:

Cross-price elasticity of demand = (Percentage change in quantity demanded of good X) / (Percentage change in price of good Y)

For this question:

Cross-price elasticity of demand = (-10%) / (20%) = -0.5

Since the calculated elasticity is negative, it confirms that goods X and Y are complements. Therefore, the correct answer is B: The coefficient of cross elasticity of demand is negative and therefore these goods are complements.