Question

Good A and Good B are substitutes in consumption, if the price of Good B decreases, what happens to P* and Q* of Good A?

a) P* decreases, Q* decreases
b) P* decreases, Q* increases
c) P* increases, Q* decreases
d) P* increases, Q* increases

Answer 1

A decrease in the price of Good B leads to a decrease in both the equilibrium price and quantity of its substitute, Good A, since consumers will prefer the cheaper Good B.

Step-by-step explanation:

When Good B has a decrease in price and it is a substitute for Good A, the demand for Good A will decrease as consumers will shift their preference to the cheaper Good B. Consequently, the equilibrium price (P*) of Good A will decrease due to the excess supply, and the equilibrium quantity (Q*) sold of Good A will also decrease because of the reduced demand.

This situation is described by positive cross-price elasticity of demand, which indicates that as the price of Good B falls, the quantity of Good A demanded declines.