Question

As the price of margarine rises by 20%, a manufacturer of baked goods increases its quantity of butter demanded by 5%. Calculate the cross-price elasticity of demand between butter and margarine. Are butter and margarine substitutes or complements for this manufacturer

Answer 1

• Cross Price Elasticity = 0.25
• Goods are SUBSTITUTES

Step-by-step explanation:

The Cross-price elasticity of two goods can be calculated by the formula;

= % Change in quantity demanded of A / % change in price of B

= 5/20

= 0.25

Positive Cross Price elasticities mean that the goods are substitutes.

This is because when the price went up in one good, the quantity demanded of the other good went up because people switched to the other good from the first good because the prices went up showing that the goods are substitutes.