Multiple Choice
Which of the following pairs of goods is most likely to have a cross-price elasticity of demand greater than zero?
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4. Elasticity
Cross-Price Elasticity of Demand
Multiple Choice
Two streaming apps raise subscription prices on the same day. If many students treat the apps as close substitutes, what does this suggest about the cross-price elasticity of demand between them?
A
Negative (cross-price elasticity is negative, indicating complements)
B
Positive and relatively large (high positive cross-price elasticity)
C
Zero (cross-price elasticity is zero, indicating unrelated goods)
D
Positive but close to zero (weak substitutes with low cross-price elasticity)
Verified step by step guidance1
Recall the definition of cross-price elasticity of demand, which measures how the quantity demanded of one good responds to a change in the price of another good. It is calculated as:
\[\text{Cross-price elasticity} = \frac{\% \text{ change in quantity demanded of Good A}}{\% \text{ change in price of Good B}}\]
Understand the economic meaning of the sign of cross-price elasticity:
- If it is positive, the goods are substitutes (an increase in the price of one leads to an increase in demand for the other).
- If it is negative, the goods are complements (an increase in the price of one leads to a decrease in demand for the other).
- If it is zero, the goods are unrelated.
Since the problem states that many students treat the two streaming apps as close substitutes, this implies that when the price of one app increases, the demand for the other app increases significantly.
This strong substitution effect means the cross-price elasticity is not only positive but also relatively large in magnitude, reflecting a strong responsiveness of demand to the price change of the other app.
Therefore, the correct interpretation is that the cross-price elasticity of demand between the two streaming apps is positive and relatively large, indicating they are close substitutes.
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