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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?
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4. Elasticity
Cross-Price Elasticity of Demand
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Which of the following is true of the cross-price elasticity of demand?
A
A positive cross-price elasticity indicates that the two goods are substitutes.
B
Cross-price elasticity of demand is always negative.
C
A cross-price elasticity of zero means the goods are complements.
D
A negative cross-price elasticity indicates that the two goods are unrelated.
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Understand the definition of cross-price elasticity of demand: it measures the responsiveness of the quantity demanded of one good to a change in the price of another good. Mathematically, it is given by the formula:
\[\text{Cross-price elasticity} = \frac{\% \text{ change in quantity demanded of Good A}}{\% \text{ change in price of Good B}}\]
Interpret the sign of the cross-price elasticity:
- If the cross-price elasticity is positive, it means that an increase in the price of Good B leads to an increase in the quantity demanded of Good A, indicating that the goods are substitutes.
- If the cross-price elasticity is negative, it means that an increase in the price of Good B leads to a decrease in the quantity demanded of Good A, indicating that the goods are complements.
Consider the case when the cross-price elasticity is zero: this implies that changes in the price of Good B have no effect on the quantity demanded of Good A, meaning the goods are unrelated or independent.
Evaluate the given statements based on these interpretations:
- A positive cross-price elasticity indicates substitutes.
- Cross-price elasticity is not always negative; it can be positive or zero depending on the relationship between goods.
- A zero cross-price elasticity means goods are unrelated, not complements.
- A negative cross-price elasticity indicates complements, not unrelated goods.
Conclude that the correct statement is the one that says a positive cross-price elasticity indicates that the two goods are substitutes.
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