Understanding Cross Elasticity of Demand: What Does $1.10 Mean for Cantaloupes and Water Melons?
What does a cross elasticity of demand of $1.10 between cantaloupes and water melons indicate?
a) People like cantaloupes 10% more than water melons.
b) People like water melons 110% more than cantaloupes.
c) A 10% increase in the price of cantaloupes will decrease the quantity demanded of water melons by 11%.
d) A $1 increase in the cost of either product will decrease the quantity purchased by 110 units per day.
e) A 10% increase in the price of cantaloupes will increase the quantity demanded of water melons by 11%.
Answer:
The correct answer is: a 10% increase in the price of cantaloupes will increase the quantity demanded of water melons by 11%.
The produce manager of a large grocery store is informed that the cross-price elasticity of demand between cantaloupes and water melons is 1.10. The cross-price elasticity of demand is a measure to calculate the change in demand for a commodity due to a change in the price of another commodity. It is calculated as a ratio of the percentage change in demand and percentage change in price. A positive price elasticity implies that the two goods are substitutes. An increase in the price of one good leads to an increase in the demand for another.
Let's assume that the price of cantaloupes increases by 10%. Then, 1.10 = [tex]\frac{\% \Delta Qy}{10 \%}[/tex]. ΔQy = 11. So we see that a 10% increase in the price of cantaloupes will cause the demand for water melons to increase by 11%.