Suppose a 3% fall in the price of strawberries increases the quantity of strawbe
ID: 1225814 • Letter: S
Question
Suppose a 3% fall in the price of strawberries increases the quantity of strawberries demanded by 4% and increases the quantity of chocolate demanded by 2%.
a. Using this information, calculate the price elasticity of demand for strawberries at the original price. Interpret your calculation in words.
b. At the original price, is the demand for strawberries price elastic or inelastic?
c. What would have happened to consumers’ total expenditures on strawberries when the price of strawberries decreased?
d. Calculate the cross-price elasticity of demand for chocolate with respect to the price of strawberries at the original price.
e. Are strawberries and chocolate complements or substitutes? Briefly explain your reasoning.
Explanation / Answer
a) Price elasticity of demand = % change in quantity demanded / % change in price
Price elasticity of demand for strawberries = 0.04 / - (0.03) (because price falls)
Price elasticity of demand for strawberries = -1.33. (negative because of inverse relationship between price and quantity demanded)
b) The absolute price elasticity of demand (without negative sign) is more than one. Hence, the demand for strawberries is elastic.
c) When price of strawberries decreases, the consumers’ total expenditures on strawberries would increase. That is, when the price elasticity of demand is elastic, a decrease in price will raise total revenue-increase in expenditure.
d) Cross price elasticity of chocolate = % change in quantity of chocolate demanded / % change in price of strawberries
XED (chocolate) = 0.02 / (-0.03)
Cross price elasticity of demand for chocolate = -0.66.
e) Strawberries and chocolate are complements. (Complementary goods have negative cross price elasticities of demand with respect to each other.
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