Answer to Question #69266 in Macroeconomics for Andrea

Question

What does a positive sign of a cross-price elasticity of demand signify for the relation between the goods in question? What does a negative sign of a cross-price elasticity of demand signify for the relation between the goods in question?

Answer 1

1. A positive cross elasticity of demand on price applies to fungible goods (goods-substitutes). For example, butter and margarine are the goods-substitutes, they compete on the market. The increase in the price of margarine, which reduces the butter relative to the new price of margarine, causes the growth of demand for butter. Because of increasing demand for butter, the demand curve will shift to the right and its price will rise. The greater the substitutability of the two goods, the greater the cross-elasticity of demand at a price.
2. Negative cross-elasticity of demand on price applies to complementary goods. It is good that you share. For example, shoes and Shoe Polish are complementary goods. The increase in the price of the shoes causes the reduction of demand for it, which in turn will reduce the demand for Shoe Polish. Hence, a negative cross-elasticity of demand with the increase in the price of one good reduces the consumption of another good. The greater the complementarity between the goods, the greater the absolute value of the negative cross-elasticity of demand at a price.