Unit 2: Elasticity and Consumer Choice

Answer: A — This question tests understanding of cross-price elasticity and the distinction between substitutes and complements. The correct answer is A. First, calculate the cross-price elasticity: percentage change in quantity demanded of butter divided by percentage change in price of margarine = -12% ÷ +20% = -0.6. The negative sign indicates an inverse relationship—when margarine (a substitute) becomes more expensive, consumers buy less butter, which seems counterintuitive at first but reflects that the price increase in margarine must be large enough relative to the demand change that the elasticity coefficient is negative in magnitude. More importantly, butter and margarine are substitutes (consumers view them as interchangeable), which is confirmed by the demand relationship: when margarine gets more expensive, some consumers switch to butter, but here the question states butter demand decreases, suggesting the net effect includes a shift away from both products, making -0.6 the correct elasticity. Option B is incorrect because butter and margarine are clearly substitutes, not complements (complements are goods used together, like peanut butter and jelly). Option C incorrectly calculates the elasticity as +1.67 (or confuses the inverse calculation) and misidentifies the sign. Option D is incorrect because it assigns a positive elasticity coefficient and identifies the goods as complements, both of which contradict the economic relationship between these products.

Answer: D — The correct answer is D because the price elasticity of demand is greater than 1, indicating that the demand is elastic. This is because the percentage change in quantity demanded (2%) is greater than the percentage change in price (1%). Options A, B, and C are incorrect because they misinterpret the relationship between the percentage changes in price and quantity demanded.

Answer: A — The correct answer is A. Cross-price elasticity of demand is calculated as: (% change in quantity demanded of good X) / (% change in price of good Y). Here: (12% / 8%) = 1.5. A positive cross-price elasticity indicates substitute goods—when one becomes more expensive, consumers switch to the other. The magnitude of 1.5 shows these are substitutes with elastic cross-price demand. When brand-name prices rise, consumers shift to the cheaper generic alternative. Option B incorrectly calculates the elasticity in reverse (8/12 = 0.67) and misidentifies the relationship as complements; complementary goods have negative cross-price elasticity and are consumed together (like cars and gasoline). Option C correctly calculates the elasticity as 1.5 but contradicts itself by claiming they are complements, which would require a negative coefficient. Option D is incorrect because cross-price elasticity for substitutes is positive, not negative; negative cross-price elasticity indicates complements (e.g., when hot dog prices rise, hot dog bun demand falls).

Answer: A — The correct answer is A. First, the relationship identifies these as substitutes because when beef price increases, chicken demand increases—consumers switch to the alternative good. The cross-price elasticity of demand is calculated as: (% change in quantity demanded of chicken) ÷ (% change in price of beef) = 12% ÷ 15% = 0.80. Since this value is positive and less than 1.0, it confirms they are substitutes with relatively inelastic cross-price elasticity, meaning chicken demand is not highly responsive to beef price changes. Option B is incorrect because it misidentifies the goods as complements (which would have negative cross-price elasticity). Option C makes an arithmetic error—it incorrectly calculates cross-price elasticity as 15% ÷ 12% = 1.25 instead of the reverse. Additionally, elasticity of 0.80 indicates relative inelasticity, not elasticity. Option D is incorrect because the positive relationship between beef price and chicken demand clearly demonstrates these are related goods, not independent ones.

Answer: C — The correct answer is C because the price elasticity of demand is 1.5, which is greater than 1, but the percentage increase in price is 10%, which means the revenue will increase by 5% (since the 10% price increase will lead to a 15% increase in revenue, but the 1.5% decrease in quantity demanded for every 1% price increase will lead to a 10% decrease in quantity demanded, resulting in a 5% increase in revenue). Option A is incorrect because the revenue will not decrease by 5%. Option B is incorrect because the revenue will not decrease by 2.5%. Option D is incorrect because the revenue will not decrease by 10%.