Question

You work for a marketing firm that has just landed a contract with Run-of-the-Mills to help them promote three of their products: guppy gummies, frizzles, and mookies. All of these products have been on the market for some time, but, to entice better sales, Run-of-the-Mills wants to try a new advertisement that will market two of the products that consumers will likely consume together. As a former economics student, you know that complements are typically consumed together while substitutes can take the place of other goods. Run-of-the-Mills provides your marketing firm with the following data: When the price of guppy gummies increases by 5%, the quantity of frizzles sold decreases by 4% and the quantity of mookies sold increases by 5%. Your job is to use the cross-price elasticity between guppy gummies and the other goods to determine which goods your marketing firm should advertise together. Complete the first column of the following table by computing the cross-price elasticity between guppy gummies and frizzles, and then between guppy gummies and mookies. In the second column, determine if guppy gummies are a complement to or a substitute for each of the goods listed. Finally, complete the final column by indicating which good you should recommend marketing with guppy gummies. Relative to Guppy Gummies Recommend Marketing with Guppy Gummies Cross-Price Elasticity of Demand Complement or Substitute Frizzles Mookies

Answer 1

Answer:

Cross Price Elasticity of Demand is a measure of the complimentary or substitutional nature of two goods. It enables one to know if goods go together or are replacements for each other.  

When the Cross Price Elasticity is Positive then both of the goods are Substitutes.

This is because when the price of one increased, some people abandoned it and went to the other one which then increased the demand of the latter.

If the Cross Price Elasticity is negative then both the goods are compliments because when the price of one increased, people decided to stop buying it and because the other good is a compliment (goes together) people didn't buy the latter either thereby reducing its demand.

The formula for Cross Price Elasticity is,

= % Change in Quantity Demanded of Good A / % Change in price of Good B

Guppy Gummies and Frizzles.

= -4%/ 5%

= - 0.8%

Cross Price Elasticity is Negative so they are Compliments.  

It IS RECOMMENDED to market Frizzles with Guppy Gummies.

Guppy gummies and Mookies

= 5% / 5%

= 1

Cross Price Elasticity is positive so these are Substitutes.

It is therefore NOT recommended to market Mookies with Guppy Gummies.