Question

A restaurant sells salsa and guacamole, each of which can be eaten with the tacos that the restaurant sells. The manager of the restaurant is not sure whether salsa and guacamole are substitutes or complements. However, after increasing the price of guacamole from $2.00 to $2.50, the manager notices that daily salsa sales rise by 5%. What is the cross price elasticity of salsa and guacamole, and what can the manager conclude about their relationship?

Answer 1

Answer:

The cross price elasticity of salsa and guacamole is 0.2. The two goods are substitutes.

Explanation:

The price of guacamole is increased from $2 to $2.5.

Percentage change in price

= $\frac{new price\ -\ initial\ price}{initial\ price} \times100$

= $\frac{2.50\ -\ 2}{2} \times100$

= 25%

The demand for salsa rises by 5%.

The cross price elasticity will be

= $\frac{percenatge\ change\ in\ quantity\ demanded}{percenatge\ change\ in\ price}$

= $\frac{5}{25}$

= 0.2

We see that the cross price elasticity is positive. This means that the two goods are substitutes. When price of one good will increase consumers will prefer the cheaper substitute, increasing its demand.