What does a negative cross elasticity of demand indicate?

What does a negative cross elasticity of demand indicate?

• A. The two goods are substitutes
• B. The two goods are complements
• C. The two goods are normal
• D. The two goods are inferior

Answer: (B)

A negative cross elasticity of demand indicates that as the price of one good changes, the quantity demanded of another good moves in the opposite direction, which is characteristic of complementary goods. When the price of one good increases, the demand for its complement decreases because these goods are typically consumed together. For example, if the price of coffee rises, the quantity demanded for cream may drop, as consumers may buy less coffee and consequently need less cream. In contrast, substitute goods have a positive cross elasticity of demand, meaning that an increase in the price of one good leads to an increase in the demand for the other as consumers switch between them. Normal and inferior goods relate to changes in income rather than price changes between two goods, and thus do not apply in the context of cross elasticity.

A negative cross elasticity of demand indicates that as the price of one good changes, the quantity demanded of another good moves in the opposite direction, which is characteristic of complementary goods. When the price of one good increases, the demand for its complement decreases because these goods are typically consumed together. For example, if the price of coffee rises, the quantity demanded for cream may drop, as consumers may buy less coffee and consequently need less cream.

In contrast, substitute goods have a positive cross elasticity of demand, meaning that an increase in the price of one good leads to an increase in the demand for the other as consumers switch between them. Normal and inferior goods relate to changes in income rather than price changes between two goods, and thus do not apply in the context of cross elasticity.