Suppose we have two pairs of substitute goods. The first are very close substitutes, such as Coke and Pepsi, while the others are less close, such as Coke and iced tea. We would expect the cross elasticity of the closer pair to be
A) positive while the less close pair to be negative
B) negative while the less close pair to be positive
C) one while the less close pair to be zero
D) the smaller of the two
E) the larger of the two

Question

Quizplus · Accepted Answer

Cross elasticity of demand for substitute goods is positive, indicating that as the price of one good increases, the demand for the substitute good also increases. The closer the substitutes, like Coke and Pepsi, the higher the cross elasticity because consumers are more likely to switch between them in response to price changes. Therefore, the cross elasticity for very close substitutes would be larger than for less close substitutes, such as Coke and iced tea.

Suppose We Have Two Pairs of Substitute Goods