A 10 percent decrease in the price of a Pepsi decreases the demand for a Coca-Cola by 50 percent. The cross elasticity of demand between Pepsi and Coca-Cola is

A 10 percent decrease in the price of a Pepsi decreases the demand for a Coca-Cola by 50 percent. The cross elasticity of demand between Pepsi and Coca-Cola is

• A. 10.
• B. 0.20.
• C. 50.
• D. 5.

Answer: (D)

Cross-price elasticity of demand shows how much the quantity demanded of one good responds when the price of another good changes. It is calculated as the percentage change in quantity of Coca-Cola divided by the percentage change in Pepsi’s price. Here, Coca-Cola’s quantity falls by 50% when Pepsi’s price falls by 10%. So the elasticity is (-50%)/(-10%) = 5. The positive value indicates the goods are substitutes: a cheaper Pepsi reduces Coca-Cola demand. A value of 5 also means the response is quite strong.

Cross-price elasticity of demand shows how much the quantity demanded of one good responds when the price of another good changes. It is calculated as the percentage change in quantity of Coca-Cola divided by the percentage change in Pepsi’s price. Here, Coca-Cola’s quantity falls by 50% when Pepsi’s price falls by 10%. So the elasticity is (-50%)/(-10%) = 5. The positive value indicates the goods are substitutes: a cheaper Pepsi reduces Coca-Cola demand. A value of 5 also means the response is quite strong.