Compare the absolute values of the cross-price elasticities and explain their magnitudes. For example, why is the cross-price elasticity of McDonald’s and Burger King less than the cross-elasticity of butter and margarine?
The Correct Answer and Explanation is :
Comparison of Absolute Cross-Price Elasticities
The absolute value of cross-price elasticity of demand (XED) measures the responsiveness of the quantity demanded for one good when the price of another good changes. The magnitude of this elasticity depends on how closely the two goods are substitutes or complements.
For instance:
- McDonald’s vs. Burger King (Low Cross-Price Elasticity)
The cross-price elasticity of McDonald’s and Burger King is relatively low because, although they are substitutes, consumers do not see them as perfect substitutes. Brand loyalty, taste preferences, convenience, and promotional differences create differentiation between the two fast-food chains. If McDonald’s increases its prices, some consumers might switch to Burger King, but many may still prefer McDonald’s due to habit or preference. - Butter vs. Margarine (High Cross-Price Elasticity)
The cross-price elasticity of butter and margarine is relatively high because they are very close substitutes. Both products serve almost identical purposes (e.g., spreading on bread, baking, or cooking), and consumers perceive them as interchangeable. When the price of butter rises, a large portion of consumers will readily switch to margarine, and vice versa, resulting in a high cross-price elasticity.
Explanation of Magnitudes
The difference in elasticity magnitude stems from product differentiation and consumer behavior:
- Degree of Substitutability – Butter and margarine are nearly identical in use, making their demand highly responsive to price changes. In contrast, McDonald’s and Burger King offer differentiated products with distinct branding, reducing substitutability.
- Brand Loyalty & Preferences – Many consumers have strong preferences for specific fast-food brands, limiting their willingness to switch based on price changes.
- Availability of Alternatives – Fast-food consumers have a wide range of options beyond just McDonald’s and Burger King, diluting their direct substitutability compared to butter and margarine.
Visual Representation
Now, I’ll generate an image comparing the elasticity of butter/margarine and McDonald’s/Burger King.
I’ve generated a visual representation comparing the cross-price elasticity of McDonald’s vs. Burger King (low elasticity) and butter vs. margarine (high elasticity). Let me know if you need any modifications or further explanations!
