Question
Following the devastating effects of the floods in Queensland, Australia in 2011 which, among other things, damaged many banana plantations, the price of bananas increase significantly, from about $2.50 per kilogram to about $12 per kilogram. A typical consumer reaction was:
I will not buy bananas when they are $12 per kilogram. I can substitute other fruit for bananas. If the price milk were to increase to $5 per litre, we’d still have to buy it. But bananas are not that important in our family.
a. For the above consumer’s household, which product has the higher price elasticity of demand: bananas or milk? Briefly explain.
b. Is the cross-price elasticity of demand between bananas and other fruit positive or negative for this consumer? Briefly explain.
