3. As the price of margarine rises by 20%, a manufacturer of baked goods increases its quantity of butter demanded by 5%. Calculate the cross-price elasticity of demand between butter and margarine. Are butter and margarine substitutes or complements for this manufacturer?
The cross-price elasticity of demand is 5%/20% = 0.25. Since the cross-price elasticity of demand is positive, the two goods are substitutes.