Cross Price Elasticity of Demand - NB This is to do with Pz and so is a shifter
Syllabus: Explain the concept of cross price elasticity of demand, understanding that it involves responsiveness of demand for one good (and hence a shifting demand curve) to a change in the price of another good.
Cross Price elasticity of demand (XED)
The cross price elasticity is a measure of the responsiveness of the demand for one good to changes in the price of a different good.
Syllabus: Calculate XED using the following equation.
Cross elasticity - formula
Cross elasticity is calculated and defined as:
XED = % change in Qd of Good A
% change in P of Good B
Where Qd = Quantity demanded
and P = Price
Syllabus: Explain that the (absolute) value (number) of XED depends on the closeness of the relationship between two goods.
Cross price elasticity varies from 0 to infinity. As before, the now familiar descriptions are used:
| Value | Description |
|---|---|
| 0 | Perfectly inelastic |
| less than 1 | Inelastic |
| 1 | Unitary |
| more than 1 | Elastic |
| Infinity | Perfectly elastic |
Be very clear about what the number does. Since a change in the price of other goods (Pz remember) is a non-price determinant of demand then a change in Pz will cause a shift of the demand curve´s position on a diagram. The number you calculate from the formula above shows you how far the demand curve shifts but not the direction it shifts in - the sign gives the direction.
Significance of XED sign
The sign is as important (or more important even) as the numerical value.
Some products tend to be bought together, others are purchased in
competition with each other.
Products bought together are called
complementary goods.
Changes in the price of a complement cause the demand curve for a given
good to shift in the opposite direction - negative relationship. Price
of one good increases, demand for the other good decreases (see
diagrams on next page).
Products which are in competition with each other are called substitute goods. Changes in the price of a substitute causes the demand curve for a given good to shift in the same direction. Price of one good increases, demand for the other good increases (see diagrams on next page).
Syllabus: Show that substitute goods have a positive value of XED and complementary goods have a negative value of XED.
Examples of complements are steak and chips, rice and curry,
cars and petrol, torches and batteries, gas and gas cookers.
Complementary goods have negative cross price elasticities.
Example - complements
Examples of substitutes are beef and lamb, gas and heating oil, petrol and diesel fuel. (Note that the substitution may not be possible at once, it may occur over time). Substitutes have positive cross price elasticities.
Example - substitutes
Cross price elasticity can change with time, therefore.
Again, here are some examples of calculations.
