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XED and business decisions

Syllabus: Examine the implications of XED for businesses if prices of substitutes or complements change.

Let´s Do Some Economics

Cross elasticity of demand: relevance for firms

Cross elasticity of demand (XED) is a measure of the responsiveness of demand for one good (good A) to a change in the price of another (good B). Can you write down the FORMULA? Follow the link to check your answer.

The numerical value of the XED will depend on the relationship between the goods in question. If the goods are either substitutes or complements, the numerical value of the XED will be much larger than if the two goods bear little relation to each other; i.e. a change in the price of one good will have a significant impact on the demand for the other good. This will be important for business decision making.


For example, consider two manufacturers of different brands of tennis shoes (for example Nike and ASICS) which are close substitutes for each other.       

A decision by Nike to lower price will, other things being equal, lead to an increase in the demand for ASICS tennis shoes. If ASICS leaves their price unchanged, they are likely to experience an increase in sales as ASICS will become relatively cheaper compared with Nike. Should ASICS also increase their price or leave it unchanged - this is now a hugely important decision for ASICS.

Can you name 5 other markets that have close substitutes (yes any markets that have distinct brands - NB Coke and Pepsi is muito chato try for some originality and applicability in choosing examples.

Market for Beef                            Market for Chicken

Price of beef falls demand for Chicken Falls (D to D1)


Conversely, consider the case of two goods that are complements, petrol and cars. This is a very complex relationship. The true complement to petrol in the short term is car use. The higher the price of petrol the less people use their cars - hopefully this is reasonably obvious.

In the longer term changes in the price of petrol will alter the pattern of demand within the car market. If the price of petrol rises and stays higher then people, when they come to change their cars, will look for cars that are more economic in terms of petrol usage:Swapping `gas-guzzlers´ for smaller cars, for example. THey could even look to altrnative fuels driven cars.

Market for Cellphones                  Market for payment plans

The price of cellphones falls, demand for payment plans increases (D to D1)