Cross Price Elasticity of Demand

XPED Cross Price Elasticity of Demand measures the responsiveness of demand for good X following a change in the price of good Y. Cross Price Elasticity of Demand measures the responsiveness of demand for good X following a change in the price of good Y. With cross price elasticity of demand we make an important distinction between substitute products and complementary products. With cross price elasticity of demand we make an important distinction between substitute products and complementary products.

Identify some Substitutes

Identify some Complements

XPED - Substitutes With substitute goods such as different brands of razors, as the price of one rises there will be increases in demand for the rival product. These products are said to have a POSITIVE cross price elasticity.

XPED Complements Goods for when the price of one good decreases, the demand for associated product increases. These goods are bought together They are said to have a NEGATIVE cross price elasticity

XPED – The formula % ∆ QD good X XPED = % ∆ P good Y % ∆ P good Y If the answer is positive, the two goods are substitutes If the answer is negative, the two goods are complements

Calculations Calculate the Cross Price Elasticity of demand for the following products. State whether the two goods are complements or substitutes. 1. Price of Good Y increases by 10%, QD of Good X increases by 12% 2. Price of Good Y increases by 45%, QD of Good X decreases by 15% 3. Price of Good Y decreases by 18%, QD of Good X decreases by 72% 4. Price of Good Y decreases by 30%, QD of Good X increases by 60%

Answers (1) Substitutes (2) Complements (3) 4 - Substitutes (4) Complements The products in question 3 are closer substitutes than those in question one. The complements in question 4 are closer complements than those in question 2 The further away from zero, the closer the relationship between the two goods.

What do they mean? The higher the number, the closer substitutes the two goods are. If the positive number is very close to zero, they are weak substitutes. The higher the number, the closer substitutes the two goods are. If the positive number is very close to zero, they are weak substitutes. The further away the negative number is from zero, the closer complements the two goods are. The further away the negative number is from zero, the closer complements the two goods are. Goods which have a Cross Price Elasticity of zero have no relationship. They are completely unrelated. Goods which have a Cross Price Elasticity of zero have no relationship. They are completely unrelated.

Draw the table shown below and fill in the blank squares Product Close Substitute Weak Substitute Good with no relationship

Draw the table shown below and fill in the blank squares Product Close Complement Weak Complement Good with no relationship

The importance of XPED to business Firms can use XPED to estimate the following: Firms can use XPED to estimate the following: The impact of a rivals pricing strategy on the demand for their own products Can help them work out the success of a complementary goods offer. E.g./ cinema tickets and popcorn are strong complements. The cinema firm can work out the impact on the demand for popcorn of a cinema ticket offer.

Question 1 A 20% rise in the price of ice cream causes the demand for sweets to increase by 4%. Calculate the Cross Elasticity of Demand for sweets with respect to ice cream Calculate the Cross Elasticity of Demand for sweets with respect to ice cream Explain what this tells you about these two products Explain what this tells you about these two products Does your answer suggest ice cream or sweets are close or distant substitutes? Does your answer suggest ice cream or sweets are close or distant substitutes?

Question 2 A 12% fall in the price of air fares leads to a 30% rise in demand for foreign holidays. Calculate the cross price elasticity of demand for foreign holidays with respect to air travel Calculate the cross price elasticity of demand for foreign holidays with respect to air travel Does your answer suggest they are close or distant complements? Does your answer suggest they are close or distant complements?