Cross Elasticity of Demand

Cross Elasticity of Demand

The responsiveness of quantity demanded of one g/s to a change in the price of another g/s

Cross Elasticity of Demand equation

XED = 〖%∆Qd〗^x/(%∆P^y ) = (〖∆Qd〗^x/〖Qd〗^x)/(ΔP^y/P^y )
Unlike PED, XED can be negative or positive and the sign matters!

If XED is -ve (e.g. -0.4, -3)

An increase in the price of one product causes a decrease in the demand for the other product
Complements (joint demand)
The higher the numerical negative value, the closer the complements (e.g. -1.6, -4)

If XED is +ve (e.g. 0.5, 2)

An increase in the price of one product causes an increase in the demand for the other product
Substitutes (competitive demand)
The higher the numerical value, i.e. greater than 1, the closer the substitutes (e.g. 1.5, 5)

If XED is 0

An increase in the price of one product causes no change in the demand for the other product
Unrelated

Relevance of XED to Firms

Key Point: A firm's best strategy in business often relies on what is happening in the markets around them. Knowing a product's XED can help a firm react to changes and maximise profits.

substitutes
complements

substitutes

A lower price for a rival product means fewer sales of your product
A firm with plenty of close substitutes will be less able to increase its prices
Firms will try to differentiate their products from the competition
This can be done through advertising and branding of the product so that consumers are less likely to switch to competitor's products
This will reduce the value of their XED meaning should they be priced higher than their rivals they won't lose as many sales

complements

Firm's might be able to increase their profits through encouraging complementary purchases as complements have joint demand
Firms will produce a range of complements to accompany their core products
For example, Apple produce accessories, such as cases and docks, that consumers are likely to buy alongside their core products, such as the iPhone
A firm that sells a range of complements is likely to increase total revenue
Firms can further increase profits from smart pricing strategies such as two part pricing