Cross Elasticity of Demand (XED) - Economics Assessment 1

Definition of XED

is a numerical measure of the responsiveness of D for one product following a change in P of a related product

Formula of XED

% change in QD of Good A/% change in P of Good B

what is a substitute?

two goods which can be used for similar purpose e.g.tea + coffee

numerical value of substitutes

- has a positive XED > 0 which means that an increase in the price of one product will lead to a rise in demand for a substitute

-if XED is >+1 (e.g. +2) = strongly related (elastic)

if XED is <+1 (e.g. +0.5) = weakly related (inelastic)

What is a compliment?

are products which are used together

e.g.tea + milk

numerical value of compliments

-has a negative XED < 0 which means that an increase in the price of tea will lead to a decrease in demand for milk

-if XED is >-1 (e.g. -4) = strongly related (elastic)

-if XED is <-1 (e.g. 0.2) = weakly related (inelastic)

What are unrelated goods?

goods with an XED of 0 TMT any change in P of one goos has no effect on Qd of another good

definition of product differentiation

is a marketing process of differentiating of g/s from other mkts to make it more appealing to consumers

why does a firm want to know XED?

-knowing the XED of its own + other related products enables the firm to map out its mkt

-mapping allows a firm to calculate how many rivals it has, and how close they are

-allows firms to measure how important complementary products are to its own goods

-this knowledge allows the firm to develop strategies to decrease its exposure to the risks associated with P changes by other firms, e.g. a increase in the p of a complement/ decrease in P of a substitute

how can risks be reduced related to XED?

1.HORIZONTAL INTEGRATION -> occurs when 2 or more firms producing similar products merge with each other or when one takes over the other, e.g. Sainsbury+Asda

2.VERTICAL INTEGRATION -> merging with a complement producer, such as a record producer merging with/taking over a record store

3.ALLIANCES AND COLLUSION -> joint alliance with competitors can also take place such as Sony+Ericsson combining resources to create mobile phones

-collusion is also a possibility, e.g. firms may enter into price fixing agreements so that the avoid having to fight a price war - most likely to happen in oligopolistic mkts, where there are only a few competitors