Cross price elasticity of Demand (XED)

XED

is the responsiveness of quantity demanded of good X following a price change in good Y

equation for XED

% change in quantity demanded of good X / % change in price of good Y

negative result means ?

goods are complementary

positive result means ?

goods are substitutes

0 ?

goods are unrelated/ independent

what does strong substitutes mean?

=high XED

customers can interchange more easily with each other

Higher absolute value = more responsive.

what does weak substitutes mean?

=low XED

does not swap easily

why is XED important for firms?

Pricing strategy → know which products compete (substitutes) or complement your product.

Product bundling → firms sell complements together (e.g., game consoles + games).

Competition analysis → anticipate how rivals' price changes affect your demand.

why is XED important for government?

Taxation policies → understanding complements/substitutes can predict impact of taxes.

Market regulation → anti-competitive pricing or collusion detection.

evaluation

-XED depends on availability of substitutes/complements → more substitutes = higher positive XED.

-Consumer habits → brand loyalty reduces sensitivity.

-Time period → demand may be more responsive in the long run.

-Elasticity varies across markets → e.g., petrol & cars in UK vs developing countries.

-Magnitude interpretation → an XED of 0.2 is weakly substitutable, while 2.0 is highly substitutable.

shifts in diagram

Substitutes: If price of Good B ↑, demand for Good A shifts right.

Complements: If price of Good B ↑, demand for Good A shifts left.