/ / Cross Elasticity of Demand Explanation-Types & Measurements

Cross Elasticity of Demand Explanation-Types & Measurements

Cross Elasticity of demand is the responsiveness of quantity demanded of Good A as a result of the change in the price of good B (i.e. related goods). This often occurs where the quantity demanded changes as a result of the change in the prices of its substitutes or complementary products.

Measurement of Cross Elasticity of Demand:

Cross Elasticity of Demand

Types of Cross Elasticity of Demand:

After applying the above formula, you will either the positive value or negative value of the cross elasticity of demand. The positive or negative value only shows the relationship between the quantities demanded of a product about the change in the price of its substitutes.

Positive:

The cross elasticity for substitute goods will be positive. It is because the increase in the price of the substitute will lead to an increase in the quantity demanded of the actual product. Let us take an example of substitute goods, i.e., tea and coffee

If the price of the coffee increases, the demand for tea will go up. Contrary to that, if the price of the coffee decreases, the demand for tea will fall.

So, the positive sign shows that goods are substitutes. However, if you get a value greater than one. It means that products are perfect substitutes for each other.

Measurement of Cross Elasticity of Demand:

Measurement in case of Substitute:

Price of TeaQuantity Demanded of Coffee
1050
50140

Cross elasticity of demand = q0c_q1cq0c+q1c / p0t-p1tp0t+p1t

 Percentage change in quantity demanded of coffee   = 50-140/ 50+140

Percentage change in price of tea =20-50/20+50

= -90/190  -30/70

= -90/19070/-30

= 6300/5700

=1.1

Hence, the cross elasticity of demand is positive which shows that it is a case of substitute products.

 Negative

The income elasticity of demand will have a negative value in the case of compliments. Complementary goods as you know, are the goods used together. So, when the price of one good rises, the demand falls for both goods. However, if the price of one falls, the demand increases for both.

So, let us take an example of DVDs and DVD players. If there is an increase in the price of DVD players. Fewer DVD players will be bought and hence, the demand for DVDs will fall ultimately.

Measurement in Case of Complements:

Price of DVD playersQuantity Demanded of DVDs
120300
140240

 Cross elasticity of demand = q0dvd_q1dvdq0dvd+q1dvd / p0dp-p1dpp0dp+p1dp

Percentage change in quantity demanded of DVD=300-240/300+240

Percentage change in price of DVD players = 120-140/120+140

=60/540-20/260

=60/540260/-20

=15600/-10800

=-1.4

Hence, the cross elasticity of demand is negative which shows that it is a case of complementary goods.

Zero:

When the goods are unrelated, the cross elasticity of demand will be zero.  For example, the price of the cellphones does not affect the demand for books.

Cross Elasticity of Demand and its Significance:

The concept has great importance in practical life. Cross elasticity of demand will amazingly help the forecasters. So, one can easily understand the role cross elasticity plays in forecasting the effect of the price change of a good on its substitute or compliments. So, it helps in determining the price of a good by analyzing the change in the demand for its substitutes or complements.

Moreover, if you want to know the nature of two goods in terms of complements or substitutes. Cross elastin of demand will guide you in this regard. The positive will tell you that goods are substitutes. Whereas, the negative value of cross elasticity determines that the goods are complementary.

The value for cross elasticity of demand indicates whether the good is the substitute or complementary goods. However, the greater values indicate that the good is a perfect substitute or complements. Hence, the lesser value indicates that the goods are imperfect complements or substitutes.

Moreover, the cross elasticity of demand also guides the seller about the type of competition in the market and the presence of the products in the market. Knowing that your product has a close substitute, you will definitely be more careful about the pricing of the product. Moreover, you will try to compete with the competitors better. So, the cross elasticity of demand held an essential place when it comes to its significance.

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