What is cross price elasticity of demand (XED)?
Cross price elasticity of demand is the figure which denotes the relationship between two goods.
How do economists calculate Cross price elasticity of demand?
XED = Percentage change in quantity demanded of good A / percentage change in the price of good B
Percentage change in quantity demanded of good A (divided by) percentage change in the price of good B
How do we interpret cross price elasticity of demand values?
Negative value = complements
If the value is greater than -1 than they are strong complements and if they are less than -1 they are weak complements.
‘0’ (zero) value = independent goods (they have no value)
Positive value = substitutes
If the value is greater than 1 then they are strong substitutes and if they are smaller than 1 they are weak substitutes
TEST YOURSELF! (Answers found below)
Q1: What type of relationship is there between two goods, X and Y, given that:
– Original price of good X =80
– Original quantity of good Y = 50
– Final price of good Y=40
– Final quantity of good Y = 40
– Original price of good Y = 5
Q2: For each of the following product pairs what would you guess about the cross price elasticity of demand? What are their relationships? Do they have a strong or weak relationship?
a) Shoes and sneakers
b) Gasoline and sports utility vehicles
c) Bread and butter
d)Instand camera film and regular camera film
Q1: XED = % change in QD of good Y / % change in P of good X
= [(40-50)/50] * 100 / [(80-40)/80] * 100
= (-10/50 ) * 100 / (-40/80) * 100
= -0.2 * 1o0 / -0.5 * 100
Therefore they are weak substitutes
Q2: (a) Weak substitues – positive value for XED which is less than 1
(b) Strong complements – negative value for XED which is greater than -1
(c) Strong complements – negative value for XED which is greater than -1
(d) Strong substitues – positive value for XED which is greater than 1