Cross Price Elasticity of Demand

 

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’ (zerovalue = 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

ANSWERS!

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
= -20/-50
= +0.4
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

Positive & Normative Economics

 

As an economist it is vital to be able to distinguish between positive analysis and normative analysis.
For the exam you will be required to tell if a statement is positive or normative.

So here is how it goes…

Positive economics is facts and figures. They are statements which can be verified and tested.For example if I tell you that Burberry shares have gone up 16.2%, this is a positive statement because you can go out and test it.

So the definition for positive statements you need to know is: it is a statement that is testable or verifiable. It is a fact or assertion.
N.B – Remember in the example to give an example if you get a chance.

On the other hand, normative analysis is based on opinions – what in economics we call “value judgements”. An easy way to recognise them is to look for words like ‘ought’ and ‘should’. For example, if I say that the company Superdry should not be in the FTSE 250 then this is a normative statement because it contains the word“should” and it is my personal opinion. It cannot be tested or verified.

An example of a normative statement which does not contain should or ought is : “Some critics are calling for government intervention as rents are becoming unfairly high” – this is in fact taken from a past exam marks scheme. The reason why this is normative is because of the adjective ‘unfairly’ what is unfair to one person is not to another. The fact that someone can disagree with the statement is another easy way to tell the if the statement is normative.

For the exam this definition you need to know is: It is a value judgement which cannot be tested or verified.

TEST YOURSELF!

This is a great quiz to test your knowledge for the first section of economics including positive and normative analysis:
http://wps.aw.com/aw_miller_econtoday_14/60/15392/3940402.cw/index.html