Cross-price elasticity of demand (XED)

Key Terms
Cross-price elasticity of demand: The responsiveness of demand for a good following a change in the price of another good.

∆ = Delta: The greek delta symbol is used to mean change
Theory

What is Cross-price Elasticity of Demand?


Equation

% ∆ in Demand for Good A
% ∆ in Price of Good B

Values

Positive XED = Substitue Goods

  • XED > 1 = Close Substitute
  • 0 < XED < 1 = Distant Substitute

    • When XED is positive, the goods are substitutes. This means if the price of one good increases, people will buy more of the alternative good. The higher the XED the closer the substitutes.


    Negative XED = Complementary Goods

  • XED < -1 = Close Complement (Less than meaning -2, -3 etc.)
  • 0 > XED > -1 = Distant Complement

    • When XED is negative, the goods are complementary i.e. they are used together. This means if the price of one goes up, people buy less of the other good. Equally if the price of one good goes down people buy more of the other. For example if the price of PS4 consoles go down, people will buy more PS4 games.


    XED = 0 = No Relationship

    If XED is zero then there is no relationship between the two goods.


    Why would a firm want to know YED?

    1) Identify rivals

    By working out the XED of its own goods in relation to other goods, firms can identify rival brands in the market. In addition a firm can work out if there are any important complementary products.


    2) Stratergy

    Understading XED is also useful for firms to develop stratergies to reduce the risks associated with other firms changing the price of their goods.









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