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Summary Cross Elasticity of demand (XED)
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A summary of XED (cross elasticity of demand)
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25/11/21Cross Elasticity of Demand (XED)
XED
- XED = Cross Elasticity of Demand
- The responsiveness of quantity demanded of one good to the change in price of another good
Formula
% change∈quantity demanded of good x
XED=
% change∈ price of good y
- XED tells you whether two goods are substitutes, complements or have no relation (unrelated)
XED results
- If XED is positive, they are substitutes
- If XED is negative, they are complements
- If XED is 0, they are unrelated
- The higher the value of the cross price elasticity, the stronger the relationship between the two goods – the
nearer the value is to 0, the more likely that the two goods are unrelated (the weaker the relationship)
o So, a high positive value shows a strong relationship between two substitutes
o So, a high negative value shows a strong relationship between two complements
o So, a low positive value shows a weak relationship between two substitutes
o So, a low negative value shows a weak relationship between two complements
Interpreting the XED
- If the XED is greater than 1 or less than -1, then the demand between two goods are price elastic and are
strongly related substitutes or complements
- If the XED is less than 1 and more than -1, then the demand between two goods are price inelastic and are
weakly related substitutes or complements
- If the XED is 0, then the demand between two goods are perfectly price inelastic and there is no
relationship between the two goods
Substitutes
- In highly competitive markets there are many close substitutes
o This means it is unwise to raise prices
- For example, if shell raise petrol prices then motorists can go to many other petrol stations
Complements
- Producers need to be aware that if the price of a close complement were to rise, they may have to cut their
prices to offset the impact
- For example, if price of video games increases significantly then producers of games consoles may have to
cut prices to maintain demand
Why XED is useful
- It allows a firm to map out its market, including how many rivals it has, how close they are, and allows the
firm to measure how important its complementary products are to its own products
- This helps firms develop strategies to reduce its exposure to the risks associated with price changes by other
firms, such as a rise in the price of a complement or a fall in the price of a substitute
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