Cross Elasticity Of Demand

The cross elasticity of demand measures the change in the quantity demanded for one good in response to a change in the price of another good. In other words, it tells you how much the quantity demanded for one good changes when the price of another good changes.

Formula:

Cross elasticity of demand = change in quantity demanded for good A / change in price of good B

Interpretation:

• If the cross elasticity of demand is positive, it means that the two goods are complements, meaning that demand for one good increases when demand for the other good increases.
• If the cross elasticity of demand is negative, it means that the two goods are substitutes, meaning that demand for one good decreases when demand for the other good increases.
• If the cross elasticity of demand is zero, it means that the two goods are unrelated, meaning that changes in the price of one good will not affect the demand for the other good.

Examples:

• If you increase the price of bread, demand for butter will probably increase. This is because bread and butter are complements.
• If you increase the price of coffee, demand for tea will probably decrease. This is because coffee and tea are substitutes.

Uses:

• Cross elasticity of demand can be used to predict how consumers will respond to changes in the price of goods.
• Cross elasticity of demand can be used to develop marketing strategies.
• Cross elasticity of demand can be used to understand the relationship between different goods.

Note:

• The cross elasticity of demand can be positive or negative, but it is always a measure of relative change.
• The cross elasticity of demand can be calculated for any two goods, but it is most commonly calculated for pairs of goods that are related to each other in some way.