Questions and Answers
What is cross elasticity of demand?
Cross price elasticity of demand (XED) measures the responsiveness of demand for good X after a change in the price of good Y.
What is the value of XED for two substitutes?
What happens to the demand for a complementary good when the price of one product falls?
How is cross elasticity of demand (XED) calculated?
Signup and view all the answers
What would the XED indicate if it is positive?
Signup and view all the answers
What would the XED indicate if it is negative?
Signup and view all the answers
Given the price of X decreased from £30 to £15, what is the % change in price of X?
Signup and view all the answers
What is indicated if two unrelated products show zero cross elasticity?
Signup and view all the answers
What does a high coefficient of cross-price elasticity indicate?
Signup and view all the answers
Study Notes
Cross Elasticity of Demand
- Cross elasticity of demand (XED) measures how demand for good X changes with a price change of good Y.
XED for Substitutes
- Substitutes are goods that compete for the same market.
- An increase in the price of one substitute results in higher demand for the other.
- XED for substitutes is always positive, indicating a direct relationship.
XED for Complements
- Complements are products that are consumed together.
- A decrease in the price of one complement leads to an increase in demand for the other.
- XED for complements is always negative, reflecting an inverse relationship.
XED Calculation
- XED is calculated by taking the change in demand for good X and dividing it by the change in the price of good Y.
Example of Substitutes
- When Beats Studio headphones are priced at £200 and increase to £220, the demand for a rival brand rises by 5%.
- XED calculation:
- % change in price of X = 10%
- % change in demand for Y = 5%
- XED = +0.5, indicating weak substitution.
Example of Complements
- If the price of good X decreases from £30 to £15 causing its quantity demanded to rise from 400 to 700, while quantity demanded of good Y increases from 250 to 400.
- XED calculation:
- % change in price of X = -50%
- % change in demand for Y = +60%
- XED = -1.2, indicating strong complementarity.
Coefficient of XED
- The strength of the relationship between two products is reflected in the coefficient of XED; higher values indicate stronger relationships.
Coefficient of Substitutes
- Close substitutes exhibit a strongly positive XED; small price changes lead to significant shifts in consumer demand.
Complements
- Strong complementary relationships yield highly negative XED values, as seen with products like game consoles and software games.
Unrelated Products
- Unrelated products have a zero cross elasticity, meaning changes in one do not affect the demand for the other, exemplified by taxi fares and cheese demand.
Summary of Definitions
- XED for substitutes pertains to competitive goods with positive elasticity.
- XED for complements relates to goods consumed together with negative elasticity.
Studying That Suits You
Use AI to generate personalized quizzes and flashcards to suit your learning preferences.
Description
Test your understanding of cross elasticity of demand (XED) with this quiz. Explore how XED varies for substitutes and complements, and learn to calculate its value with practical examples. Challenge yourself to apply these concepts in real-world scenarios.
