Cross Elasticity of Demand | Definition, Types, Example, Formula

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Tutorial Topic: What is Cross Elasticity of Demand Definition, Types, Example, Formula of cross elasticity of demand.


What is Cross Elasticity of Demand?

The cross elasticity of demand can be defined as a measure of a proportionate change in the demand for goods as a result of a change in the price of related goods.


Cross Price Elasticity of Demand Definition

The cross elasticity of demand is the proportional change in the quantity demanded of good X divided by the proportional change in the price of the related good Y.

Ferguson

Cross Elasticity of Demand Formula

The cross elasticity of demand can be measured as:

Cross Elasticity of Demand Example

Let us understand the concept of cross elasticity of demand with the help of an example.

Example: Assume that the quantity demanded for detergent cakes has increased from 500 units to 600 units with an increase in the price of detergent powder from 150 to 200. Calculate the cross elasticity of demand between two products.

Solution: Given that


X = Detergent cakes
Y = Detergent powders
Qx = 500
ΔQx = 100(600-500)
Py = 150
ΔPy = 50


Types of Cross Elasticity of Demand

Cross elasticity of demand can be categorised into three types, which are as follows:

Positive cross elasticity of demand

When an increase in the price of a related product results in an increase in the demand for the main product and vice versa, the cross elasticity of demand is said to be positive. Cross-elasticity of demand is positive in the case of substitute goods.

For example, the quantity demanded tea has increased from 200 units to 300 units with an increase in the price of coffee from 25 to 30. In this case, the cross elasticity would be:

Negative cross elasticity of demand

When an increase in the price of a related product results in the decrease of the demand of the main product and vice versa, the negative elasticity of demand is said to be negative. In complementary goods, cross elasticity of goods is negative.

For example, if the price of butter is increased from 20 to 25, the demand for bread is decreased from 200 units to 125 units. In such a case, cross elasticity will be calculated as:

Zero cross elasticity of demand

When a proportionate change in the price of a related product does not bring any change in the demand for the main product, the negative elasticity of demand is said to be negative. In simple words, cross elasticity is zero in case of independent goods. In this case, it becomes zero.

By studying the concept of cross elasticity of demand, organisations can forecast the effect of change in the price of a good on the demand for its substitutes and complementary goods. Thus, it helps organisations in making pricing decisions by determining the expected change in the demand for its substitutes and complementary goods. Moreover, it helps an organisation to anticipate the degree of competition in the market.


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