Introduction to cross-price elasticity of demand

Learning Contents:                                                            

·        Cross price elasticity of demand 

Introduction

Demand for a commodity is not only affected by its own price but also through the price of another good. Change in the price of one commodity might impact the demand for another commodity.  If demand for a commodity increases as a result of rise in the price of another good, the good will be a substitute. On the other hand, if demand for a commodity increases as a result of fall in the price of another good, the good will be a complementary. The present post will discuss the meaning of cross price elasticity of demand and its relationship with substitute and complementary good.

Cross price elasticity of demand indicates the responsive of the demand for a good to changes in the price of another good. In other words, when demand for a good change as a result of change in the price of its related goods; which might be a substitute good or a complementary good is referred to as, cross price elasticity of demand. Mathematically, it is calculated as percentage change in quantity demanded for a good as a result of percentage change in the price of its related goods.

1. Substitutes

Substitutes are usually referred to a pair of goods which can be used in place of each other (such as orange juice and pineapple juice). The cross price elasticity of demand for substitutes is positive as the demand for a good increases when price of its substitutes increases. An example of substitute good could be two different brands of cookie. If the price of one brand of a cookie increases, then a consumer might switch to the second brand of cookie whose price has not been increased and ultimately will increase the quantity demand of the second brand of cookie.




2.     



    Complements



Complements are usually referred to a pair of goods which are used together (such as burger and patty). The cross price elasticity of demand for complements is negative as if price of one good increases, the demand for its closely related or complementary good will also decrease because the demand for the main good is decreased on account of its increased price. An example of complementary good could be an electronic toy and its battery. A consumer will purchase fewer toys if its price increases and subsequently the demand for the batteries needed to operate that toy will also decrease.

 



 


Let’s try some questions

Choose the Correct Answer

1. When demand for a commodity changes as a result of change in the price of another commodity, it is

a. Income elasticity of demand

b. Own price elasticity of demand

c. Cross- price elasticity of demand

d. None of these

2. The cross elasticity of demand measures the responsiveness of the quantity demanded of a particular good to changes in the prices of

a. its substitutes and its complements.   

b. its substitutes but not its complements.

c. its complements but not its substitutes.

d. neither its substitutes nor its complements.

3. If goods are complements, their cross elasticity will be:

a. zero

b. positive

c. negative

d. None of these

4. If goods are substitutes, definitely their

a. cross elasticities are positive

b. income elasticities are positive.

c. income elasticities are negative.

d. cross elasticities are negative.

5. If a rise in the price of good-1 decreases the quantity of good- 2 demanded,

a. the cross elasticity of demand is negative.

b. the cross elasticity of demand is positive.

c. good 1 is an inferior good.

d. good 2 is an inferior good.

6. If the cross elasticity of demand between good A and B is positive,

a. A and B are complements.

b. A and B are substitutes.

c. A is substitute and B is complement.

d. A is complement and B is substitute.

7.  If the cross elasticity of demand between goods A and B is negative,

a. A and B are complements.

b. A and B are substitutes.

c. A is substitute and B is complement.

d. A is complement and B is substitute.

8. Which of the following has positive cross price elasticity?

a. Burger and Patty

b. Hotdog and Burger

c. Ice-cream and topping

d. Electronic toys and battery

Answer Key

 

1.c

2.a

3.c

4.a

5.a

6. b

7. a

8. b

 

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