- Types of Economic Systems
- Macroeconomics vs Microeconomics
- Economies of Scale vs Economies of Scope
- Elastic vs Inelastic Demand
- Cross Price Elasticity of Demand Formula
- Price Elasticity of Supply
- Marginal Revenue Formula
- Consumer Surplus Formula
- Supply vs Demand
- Aggregate Supply
- Price Elasticity of Demand Formula
- Currency Devaluation
- Money vs Currency
- Finance vs Economics
- Behavioural Economics
- Diseconomies of Scale
- Economic Profit
- Perfect Competition
- Monopolistic Competition Examples
- Monopoly vs Monopolistic Competition
- Oligopoly Examples
- Monopoly vs Oligopoly
- Perfect Competition vs Monopolistic Competition
- Disposable Income
- Purchasing Power Parity Formula
- Absolute Advantage vs Comparative Advantage
- Asymmetric Information
- Economic Utility
- Marginal Propensity To Consume (MPC) Formula
- Neoclassical Economics Theory
- Comparative Advantage Formula
- Cross Price Elasticity of Demand
Cross Price Elasticity of Demand Definition
Cross Price Elasticity of Demand is referred to the percentage change in quantity demand (∆QX/QX) for a good X after a change in the price (∆PY/PY) of another good Y. In simple terms, it measures the sensitivity of demand for one quantity X when the price of related good Y is changed.
Cross Price Elasticity of Demand formula
It is calculated by dividing the percentage change in the quantity of good X by percentage change in the price of good Y which is represented mathematically as
Further, the formula for cross-price elasticity of demand can be elaborated into
- Q0X = Initial demanded quantity of good X,
- Q1X = Final demanded quantity of good X,
- P0Y = Initial price of good Y and
- P1Y = Final price of good Y
Explanation of the Cross Price Elasticity of Demand
This can be determined in the following five steps:
- Step #1: Firstly, identify P0Y and Q0X which is the initial price of good Y an initially demanded quantity of good X respectively.
- Step #2: Now, determine the final demanded quantity of good X and the final price of good Y which are termed as Q1X and P1Y respectively.
- Step #3: Now work out the numerator of the formula which represents the percentage change in quantity. It is arrived at by dividing the difference of final and initial quantities (Q1X – Q0X) by summation of the final and initial quantities (Q1X + Q0X) i.e. (Q1X – Q0X) / (Q1X + Q0X).
- Step #4: Now work out the denominator of the formula which represents the percentage change in price. It is arrived at by dividing the difference of final and initial prices (P1Y – P0Y) by summation of the final and initial prices (P1Y + P0Y) i.e. (P1Y – P0Y) / (P1Y + P0Y).
- Step #5: Finally, the cross-price elasticity of demand is calculated by dividing the expression in Step 3 by expression in Step 4 as shown below.
Cross price elasticity of demand Formula = (Q1X – Q0X) / (Q1X + Q0X) ÷ (P1Y – P0Y) / (P1Y + P0Y)
Examples of Cross Price Elasticity of Demand
Let’s understand the concept of this with the help of an example.
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Let us take the simple example of gasoline and passenger vehicles. Now let us assume that a surge of 50% in gasoline price resulted in a decline in the purchase of passenger vehicles by 10%. Calculate the cross price elasticity of demand in this case.
Using the above-mentioned formula the cross price elasticity of demand can be calculated as:
Percentage change then the number of passenger vehicles ÷ Percentage change the price of gasoline
Since we can see a negative value for cross elasticity of demand, it vindicates the complementary relationship between gasoline and passenger vehicles.
Let us assume that there two companies in the business of selling soft drinks. At present, company 2 sells soft drinks Y at $3.50 per bottle, while company 1 is able to sell 4,000 bottles of soft drinks Y per week. In order to impact the sales of company 1, company 2 has been decided to decrease the price to $2.50 which resulted in decreased sales of 3,000 bottles of soft drinks Y per week. Calculate the cross price elasticity of demand in the case.
Given, Q0X = 4,000 bottles, Q1X = 3,000 bottles, P0Y = $3.50 and P1Y = $2.50
- Cross price elasticity of demand Formula = (3,000 – 4,000) / (3,000 + 4,000) ÷ ($2.50 – $3.50) / ($2.50 + $3.50)
- = (-1 / 7) ÷ (-1 / 6)
- = 6/7 or 0.857
Since, we can see a positive value for cross elasticity of demand, it vindicates the competitive relationship between soft drink X and soft drink Y.
Relevance and Use
It is of paramount importance for a business to understand the concept and relevance of cross-price elasticity of demand to understand the relationship between the price of a good and the quantity demanded of another good at that price. It can be used to decide the pricing policy for different markets and for various products or services. The cross-price elasticity behaves differently based on the type of relationship between the goods which are discussed below.
#1 – Substitute products
In case both goods which are perfect substitutes to each other resulting in perfect competition, then an increase in the price of one good will lead to an increase in demand for the rival product. For example, various brands of cereal are examples of substitute goods. It is to be noted that the cross price elasticity for two substitutes will be positive.
#2 – Complementary products
If in case one good is complementary to the other good, then a decrease in the price of one good will lead to an increase in demand for the complementary good. The stronger the relationship between the two products, the higher will be the coefficient of cross-price elasticity of demand. For example, game consoles and software games are examples of complementary goods. It is to be noted that the cross elasticity will be negative for complementary goods.
#3 – Unrelated products
In case there is no relationship between the goods, then an increase in the price of one good will not affect the demand for the other product. As such, unrelated products have a zero cross elasticity. For example, the effect of changes in taxi fares on the market demand for milk.
This has been a guide to Cross Price Elasticity of Demand, its definition, and its meaning. Here we discuss the formula to calculate Cross Price Elasticity along with practical examples and its relevance. You can learn more about from the following articles –