Cross Elasticity of Demand - Explained
What is Cross Elasticity of Demand?
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What is Cross Elasticity of Demand?
Cross elasticity of demand, also referred to as the cross-price elasticity of demand, refers to an economic concept that measures the responsiveness in the demanded quantity of one good when the price of a completely separate product changes.
How is Cross Elasticity of Demand Used?
Cross elasticity on demand measures the sensitivity of the demand for a product or service to the variation of the price of a different good or service. As such, the subject seeks to determine how much the consumption of product changes when the value and cost of a different product also changes.
For instance, how much increase in the price of vehicles there is when the price of gasoline declines. Or better yet, how much the decrease in the purchase of printers there will be if the price of the printer tub goes up.
How to Calculate Cross-Elasticity of Demand
Cross elasticity of demand is calculated by taking the percentage difference in the demanded quantity of one good and then diving it by the percentage difference in the price of another product.
To calculate the cross elasticity, it was evaluated in the following way:
Cross-Price Elasticity of Demand between X and Y = Percentage Variation of the quantity demand of X / Percentage variation of the price of product Y.
In arithmetic terms, the following formula will be used:
Qx = amount of x
Qy = amount of y
Px = price of x
Py = price of y = variation
Cross Elasticity of Substitute Goods
When the cross-elasticity of demand is positive, the product, Y, is substituted for X. In this case, before experiencing an increase in price Y, the quantity demand of X will increase. The above illustration implies that consumers can be a great substitute such that when the price of product Y increases, they reduce the purchasing power of Y to replace them to a more significant purchase amount of X.
Let us look at this example closely: butter can substitute margarine. This is at least for many people. In this instance, if the price of butter goes up, the amount of margarine demanded is expected to increase as well.
Cross Elasticity of Complementary Goods
When the cross-elasticity is negative, the products, as well as services, are complementary. This implies that they are consumed together - for instance, bread and butter. Because most individuals like to consume the products, they will reduce the purchase of these items thereby reducing the purchase of bread.
Cross Elasticity of Independent Goods
When the cross elasticity is zero, the goods, as well as services, are interconnected and independent. That implies that buyers don't consider these goods as substitutes or complements. Therefore, their demands are independent.
For example, shoes and milk are goods that satisfy entirely different needs. There's no expected reaction in the industry of shoes prior to a variation in the milk industry.