Introduction to Cross Elasticity of Demand
Cross elasticity of demand is the measure of response in the demand of one good with reference to the change in the price of another good. Both the goods are related in one sense that, when the price of one good changes, the other good’s price and/or demand changes
Understanding Cross Elasticity of Demand
Elasticity of demand refers to how the demand of a product changes due to a series of factors affecting that good—like price of the product, the income of the consumer, etc. Cross price elasticity of demand, in specific, refers to the measurement of relative change in the quantity demanded of one good due to the change in price of the other, related product. There are two types of goods: substitute goods and complementary goods. Coffee and tea, a variety of soft drinks, competing products in the market, are examples of substitute goods. Complementary goods are like petrol and automobiles, who are interdependent on each other. By cross elasticity, substitute goods have a positive elasticity. Because the price of one choice in the industry is going up, the demand for that product will decrease, as per the law of demand. Due to the increased price, the substitute of that good has a relatively lesser price, due to which consumers can choose to purchase the substitute, thereby increasing the demand of the substitute. For complementary goods, because the price of one good is increasing, the quantity demanded of the other good will decrease. The reason for studying cross elasticity of demand is to understand the pricing pattern when entering the market. It becomes essential in strategizing the market position that the good will hold, which will establish the market share. Price elasticity is measured by: Elasticity (xy) = Percentage Change in Quantity of X / Percentage Change in Price of Y
Highlights of Cross Elasticity of Demand
Cross elasticity is the same as cross price elasticity of demand. However, cross elasticity of demand and elasticity of demand are not the same; cross price elasticity of demand is a specific study of pricing strategy under elasticity of demand. Cross elasticity of demand of goods can be zero when the goods are independent of each other. Unrelated goods do not influence the change in demand of another product, unless other factors than price are playing a role.
