Cross price elasticity of demand is the figure which denotes the relationship between two goods.
How do economists calculate Cross price elasticity of demand?
XED = Percentage change in quantity demanded of good A / percentage change in the price of good B
Percentage change in quantity demanded of good A (divided by) percentage change in the price of good B
How do we interpret cross price elasticity of demand values?
Negative value = complements
If the value is greater than -1 than they are strong complements and if they are less than -1 they are weak complements.
'0' (zero) value = independent goods (they have no value)
Positive value = substitutes
If the value is greater than 1 then they are strong substitutes and if they are smaller than 1 they are weak substitutes
TEST YOURSELF! (Answers found below)
Q1: What type of relationship is there between two goods, X and Y, given that:
- Original price of good X =80
- Original quantity of good Y = 50
- Final price of good Y=40
- Final quantity of good Y = 40
- Original price of good Y = 5
Q2: For each of the following product pairs what would you guess about the cross price elasticity of demand? What are their relationships? Do they have a strong or weak relationship?
a) Shoes and sneakers
b) Gasoline and sports utility vehicles
c) Bread and butter
d)Instand camera film and regular camera film
Q1: XED = % change in QD of good Y / % change in P of good X
= [(40-50)/50] * 100 / [(80-40)/80] * 100
= (-10/50 ) * 100 / (-40/80) * 100
= -0.2 * 1o0 / -0.5 * 100
Therefore they are weak substitutes
Q2: (a) Weak substitues - positive value for XED which is less than 1
(b) Strong complements - negative value for XED which is greater than -1
(c) Strong complements - negative value for XED which is greater than -1
(d) Strong substitues - positive value for XED which is greater than 1