Chapter 10: Cross price elasticity of demand (1.2)

  • Definition of cross price elasticity of demand

The definition of cross-price elasticity of demand is very similar to PED. All we are doing is calculating the sensitivity of Good X with respect to another good, Good Y. Dividing the percentage change in quantity demanded for good X by the percentage change in the price of Good Y gives us a value of the cross-price sensitivity of the two goods.

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Definition: Cross-price elasticity of demand

The cross-price elasticity of demand – CPED – measures the relative sensitivity of a change in the quantity demanded of Good X with respect to a change in the price of Good Y. Cross-price elasticity measures the closeness of substitutes and the relevance of complements.

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  • Formula
  • Significance of sign – complements and substitutes

When looking at printers, one will of course look at the total cost picture; a printer needsink cartridges. Say that the price of ink cartridges fell from €15 to €13.5 (-10%) and that subsequently demand for printers increased from 10,000 units per week to 12,000 (+20%). The cross-price elasticity (X = printers; Y = ink cartridges)of printers with regard to cartridges would be:

Notice the appropriate signs in the formula and answer. Take heed; it is most important to assign these signs correctly to cross price elasticity values. The minus sign tells us that we are dealing with complement goods; as the goods are complementary a decrease in the price of one good will cause an increase in the quantity demanded of the other.

(Small heading) Substitutes

Let us continue with the example of DVD players and Blu-Ray players. Assume that the price of Blu-Ray players falls. This would most certainly have an effect on the demandfor DVD players as the two goods would seem to be highly substitutable. Say that the price of Blu-Ray players went from USD200 to USD180 and that the quantity demanded of DVD players decreased from 10,000 units to 9,500 units during a given time period. Our cross-price elasticity (X =DVD players; Y = Blu-Ray players)would be:

A positive value of 0.5 tells us that the goods are substitutes– but a value of less than one tells us that they are relatively weak substitutes.

Accept no substitutes! (On the road in the Yucatan, Mexico, July 2007

Complement goods – shifting demand

(Smaller heading) Substitute goods – shifting demand

As for substitute goods, DVD players and Blu-Ray players are of course in competitive demand. In figure 10.3a and b, the supply of Blu-Ray players has increased, say due to lower production costs in manufacturing. This lowers the market price of Blu-Ray players and decreases demand for DVD players which are substitutes.