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Cross Elasticity of Demand

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20 views12 pages

Cross Elasticity of Demand

Uploaded by

hamna.sadiq
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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AS Economics – Unit 1 – Lesson 11

Cross elasticity of demand


◼ Today’s lesson:
1) Recap: PED and YED
2) Cross elasticity of demand
3) Positive cross elasticity
4) Negative cross elasticity
5) The significance of XED
6) The Internet and XED
Link then up!

◼ Price+ elastic demand


◼ Substitute goods + inelastic demand
◼ Income + normal goods
◼ Income + inferior goods
Cross elasticity of demand
◼ Cross elasticity of demand
measures the responsiveness of
demand for one product to changes in
the price of another good.
◼ The cross elasticity of demand
between two goods or services
indicates the nature of the demand
relationship between the goods.
Cross elasticity = % change in Q of A
% change in P of B

XED can be positive, negative or zero, indicating


an increase, decrease or no change in demand.
The numerical value of XED indicates the extent
of the change in demand.
Cross elasticity of demand
◼ There are three possible relationships:
1) Competing demand: where we have
positive cross elasticity, a rise in the price of
one product is likely to cause demand for its
substitutes to increase.
2) Joint demand: where we have negative
cross elasticity, a rise in the price of one
product causes demand for complementary
products to decrease.
3) No relationship: where we have zero cross
elasticity.
Positive cross elasticity on a graph

Here we have a
Demand positive cross
elasticity – where
Price of B

P2 the rise in price of


good B from P1 to
P2 results in an
P1 increase in the
quantity of A
demanded from Q1
to Q2.
Q1 Q2 Demand for the
substitute (A) rises
Quantity of A demanded as the price of B
rises.
Negative cross elasticity on a graph

Demand Here we have a


negative cross
elasticity – where
Price of B

P2 the rise in price of


good A from P1 to
P2 results in an
P1 decrease in the
quantity of B
demanded from Q1
to Q2.
Q2 Q1 So demand for the
complementary
Quantity of A demanded good (B) decreases
as the price of A
rises.
The significance of XED
◼ Cross elasticity of demand is of particular
significance to firms.
◼ If experience and surveys show that your
product has a high positive XED then it may
be an incentive to cut prices and attract
customers.
◼ It will also warn the firm that raising prices
would lead to lost customers.
◼ A low positive XED gives a firm more power
to raise its prices but less opportunity to
benefit from cutting prices.
The significance of XED
◼ A high negative XED between a firm’s
product and another firm’s produce
means that the firm can expect a rise in
demand for their product should the
other firm’s prices fall.
The Internet & XED
◼ It is worth noting that the rise of the
Internet has had a big effect upon the
competitiveness of markets.
◼ Consumers can now easily check prices
across a range of companies and can
then choose the price that suites them.
◼ This reduces each firm’s ability to raise
their prices above that of the
competition
Remember, the more competition there is, the better a firm will
have to do to keep you from buying from their competitors.
Summary
◼ Firm’s need to be aware of cross
elasticities associated with their products.
◼ If you are operating in a competitive
market then you are likely to have positive
cross elasticity of demand, so rising prices
will cause demand for substitutes to rise.
◼ Sometimes demand for your good is
affected by the price of complementary
goods, and your cross elasticity is
negative.

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