Cross-Price Elasticity Shows How A Product Is To A Change in Price of Another Good It Shows If Two Goods Are Substitutes or Complements

Cross-Price Elasticity of Demand (XED)
Cross-Price elasticity shows how sensitive a

product is to a change in price of another good
It shows if two goods are substitutes or
complements

P increases 20% Q decreases 15%
• XED coefficient is negative = complements

• XED coefficient is positive = substitutes
XED practice
The owners of a pizza shop find that when their competitor, a hamburger shop,
lowers the price of a burger from $2 to $1.80, the number of pizza slices that
they sell each week falls from 400 to 380, due to the lower-priced burger.
With this information, we can calculate the XED for the pizza slices
Step 1 – calculate % change in price of product y

Step 2 – calculate % change in quantity demanded of product x

Step 3 – calculate XED or product x

Unlike PED, XED may be positive or negative
The sign is important
XED values show the strength of the relationship.

• High positive number = very close substitutes
XED value Negative Zero Positive
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complements complements products substitutes substitutes
More XED practice
Calculate the XED and state whether the
goods are complements or substitutes
1. A 10% rise in the price of fish may cause
demand for chicken to increase by 2%.
2. The fall in the price of paper by 20% causes
the demand for pens to increase by 5%.
3. A 20% rise in the price of ice cream causes
demand for sweets to increase by 4%.
4. A 12% fall in the price of air fares leads to a
30% rise in the demand for foreign holidays.
5. A 10% rise in bikes will leave the demand for
cheese unaffected.
Answers…
A 10% rise in the price of fish may cause demand for

chicken to increase by 2%. +2% / +10% = +0.2
The fall in the price of paper by 20% causes the
demand for pens to increase by 5%. +5% / -20%
= -0.25
A 20% rise in the price of ice cream causes demand
for sweets to increase by 4%. +4% / +20% =
+0.2
A 12% fall in the price of air fares leads to a 30% rise
in the demand for foreign holidays. +30% / -12%
= -2.5
A 10% rise in bikes will leave the demand for cheese
unaffected. 0% / +10% = 0
Who cares?
Firms can use XED estimates to predict:
• The impact of other firms’ pricing strategies on

demand for their own products:
Who cares?
Pricing strategies for complementary goods:

– Popcorn and cinema tickets are strong
complements. Popcorn has a very high mark
up i.e. popcorn costs very little to make but
sells for a high price
– If firms have a reliable estimate for XED they
can estimate the effect, say, of a two-for-one
cinema ticket offer on the demand for popcorn
Income Elasticity of Demand (YED)
Income elasticity shows how sensitive a product

is to a change in INCOME
It shows if goods are normal or inferior

Income increases 20%, and quantity decreases 15%

then the good is a… INFERIOR GOOD
Unlike PED, but like XED, YED may be positive or negative
The sign is important
YED = negative = inferior good
YED = positive = normal good

YED practice
A person has an increase in annual income from $60,000 per year to $66,000
per year. She then increases her annual spending on holidays form $2,500 to
$3,000.
With this information, we can calculate her YED for holidays
Step 1 – calculate % change in income

Step 2 – calculate % change in quantity demanded

Step 3 – calculate YED

Two more good types…
Necessity goods
• Income inelastic
• Demand changes little as
income rises or falls
Two more good types…
Luxury goods
• Income elastic
• Demand changes significantly
as income rises/falls
• Non-essential
Applications of YED
Three sectors of production

Primary
• Makes direct use of resources,
e.g. Agriculture, Forestry, Mining
Secondary
• Manufacturing
Tertiary
• Services
What kind of YED would each sector have?

Applications of YED
Three sectors of production

Primary Inelastic
• Makes direct use of resources,
e.g. Agriculture, Forestry, Mining
Secondary More elastic

• Manufacturing
Tertiary More elastic

again
• Services
What kind of YED would each sector have?

Applications of YED
As incomes increase…
• What happens to the demand for primary products?
• What happens to the demand for secondary products?
• What happens to the demand for tertiary products?
The income gap widens

Applications of YED
Businesses need to understand consumer

responsiveness
In good times, people will buy

more income elastic goods
In bad times, customers will

‘tighten their belts’, and put off their
spending.
Price Elasticity of Supply
THE LAW OF SUPPLY SAYS...

Producers will supply more when prices
go up and less when prices go down
HOW MUCH MORE OR LESS?

DOES IT MATTER?
Price Elasticity of Supply (PES)
Elasticity of Supply-
• Measurement of producers’
responsiveness to a change in price.
• What will happen if prices increase? How
much will it affect Quantity Supplied
INelastic = Insensitive to a change in price (Steep curve)
• Most goods have INelastic supply in the short-run
Elastic = Sensitive to a change in price (Flat curve)
• Most goods have elastic supply in the long-run
Perfectly Inelastic = Q doesn’t change (Vertical line)
• Set quantity supplied
Price Elasticity of Supply

Perfectly Inelastic Supply
Price Supply
Quantity supplied
Perfectly Elastic Supply
Price
Supply
Quantity supplied
Price Elasticity of Supply (PES)
PES practice
A publishing firm realises that they can now sell their monthly magazine for
$5.50 instead of $5.00. In light of this, they increase their supply from 200,000
to 230,000 magazines per month.
With this information, we can calculate the PES for the magazine.
Step 1 – calculate % change in price

Step 2 – calculate % change in quantity supplied

Step 3 – calculate PES

Elastic supply PES > 1
e.g. DVDs
• Short production time

• Easy to store
Inelastic supply PES < 1
e.g. Primary products
• Long production time

• Hard to store
Show the effect of an increase in demand for apples when apples have a
perfectly inelastic supply curve in the short run.
Examples of PES
A 10-percent increase in the

price of steel causes a 15-
percent increase in the
quantity supplied. What is
Suppose the price elasticity of supply of
the PES? bread is 2.
The price elasticity of supply for steel is
What will be the effect of a 10% decline in
15%/10% = 1.5.
the price of bread?

Examples of PES
Suppose the price elasticity of

supply of bread is 2.
A 10-percent decline in the
price of bread will, therefore,
result in a 20-percent
reduction in quantity
supplied, because
–20%/ –10% = 2.
Determinants of PES
1. How much costs rise as output is increased
A new factory?
Is there spare capacity?
High costs of increasing supply = inelasticity

Determinants of PES
2. Time period considered
In the short run, supply tends to be inelastic
In the long run, supply tends to be elastic

Determinants of PES
3. Ability to store stocks
For durable goods, stockpiles can be used to ensure

supply elasticity
There are goods that can’t be stored.

E.g. labour, perishables

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Cross-Price Elasticity of Demand (XED)

Cross-Price elasticity shows how sensitive a

P increases 20% Q decreases 15%

• XED coefficient is negative = complements

Step 1 – calculate % change in price of product y

Step 2 – calculate % change in quantity demanded of product x

Step 3 – calculate XED or product x

Unlike PED, XED may be positive or negative

The sign is important

XED values show the strength of the relationship.

XED value Negative Zero Positive

R’ship Close Remote Unrelated Remote Close

A 10% rise in the price of fish may cause demand for

Firms can use XED estimates to predict:

• The impact of other firms’ pricing strategies on

Pricing strategies for complementary goods:

Income elasticity shows how sensitive a product

Income increases 20%, and quantity decreases 15%

Unlike PED, but like XED, YED may be positive or negative

The sign is important

YED = negative = inferior good

YED = positive = normal good

With this information, we can calculate her YED for holidays

Step 1 – calculate % change in income

Step 2 – calculate % change in quantity demanded

Step 3 – calculate YED

Two more good types…

Two more good types…

Three sectors of production

What kind of YED would each sector have?

Three sectors of production

Secondary More elastic

Tertiary More elastic

What kind of YED would each sector have?

The income gap widens

Businesses need to understand consumer

In good times, people will buy

In bad times, customers will

THE LAW OF SUPPLY SAYS...

HOW MUCH MORE OR LESS?

Step 1 – calculate % change in price

Step 2 – calculate % change in quantity supplied

Step 3 – calculate PES

• Short production time

e.g. Primary products

• Long production time

A 10-percent increase in the

Suppose the price elasticity of

1. How much costs rise as output is increased

Is there spare capacity?

High costs of increasing supply = inelasticity

2. Time period considered

In the short run, supply tends to be inelastic

In the long run, supply tends to be elastic

3. Ability to store stocks

For durable goods, stockpiles can be used to ensure

There are goods that can’t be stored.

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