Cross-Price Elasticity: Definition, Formula and Examples

With the formula cross-price elasticity (XED) = (% change in demand of product A) / (% change of price of product B), you can evaluate the relationship between quantity of demand and selling price.

Cross elasticity of demand | Elasticity | Microeconomics | Khan Academy

Types of cross-price elasticity

There are three types of cross-price elasticity, and when you calculate this value using the formula, the results you get allow you to distinguish between each type:

Substitutes

Cross price elasticity substitutes refer to products and services that are different but satisfy similar customer needs. For example, if the quantity of a product “A” in demand increases because of the rise in the price of a product “B,” it indicates that the customer market is now consuming product “A” over product “B.” This effect creates a substitution scenario in the cross-price elasticity, which results in a value greater than zero when you calculate XED using the formula.

Complements

On the opposite side of substitutes are complements in cross-price elasticity. As an example, assume the quantity customers demand of product X decreases in response to an increase in price for product Y. This scenario indicates that due to the new higher price of product X, customers reduced their demand for product Y because consuming these products together becomes more expensive.

This consumer behavior may also indicate the perception that products X and Y are complements of each other and more fulfilling together. The cross-price elasticity of complements results in a value less than zero when using the formula.

Unrelated offerings

Unrelated products and services include offerings that appear to have no relationship between changes in selling prices and quantity of product demand. This means that a price change in one product doesnt affect the quantity customers demand of another product. When using the formula for cross-price elasticity, a result of zero always indicates unrelated price elasticity.

What is the cross-price elasticity formula?

The cross-price elasticity formula is an equation for calculating the cross-price elasticity of demand (XED) of two separate products or services:

Cross price elasticity (XED) = (% change in demand of product A) / (% change of price of product B), where products A and B are different offerings.

Cross-price elasticity is a ratio that represents the rate of change between the response of demand for one product or service to a change of price for another product or service. Its a percentage that can help businesses determine whether increasing or decreasing selling prices or substituting one good over another will be beneficial for boosting revenue generation.

You must know the percentage of change in demand of product A along with the percentage of increase or decrease for the selling price of product B before finding cross-price elasticity using the formula. To calculate the percentages of change for both demand and price, follow these formulas so you can use your results in the cross-price elasticity formula:

% change in demand of a product = (new product quantity – old product quantity) / (old product quantity)

% change in the price of a product = (new selling price – old selling price) / (old selling price)

The cross-price elasticity formula is useful for calculating several types of cross-price elasticity and is an important tool that gives businesses and organizations insight into what strategies to implement to succeed in the market.

When to use the formula for cross-price elasticity

Businesses and organizations gain insight from evaluating a products cross-price elasticity, such as a better understanding of the market and consumer behavior. In addition to learning more about the consumer market it serves, a company may use the cross-price elasticity formula when:

How to use the cross-price elasticity formula

To apply the cross-price elasticity formula, follow these four simple steps:

1. Find the percentage of change in the quantity of demand

Calculate the percentage of change in the quantity of product demand using the formula % change in demand of a product = (new product quantity – old product quantity) / (old product quantity).

The result represents the percent change in demand of product A in the cross-price elasticity formula. Assuming the “new product quantity” is 6,000 of an item and the “old product quantity” is 11,350 of the item, use the formula to find the percentage of change in demand:

% change in demand of a product = (new product quantity – old product quantity) / (old product quantity) = (11,350 – 6,000) / (6,000) = 0.89 or 89%. This indicates that the consumption rate of the new product increases by 89%.

2. Calculate the percentage of change in selling price

Find the percentage of change in the price of product B for the cross-price elasticity formula by using the calculation % change in the price of a product = (new selling price – old selling price) / (old selling price).

The value you get represents the percentage of change in the selling price of product B. Assume the “new selling price” of product B is $50 and the “old selling price” is $37. Using the formula for percentage of change in price, plug these values in:

% change in price of a product = (new selling price – old selling price) / (old selling price) = ($50 – $37) / ($37) = 0.35 or 35%. This value means that the selling price increases by 35% for the second product.

3. Divide the percentages of change in the quantity of demand and price

Plug in the values you get from your first two calculations into the cross-price elasticity formula. Using the example values of 89% and 35%, solve for the cross-price elasticity:

Cross price elasticity (XED) = (% change in demand of product A) / (% change of price of product B) = (89%) / (35%) = 2.54. This is a positive value greater than zero, which indicates products A and B are substitutes of one another.

4. Interpret your results to determine the type of cross-price elasticity

When you have your results, you can gain insight into the behavior of customers purchasing both products. For instance, the example result implies that the demand for product A increases with the price increase of product B.

This can mean that consumers are choosing product A more now because its less expensive than product B. This insight also indicates that both products A and B are fulfilling similar market needs, since consumers are substituting the less expensive product A for product B.

FAQ

How do you calculate cross price elasticity?

Also called cross-price elasticity of demand, this measurement is calculated by taking the percentage change in the quantity demanded of one good and dividing it by the percentage change in the price of the other good.

How is cross elasticity of demand calculated with example?

The cross-price elasticity formula is the percentage change in quantity demanded for one good divided by the percentage change in the price of another and is calculated by dividing the resulting change in quantity demanded for one good by the change in the price of another.

What is meant by cross price elasticity?

Cross price elasticity of demand refers to the percentage change in the quantity demanded of a given product due to the percentage change in the price of another “related” product.

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