Cross elasticity of demand | Elasticity | Microeconomics | Khan Academy
Types of cross-price elasticity
You can distinguish between each of the three types of cross-price elasticity by computing this value using the formula, which yields the following results:
Substitutes
Cross price elasticity substitutes are different goods and services that meet comparable client needs despite their differences in price. For instance, if the price increase of a product “B” results in a greater demand for product “A,” it means that the target market is now favoring product “A” over product “B.” When you use the formula to calculate XED, this effect produces a substitution scenario in the cross-price elasticity, leading to a value greater than zero.
Complements
Complements are on the other side of substitutes in terms of cross-price elasticity. Consider, for illustration, that customers’ demand for product X declines in response to a rise in the price of product Y. This scenario shows that customers decreased their demand for product Y as a result of the new higher price of product X because consuming these products together costs more money.
This purchasing pattern may also reflect the belief that products X and Y complement one another and are more satisfying as a set. When applying the formula, the cross-price elasticity of complements yields a value less than zero.
Unrelated offerings
Offerings that appear to have no correlation between changes in selling prices and the volume of product demand are examples of unrelated goods and services. This means that a change in one product’s price has no impact on the amount of another product’s demand from consumers. A result of zero when applying the cross-price elasticity formula always denotes unrelated price elasticity.
What is the cross-price elasticity formula?
The following equation can be used to determine the cross-price elasticity of demand (XED) between two different goods or services:
Where products A and B are different offerings, cross price elasticity (XED) is calculated as (% change in demand of product A) / (% change in price of product B).
Cross-price elasticity is a ratio that shows how quickly demand for one good or service changes in response to a change in the price of another good or service. It’s a ratio that businesses can use to determine whether raising or lowering selling prices or substituting one good for another will be advantageous for increasing revenue generation.
Before using the formula to determine cross-price elasticity, you must be aware of the percentage change in demand for product A as well as the percentage increase or decrease in the selling price of product B. Use these formulas to determine the percentages of change for both demand and price so that you can input your findings into the cross-price elasticity formula.
(New Product Quantity – Old Product Quantity) / (Old Product Quantity) equals the percentage change in a product’s demand.
(New Selling Price – Old Selling Price) / (Old Selling Price) equals the percentage change in a product’s price.
The cross-price elasticity formula is an important tool that provides businesses and organizations with insight into what strategies to implement in the market. It is useful for calculating several types of cross-price elasticity.
When to use the formula for cross-price elasticity
Businesses and organizations can learn more about the market and consumer behavior by analyzing a product’s cross-price elasticity. A business may employ the cross-price elasticity formula in addition to learning more about the consumer market it serves when:
How to use the cross-price elasticity formula
Follow these four easy steps to apply the cross-price elasticity formula:
1. Find the percentage of change in the quantity of demand
Use the formula% change in demand of a product = (new product quantity – old product quantity) / (old product quantity) to calculate the percentage of change in the quantity of product demand.
The formula for cross-price elasticity shows that the result is the percent change in demand for product A. Use the following formula to determine the percentage of change in demand if the “new product quantity” is 6,000 and the “old product quantity” is 11,350.
(new product quantity – old product quantity) / (old product quantity) = (11,350 – 6,000) / (6,000) = 0% is the percentage of a product’s demand that has changed. 89 or 89%. This shows that the new product’s consumption rate has increased by 89%.
2. Calculate the percentage of change in selling price
Using the formula% change in price of a product = (new selling price – old selling price) / (old selling price), determine the percentage change in the price of product B for the cross-price elasticity formula.
The amount you receive reflects the percentage change in product B’s selling price. Assume that product B’s “new selling price” is $50 and its “old selling price” is $37. Put these values into the formula for price change as a percentage:
(New Selling Price – Old Selling Price) / (Old Selling Price) = ($50 – $37) / ($37) = 0% for a product’s percentage price change. 35 or 35%. This value indicates a 35% price increase for the second product’s selling price.
3. Divide the percentages of change in the quantity of demand and price
the cross-price elasticity formula with the values you obtain from your first two calculations. Calculate the cross-price elasticity using the example values of 89% and 35%:
Cross price elasticity (XED) is calculated as follows: (% change in product A demand) / (% change in product B price) = (89%) / (35%) = 2 54. This indicates that the products A and B can be substituted for one another because it is a positive value greater than zero.
4. Interpret your results to determine the type of cross-price elasticity
Once you have your results, you can learn more about how customers who bought both products behaved. For instance, the example result suggests that as the price of product B rises, demand for product A also rises.
This could indicate that consumers are now more likely to choose Product A over Product B due to the lower price of Product A. Given that consumers are choosing the less expensive product A over the more expensive product B, this information also suggests that both products A and B are meeting similar market needs.
FAQ
How do you calculate cross price elasticity?
This measurement, which is also known as cross-price elasticity of demand, is calculated by dividing the percentage change in the quantity demanded of one good by the percentage change in its price.
How is cross elasticity of demand calculated with example?
Calculated by dividing the resulting change in quantity demanded for one good by the change in price of another, the cross-price elasticity formula is the percentage change in quantity demanded for one good divided by the percentage change in price of another.
What is meant by cross price elasticity?
The percentage change in the amount of a given product that is demanded as a result of the percentage change in the price of another “related” product is known as cross price elasticity of demand.
