In today’s world, whenever we are running a business or even studying some of the concepts of economics or finance, we come across this term which is Cross Price Elasticity or Cross price elasticity of demand.
It is a general concept that is to make us understand the fluctuations of the market concerning the demand for the substance. In many fields, this term is used. Moreover, it is also important for the students who are studying economics as it is also considered as the base of fundamentals. Today, in this article, we are going to see what is the cross-price elasticity of demand and how it works.
What is Cross Price Elasticity of Demand?
The answer is simple. Cross Elasticity of Demand is an economical concept that helps us for the measurement of fluctuations in the demand for quantity when the price of other quantities increases or decreases. In other terms, it is also called Cross Price Elasticity of Demand.
The calculation formula is also simple. It does nothing but divides the Percentage change of the quantity of one good with the percentage change of the price of other goods. Here, we take the quantity of one good and the price of the other good for the calculation, and hence, the term “Cross” price elasticity of Demand arises.
Let us look below the actual formula so that it makes your conceptual base clear.
Cross Price Elasticity of Demand:
The formula for calculating Cross Elasticity of Demand is as follows:
Let us assume two goods as X and Y.
X is the good that we measure the quantity of
Y is the good that we measure the price of
Exy=Percentage change in Quantity of X Percentage Change in Price of Y
Here, Qx means the quantity of substance X
Similarly, Py, is nothing but the price of substance Y
means the change in a particular amount
Cross Elasticity of Demand in Substitute Goods
If we talk in general, the cross elasticity of demand may vary from substance to substance. But for the substitute substances, it is observed that the cross elasticity of demand is always positive. This is evident because the demand for a particular good increase when the price for the substitute product increases. If we want to take an example, let us take an example of coffee along with tea.
If the price of coffee increases with time, then the quantity of tea demanded will also increase. The people who are consuming them would prefer a similar type of alternative having less price. Here, Tea is the substitute drink for coffee. Hence, with the increase in the price of coffee, the increase in demand for a quantity of tea is evident. If we observe the formula, we can find that the numerator which shows us the total percentage change for the demand gives positive results, as well as the price of coffee in the denominator, gives positive results, and hence, the overall result becomes positive.
It is also vital to note that the substances that are a strong substitute for each other show a high amount of cross elasticity of demand. While the substances like coffee and tea which are weak substitutes show a low amount of cross elasticity of demand. No doubt, the cross elasticity of demand is positive, but the amount varies from high to low. If we take an example if the price of coffee of one company increases. Its impact can see in the demand for other company’s coffee.
Cross Elasticity of Demand for Complementary Goods
Interestingly, if we talk about the cross elasticity of demand for complementary goods, we can observe that it is negative. Price increase in one item results in a decrease in price for its complementary product. Which is nearly related to the item and is necessary for intake. This is because the demand for the main item has fallen, and hence it impacts the complementary products also.
For example, if we take the example of coffee. If the price of coffee increases, then the people might drink less coffee. Which results in less quantity demanded of the coffee sticks, and will purchase fewer sticks for the same. If we look at the formula and observe, we can find that the quantity demanded sticks used for stirring (numerator) is negative and the price of the coffee (denominator) is positive which gives the overall outcome of the formula, Cross elasticity of demand is negative.
If we want to take a numeric example, we can say that if the price of a good is increased by 20 percent while the demand for its complementary product is decreased by 10 percentage, then the total cross elasticity of demand will be -20%/10%= -2
Application and Usefulness of Cross Price Elasticity of Demand
Various companies across the globe use this cross elasticity of demand. They use this term to fix the prices at which they can sell the product. For unique products that do not have a proper competitive substitute in the market. There is no cross elasticity of demand and hence, the same products can sell at greater prices. Sometimes price keeping futuristic moves in mind such a printer can sell at a lesser price than its production cost. In the future, the demand for the ink of the printer will increase.
This was all about cross-price elasticity of demand. Cross price elasticity of demand is an important concept in the market and is widely applied over a range of products. Using it, many people apply the appropriate price for their goods and sell them. We hope that this article served its purpose and gave you enough insights on the cross-price elasticity and will help you in understanding the concept whenever you want to give it a brief look!
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