Cross Price Elasticity of Demand

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Cross Price Elasticity of Demand

• AS Economics

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Cross Elasticity of Demand (CPed)

• Cross price elasticity (CPed) measures the
  responsiveness of demand for good X following a
  change in the price of good Y (a related good)
• CPeD change in qty D of product A
• change in price of product B
• With cross price elasticity we make an important
  distinction between substitute products and
  complementary goods and services.

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Identify some Substitutes
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Identify some Complements
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Cross Price Elasticity for Substitutes
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Complementary Goods
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Cross Elasticity of Demand (CPed)
Substitutes

• Substitutes
• With substitute goods such as brands of razors,
  an increase in the price of one good will lead to
  an increase in demand for the rival product
• Weak substitutes inelastic CPed
• Close substitutes elastic CPed

Cross price elasticity will be positive

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Cross Elasticity of Demand (CPed) -
Complements

• Complements
• Goods that are in complementary demand
• Weak complements inelastic CPed
• Close complements
• elastic CPed

The cross price elasticity of demand for two
complements is negative
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The Diagrams!
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Substitutes

Two Weak Substitutes
Price of Good S
Goods S and T are weak substitutes A rise in the
price of Good S leads to a small rise in the
demand for good T The cross price elasticity of
demand will be positive but the coefficient of
elasticity will be less than one
Demand
P2
P1
Ice cream and lollies!
Quantity demanded of Good T
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Complements
-
Two Close Complements
Price of Good X
Goods X and Y are close complements A fall in the
price of good X leads to a large rise in the
demand for good Y The cross price elasticity of
demand will be negative and the coefficient of
elasticity will be more than one Complements are
said to be in JOINT DEMAND
Demand
P1
P2
Foreign holidays air flights!
Quantity demanded of Good Y
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Goods with zero cross-price elasticity of demand
aka. INDEPENDENT
Demand
Price of Good A
Goods A and B have no relationship. A fall in the
price of good A leads to no change in the demand
for good B Therefore the cross-price elasticity
of demand is zero
P1
P2
Apples and gloves!
P3
Quantity demanded of Good B
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Get your calculators ready
CPeD change in qty D of product A change
in price of product B
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Calculate the CPeD and state whether the goods
are complements or substitutes?

• A 10 rise in the price of fish may cause demand
  for chicken to increase by 2.
• The fall in the price of paper by 20 causes the
  demand for pens to increase by 5.
• A 20 rise in the price of ice cream causes
  demand for sweets to increase by 4.
• A 12 fall in the price of air fares leads to a
  30 rise in the demand for foreign holidays.
• A 10 rise in bikes will leave the demand for
  cheese unaffected.

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Answers
Positive substitute goods Negative
complementary

• 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

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Look at some figures for interpretation

• Real statistics!

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Positive substitute goods Negative
complementary
Estimated Elasticity for Alcohol
How can beer be a good complement to beer?
In your own words explain the wine CPeD numbers
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Importance of CPed for businesses

• Firms can use CPed estimates to predict
• The impact of a rivals pricing strategies on
  demand for their own products
• Pricing strategies for complementary goods
• Popcorn and cinema tickets are strong
  complements. Popcorn has a very high mark up i.e.
  popcorn costs pennies to make but sells for more
  than a pound
• 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

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Applications of Cross Elasticity (1)

• Effects of the national minimum wage on demand
  for younger and older workers (might younger
  workers be replaced?)
• Higher indirect taxes on goods such as tobacco
  the impact on demand for nicotine patches and
  other substitutes

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Applications of Cross Elasticity (2)

• Effect on demand for different modes of mass
  transport following introduction of road pricing
  schemes in urban areas (e.g. the London
  congestion charge and the M6 Toll Road)
• Rise in the price of natural gas effect on the
  demand for coal used in power generation

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Homework

• Revise for test next lesson to review basic
  definitions, formulas, diagrams, elastic
  inelastic numbers
• PeD
• YeD
• PeS
• CPeD