What is Cross-Price Elasticity of Demand
Cross-price elasticity of demand is refer to the responsiveness of demand to the change in prices of related goods (also known as complement goods and substitute goods). The cross-price elasticity of demand determines how many percentage changes in the price of related goods affect the demand of the product.
The cross-price elasticity of demand can be calculated by dividing the percentage change in demand by the percentage change in the prices of related goods, or the following formula:
Cross-price elasticity of demand = Percentage change in demand ÷ Percentage change in the price of a related good
For instance, if percentage change in the price of product fall by 20% cause the demand of a related product decreased by 5%.
Then, the cross price elasticity of demand = 5 ÷ 20 = 0.25
Types of Cross-Price Elasticity of Demand
Normally, the value of cross-price elasticity of demand can define the two types of related products in economics, which include:
- Substitute Goods: When the cross-price elasticity of demand is positive.
- Complement Goods: When the cross-price elasticity of demand is negative.
When the price of Apple iPhones rises, the demand for Android phones is likely to rise, this means the cross-price elasticity between the two is positive. The positive cross-price elasticity of demand indicates that the goods are substitute goods.
Substitute good is a good that can be used instead of one another (like iOS and Android phones). When the price of a good increases, the demand for the substitute good goes up.
In contrast, when the coss-price elasticity of demand is negative, this indicates that the goods are complements goods. Complement goods are goods that used in conjunction with other. When the price of a good decreases, the demand for its complement good goes up. For example, the price of hot dog and demand for ketchup.