1. Cross Price Elasticity of Demand (XED)
Cross Elasticity of Demand (CPeD)
Cross Price Elasticity of Demand (XED)
IB Economics

2. XED Learning Outcomes:
Outline the concept of cross-price elasticity of demand
Calculate XED
Substitute vs. Complementary goods
Value of XED
Examine the implications of XED for businesses if prices of substitutes or complements change.

3. Cross-Price Elasticity of demand (XED)
XED is a measure of the responsiveness of consumers of one good to a change in the price of a related good.
Measure of how much the demand for a product changes when there is a change in the price of another product.

4. Cross-Price Elasticity of demand (XED)
% D Qty Demanded of good X
FORMULA =
% D Price of good Y
Percent change in quantity demanded / Percent change in price

5. Cross Price Elasticity of Demand (XED)
Cross Elasticity of Demand (CPeD)
Cross Price Elasticity of Demand (XED)
With cross price elasticity we make an important distinction between substitute products and complementary goods and services.

6. What is a substitute good (demand)?
Cross Elasticity of Demand (CPeD)
What is a substitute good (demand)?
Is one for which demand will increase when the price of another good increases.
Demand for a substitute good will decrease when the price of its substitute decreases.
How responsive are the consumers of one to a change in the price of the other?
Example: Beef vs. Chicken

7. Market demand for chicken
Point
Price
(per kg) 20
Market demand
(tonnes 000s)
700 A
Price (per kg) A D
Quantity (tonnes: 000s)

8. Market demand for chicken
Point
Price
(per kg) 20 40
Market demand
(tonnes 000s)
700
500 A B
Price (per kg) B A D
Quantity (tonnes: 000s)

9. Increase in the price of chicken, increases the demand for beefQ0 Q1
Quantity

10. Identify some Substitutes
Cross Elasticity of Demand (CPeD)
Identify some Substitutes

11. What is complementary goods?
Cross Elasticity of Demand (CPeD)
What is complementary goods?
Goods that are typically consumed together
Demand for one is decreased by the price increase of the other
How responsive are the consumers of one to a change in the price of the other?
Example: Cameras vs. Memory Cards

12. Increase in price of camerasD
Price P2 P1 O Q2 Q1
Quantity

13. Demand for Memory CardsP
Price O Q0 Q1
Quantity

14. Identify some Complements
Cross Elasticity of Demand (CPeD)
Identify some Complements

15. Example of XED XED = -5% / -10% = +0.5
The owners of a pizza stand find that when their competitor, a hamburger stand, lowers the price of a burger from $2 to $1.80, the number of pizza slices that they sell each week falls from 400 to 380, because of the lower priced burger. Calculate XED.
XED = -5% / -10% = +0.5

16. Range of Values of XED
XED may be positive or negative. Sign is important since it tells us what the relationship between the two goods in question is.

17. Range of Values of XED
If the value of XED is positive, then the two goods in question may be said to be substitutes for each other.
If the value of XED is negative, then the two goods in question may be said to be complements for each other.
If the value of XED is zero, the two goods are unrelated.

18. XED values and the strength of the relationship between products
Negative
Zero
Positive
Weak/Remote Complements
Weak/Remote Substitutes
Close Complements
Unrelated Products
Close Substitutes
Relationship

19. Cross Price Elasticity for Substitutes
Cross Elasticity of Demand (CPeD)
Cross Price Elasticity for Substitutes
Product
Close Substitute
Weak Substitute
Good with no relationship
Coca Cola
Cheddar Cheese
KTX from Daejon to Seoul
Starbucks Coffee
Apple Computer

20. Cross Price Elasticity for Substitutes
Cross Elasticity of Demand (CPeD)
Cross Price Elasticity for Substitutes
Product
Close Substitute
Weak Substitute
Good with no relationship
Coca Cola
Pepsi
Orange Juice
Computer
Cheddar Cheese
KTX from Daejon to Seoul
Starbucks Coffee
Apple Computer

21. Cross Price Elasticity for Substitutes
Cross Elasticity of Demand (CPeD)
Cross Price Elasticity for Substitutes
Product
Close Substitute
Weak Substitute
Good with no relationship
Coca Cola
Pepsi
Orange Juice
Computer
Cheddar Cheese
Jack Cheese
Blue Cheese
Apples
KTX from Daejon to Seoul
Starbucks Coffee
Apple Computer

22. Cross Price Elasticity for Substitutes
Cross Elasticity of Demand (CPeD)
Cross Price Elasticity for Substitutes
Product
Close Substitute
Weak Substitute
Good with no relationship
Coca Cola
Pepsi
Orange Juice
Computer
Cheddar Cheese
Jack Cheese
Blue Cheese
Apples
KTX from Daejon to Seoul
“Slow” train
Bus ride
Soccer Ball
Starbucks Coffee
Apple Computer

23. Cross Price Elasticity for Substitutes
Cross Elasticity of Demand (CPeD)
Cross Price Elasticity for Substitutes
Product
Close Substitute
Weak Substitute
Good with no relationship
Coca Cola
Pepsi
Orange Juice
Computer
Cheddar Cheese
Jack Cheese
Blue Cheese
Apples
KTX from Daejon to Seoul
“Slow” train
Bus ride
Soccer Ball
Starbucks Coffee
Dunkin Donut Coffee
Nescafe instant coffee
Pencil Sharpener
Apple Computer

24. Cross Price Elasticity for Substitutes
Cross Elasticity of Demand (CPeD)
Cross Price Elasticity for Substitutes
Product
Close Substitute
Weak Substitute
Good with no relationship
Coca Cola
Pepsi
Orange Juice
Computer
Cheddar Cheese
Jack Cheese
Blue Cheese
Apples
KTX from Daejon to Seoul
“Slow” train
Bus ride
Soccer Ball
Starbucks Coffee
Dunkin Donut Coffee
Nescafe instant coffee
Pencil Sharpener
Apple Computer
Dell Computer
No name brand
Movie tickets

25. Cross Elasticity of Demand (CPeD)
Complementary Goods
Product
Close Complement
Weak Complement
Good with no relationship
Personal Computer
DVD Player
Short Break Weekend in Barcelona

26. Cross Elasticity of Demand (CPeD)
Complementary Goods
Product
Close Complement
Weak Complement
Good with no relationship
Personal Computer
Mouse
Stylus
Eraser
DVD Player
Short Break Weekend in Barcelona

27. Cross Elasticity of Demand (CPeD)
Complementary Goods
Product
Close Complement
Weak Complement
Good with no relationship
Personal Computer
Mouse
Stylus
Eraser
DVD Player
DVDs (Video Discs)
Remote Control
Tables & Chairs
Short Break Weekend in Barcelona

28. Cross Elasticity of Demand (CPeD)
Complementary Goods
Product
Close Complement
Weak Complement
Good with no relationship
Personal Computer
Mouse
Stylus
Eraser
DVD Player
DVDs (Video Discs)
Remote Control
Tables & Chairs
Short Break Weekend in Barcelona
Tour Package (incl. running with the bulls)
Champagne breakfast
Toothpick

29. Cross-Price Elasticity of Demand (XED) + = Substitutes
Cross Elasticity of Demand (CPeD)
Cross-Price Elasticity of Demand (XED) + = 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 XED
Close substitutes – elastic XED
Cross price elasticity will be positive +

30. Cross-Price Elasticity of Demand (XED) - = Complements
Cross Elasticity of Demand (CPeD)
Cross-Price Elasticity of Demand (XED) - = Complements
Complements:
Goods that are in complementary demand
Weak complements – inelastic XED
Close complements –
elastic XED
The cross price elasticity of demand for two complements is negative

31. Cross Elasticity Exercise

32. Calculate the XED 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.

33. Positive = substitute goods Negative = complementary
Answers…
Positive = substitute goods
Negative = complementary
A 10% rise in the price of fish may cause demand for chicken to increase by 2% % / +10% = +0.2
The fall in the price of paper by 20% causes the demand for pens to increase by 5% % / -20% = -0.25
A 20% rise in the price of ice cream causes demand for sweets to increase by 4% % / +20% = +0.2
A 12% fall in the price of air fares leads to a 30% rise in the demand for foreign holidays % / -12% = -2.5
A 10% rise in bikes will leave the demand for cheese unaffected. 0% / +10% = 0

34. XED values and the strength of the relationship between products
Negative
Zero
Positive
Weak/Remote Complements
Weak/Remote Substitutes
Close Complements
Unrelated Products
Close Substitutes
Relationship

35. Importance of XED for businesses
Cross Elasticity of Demand (CPeD)
Importance of XED for businesses
Firms can use XED estimates to predict:
The impact of a rival’s 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 $1.00
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

36. Applications of Cross Elasticity
Cross Elasticity of Demand (CPeD)
Applications of Cross Elasticity
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

37. Applications of Cross Elasticity
Cross Elasticity of Demand (CPeD)
Applications of Cross Elasticity
Effect on demand for different modes of mass transport following introduction of road pricing schemes in urban areas
Rise in the price of natural gas – effect on the demand for coal used in power generation

38. Cross Elasticity Exercise
Additional Exercises

39. Exercise
“Light-Bites”, a sandwich shop, finds that when its rival, “Super-Snack”, reduces the price of its chicken wraps from $5 to $4.60, the demand for “Light-Bites” sandwiches falls from 400 sandwiches a week to 340 sandwiches a week. In addition, “Super-Snack” finds that following the fall in price of their chicken wraps, the demand for soft drinks rises from 600 cans to 630 cans per week.
Calculate the cross elasticity of demand between “Light-Bite” sandwiches and “Super-Snack chicken wraps.
Explain the relationship above in terms of
cross elasticity of demand.

40. Exercise
“Light-Bites”, a sandwich shop, finds that when its rival, “Super-Snack”, reduces the price of its chicken wraps from $5 to $4.60, the demand for “Light-Bites” sandwiches falls from 400 sandwiches a week to 340 sandwiches a week. In addition, “Super-Snack” finds that following the fall in price of their chicken wraps, the demand for soft drinks rises from 600 cans to 630 cans per week.
Calculate the cross elasticity of demand between “Super-Snack” sandwiches and the “Super-Snack” soft drinks.
Explain the relationship above in terms of
cross elasticity of demand.