Cross Elasticity of Demand Meaning
Cross elasticity of demand is an important concept of economics as it measures the change in demand for a good in relation to change in price of either substitute goods or complementary good where substitute goods refer to those goods which are direct competitor of each other that is one can use either of the two goods depending on the price of the good as higher price of one product will imply higher demand for other product, while complementary goods are those goods which are used together and that is the reason why the higher price of one product will lead to a fall in demand for other complementary product. In order to have a better understanding of this concept one should look at formula as well as an example of cross elasticity of demand for both substitutes as well as complements –
Formula for Calculating Cross Elasticity of Demand
Cross elasticity of demand = percent change in quantity demand/ percent change in the price of substitutes or complements
Cross Elasticity of Demand for Substitutes Example
Suppose a shop sells both tea and coffee and the price of tea is $1 and shop owner sells 1000 tea per day, while the same shop owner sell coffee and the owner increases the price of coffee from $1 to $2 and due to it the demand for tea increases from 1000 tea per day to 1500 tea per day assuming all other things remaining constant. Here the average quantity of tea demanded is 1000+1500/2 = 1250 tea so percentage change in the quantity of tea demanded 1500-1000/1500 = 33.33 percent. The average price of coffee is $1+$2/2 = $1.5 and percentage change in the price of coffee is $2-$1/$1.5 = 66.66 percent so the cross elasticity of demand of tea relative to the price of coffee will be 33.33/66.66 = .50. It should be noted that cross elasticity of demand for substitutes is always positive
Cross Elasticity of Demand for Complements Example
Suppose a mobile shop owner sells Samsung mobiles, as well as Samsung mobile, covers now shop owner sells mobile cover at $5 and suppose the price of Samsung mobile has increased from $400 to $800 due to which the sales of mobile cover reduced from 600 mobile covers to 400 mobile covers. Here the average quantity of mobile cover demanded is 600+400/2 = 500 mobile covers so percentage change in quantity demanded is 400-600/500 =- 40 percent, while average price of Samsung mobile is $400+$800/2 = $600 percentage change in price of Samsung mobile, is $800-$400/$600 = 66.67 percent so the cross elasticity of demand for mobile covers relative to the price of Samsung mobile is -40 percent/66.67 percent = – .60. It should be noted that cross elasticity of demand for the complements is always negative.