What is Cross Price Elasticity of Demand?

//What is Cross Price Elasticity of Demand?
What is Cross Price Elasticity of Demand? 2017-10-02T08:07:47+00:00

Definition: Cross price elasticity of demand, often called cross elasticity, is an economic measurement that show how the quantity demanded for one good responds when the price of another good changes. In other words, it answers the question, do more people demand product A when the price of product B increases?

What Does Cross-Price Elasticity of Demand Mean?

What is the definition of cross price elasticity? This is a common equation in economics and in business. Economists want to gauge consumer behavior based on pricing trend of different commodities. Businesses want to know what consumers will demand based on the price of their goods and their competitors’ goods.

The cross elasticity of demand formula is calculated by dividing the product A’s percentage change in the quantity demanded by product B’s percentage change in price. These two goods can have two different types of relationships: complementary and substitutions.

Let’s look at an example of each type of relationship.

Example

A complementary good is one that is bought along side of another. For instance, peanut butter and jelly are compliments. If the price of peanut butter goes up, the demand for jelly will probably go down due to less people wanting to make PB&J sandwiches, all things equal.

Conversely, a substitute good is one that can be exchanged for another. For example, deli meat might be substitute for peanut butter. If the price of peanut butter rises too much, consumers might choose to purchase deli meat instead.

You can see how the price of one good influences the demand of another good. The degree to which the price changes influence the demand is considered the elasticity. A perfectly elastic demand will have a directly relationship between price and demand. Thus, the more elastic the demand, the more likely the price will influence consumer behavior.

Here are three basic rules of elasticity:

  1. Greater than 0; the two goods are substitutes
  2. Equal to 0; the two goods are independent of each other
  3. Less than 0; then the two goods are complements

If coefficient is 0, it indicates that the two goods are not related.

Summary Definition

Define Cross Price Elasticity of Demand: Cross Elasticity means the degree to which demand of a product changes relative to the demand or price of another product.