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Cross Elasticity of Demand (Magnitude of XED (Larger value (Closer…
Cross Elasticity of Demand
Responsiveness of demand for one good to changes in the price of another good
Shift in demand curve of good A in response to a price change of good B
% change in qty of A/
% change in price of B
Magnitude of XED
Larger value
Closer Corelation
Zero
Two goods are independent
Magnitude > 1
Change in price of A bring about more than proportionate change in demand for B
Magnitude < 1
Change in price of A bring about less than proportionate change in demand for B
Determinants of Substitutability
Significant Differences
XED lower (not always < 1)
Time Factor
Variable, depending on circumstances
Other competitor actions
More time needed to respond to change
Substitutes
Positive XED
Fall in price of one good, demand for substitute decreases
Unrelated Goods
XED = 0
A is independent of B
Complements
Negative XED
If the price of one good rises, the demand for the complement will fall
Degree of complementarity illustrated by magnitude of shifts in the respective demand curves for A when there is price change in good B
Determinants of Complementability
Depends on usage
Time factor
Same as for substitutability
For Business People
Needs to know the extent by which consumers would react to changes in prices of other goods
Respond appropriately to pricing policies of other firms and maintain/raise total revenue
XED is positive and high
Close Substitutes Present
If competitor increases price of item that consumers substitute in favour of Good A
Increase stock in preparation for an increase in demand for Good A
Solutions to reduce magnitude of cross elasticity btw good and rival. If successful, need not fear drastic drop in total revenue when competitors reduce price
Create product differentiation btw product and that of rival
Brand loyalty through aggressive advertising/introducing additional features in product
Provide more efficient services
XED is negative and high
Response to a fall in price of a complement
Prepare to meet rise/fall of stock by ensuring adequate stock
If price of complementary good rise due to cost increases
Reduce production
Consider supplying to new markets