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Cross-elasticity of demand (XED) (XED relevance for firms (A firm with…
Cross-elasticity of demand (XED)
Is a measure of the responsiveness of a demand for one good, compared to a change in price of another good
XED
% change in Qd of one good / % change in price of another good
If it is positive it means its a substitute
If it's 0 it means there is no relationship
If it's - it means its a complement (goes along with another)
Cross elasticity of demand theory
An increase in price on one good could see a fall in demand
It can lead to an increase of demand of a similar good
Close substitute
Small increase in price of one good can lead to an increase in demand for another
If price for coke increases, the demand for pepsi increase
Weak sub
A large increase in price of one good can lead to a small increase in demand for another good
A large increase in sprite can lead to a small increase in demand for 7up
Complements
An example is milk and cereal
Nachos and cheese
A good that goes along with another
Close complements
Small increase in price of milk is when there is a large increase in demand for cereal
Weak complement
Large increase in price of bread will lead to a small increase in demand of butter
Determinants of XED
Complements
Has no relationship
Substitutes
XED relevance for firms
A firm with plenty of subs will be less able to increase its prices
Firms will produce a range of complements
This is done through branding and advertising
This is to accompany their products
Substitutes will differentiate their products from the competition
Firms that sells a range of complements will most likely increase their revenue