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Cross Price Elasticity of Demand (Subsitutes (Implications (A single firm,…
Cross Price Elasticity of Demand
Measures the responsiveness of demand for good x following a change in the price of good y involving demand curve shifts.
Calculations
**XED = % change in Qd of good x /
% change in P of good y
e.g. The P of pizza :arrow_up: by 10% and the Qd of coke :arrow_down: by 5%.
XED = -5% / 10% = -0.5%
This means the goods are complimentary
Key
It can be either '-' or '+'. Positive indicates a substitute good whereas, a negative sign indicates a complementary good
The absolute value of the XED depends on how close the goods are to one another (e.g. pepsi and cola)
Subsitutes
POSITIVE XED VALUE
Qx and Py change in the same direction.
e.g. Cola and Pepsi are substitutes
If the P for cola :arrow_up:, the D for Pepsi would :arrow_up: and the D for Cola :arrow_down:. This results in a rightward shift of the D curve for Pepsi and a leftward shift in the D curve for Cola.
The larger the value of XED, the greater the substitutability between both goods and the larger the shift of the demand curve.
e.g. goods with an XED value of +0.7 have a higher substitutability than that of +0.3.
Implications
A single firm
e.g. PepsiCo produces both 7up and Pepsi. If XED is high, sales would be disturbed from both products.
If XED is low, sales would only be disturbed from one of the two products and the other would slightly be.
Rival firms
Adidas v Nike. Knowledge of XED for their products, allows the rival firm to predict their sales patterns in relation to changes in P.
Mergers between firms
Two rivals producing substitutes with high XED's may want to merge to eliminate competition.
Complements
NEGATIVE XED VALUE
Qx and Py change in opposite directions
e.g. coffee and sugar. If P:arrow_up: for Coffee = D :arrow_down: for Coffee = P :arrow_up: for sugar = D :arrow_down: for sugar.
The greater the absolute value for the negative XED, the greater the complementarity of both goods.
Implications
Knowledge for other businesses can be useful as if a complements P were to change, D for the complements may significantly change. Thus, info can lead to collaboration between firms where both may gain from a lower P.
Info on XED may also predict effects of indirect tax on products. e.g. if the P for gasoline :Arrow_up:, the D for large cars would :arrow_down:
If XED = 0 the goods are unrelated e.g. hotdogs and shoes. If hotdogs changed price, there would be 0 impact on shoes.