Cross-price elasticity of demand measures the responsiveness of the demand for one good to a change in the price of another good. It quantifies the degree to which the demand for a product is influenced by the price changes of related products.
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Cross-price elasticity of demand is calculated as the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good.
Positive cross-price elasticity indicates that the goods are substitutes, while negative cross-price elasticity indicates that the goods are complements.
The magnitude of cross-price elasticity determines the strength of the relationship between the two goods, with a higher absolute value indicating a stronger relationship.
Cross-price elasticity is an important concept in understanding consumer behavior and the interactions between related products in a market.
Analyzing cross-price elasticity can help businesses make informed pricing and product decisions, as well as help policymakers understand the potential impacts of changes in prices on consumer demand.
Review Questions
Explain how cross-price elasticity of demand differs from price elasticity of demand, and provide an example of each.
Price elasticity of demand measures the responsiveness of the quantity demanded of a good to a change in its own price, while cross-price elasticity of demand measures the responsiveness of the quantity demanded of one good to a change in the price of another good. For example, the price elasticity of demand for gasoline would measure how the quantity of gasoline demanded changes when the price of gasoline changes, while the cross-price elasticity of demand for gasoline and public transportation would measure how the quantity of gasoline demanded changes when the price of public transportation changes.
Describe the relationship between cross-price elasticity of demand and the concepts of substitutes and complements.
Cross-price elasticity of demand is directly related to the concepts of substitutes and complements. If two goods are substitutes, such as coffee and tea, an increase in the price of one will lead to an increase in the demand for the other, resulting in a positive cross-price elasticity of demand. Conversely, if two goods are complements, such as computers and computer software, an increase in the price of one will lead to a decrease in the demand for the other, resulting in a negative cross-price elasticity of demand. The magnitude of the cross-price elasticity reflects the strength of the relationship between the two goods.
Analyze how changes in cross-price elasticity of demand can affect consumer behavior and market equilibrium in the context of 5.4 Elasticity in Areas Other Than Price and 6.2 How Changes in Income and Prices Affect Consumption Choices.
Changes in cross-price elasticity of demand can significantly impact consumer behavior and market equilibrium. In the context of 5.4 Elasticity in Areas Other Than Price, a higher cross-price elasticity of demand between two goods indicates that consumers are more responsive to changes in the relative prices of those goods, leading to greater substitution between them. This can affect the overall demand for each product and shift the market equilibrium. Similarly, in the context of 6.2 How Changes in Income and Prices Affect Consumption Choices, changes in cross-price elasticity can influence how consumers allocate their budgets among related goods as their incomes and the relative prices of those goods change. Understanding cross-price elasticity is crucial for businesses to make informed pricing decisions and for policymakers to anticipate the potential impacts of economic changes on consumer demand.