key term - Cross-Price Elasticity of Demand

Definition

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 affected by the price changes of a related product.

5 Must Know Facts For Your Next Test

1. Cross-price elasticity of demand is used to determine the relationship between two goods, whether they are substitutes or complements.
2. The cross-price elasticity of demand is calculated as the percent change in quantity demanded of one good divided by the percent change in price of another good.
3. If the cross-price elasticity is positive, the two goods are considered substitutes, meaning an increase in the price of one good leads to an increase in demand for the other.
4. If the cross-price elasticity is negative, the two goods are considered complements, meaning an increase in the price of one good leads to a decrease in demand for the other.
5. The magnitude of the cross-price elasticity coefficient indicates the strength of the relationship between the two goods, with a higher absolute value indicating a stronger relationship.

Review Questions

• Explain how the concept of cross-price elasticity of demand relates to the topic of 'Elasticity in Areas Other Than Price'.
  • Cross-price elasticity of demand is a specific type of elasticity that examines how the demand for one good is affected by changes in the price of another good, rather than changes in its own price. This concept is an important extension of the general idea of price elasticity, as it allows economists to understand the relationships between different products in a market and how changes in one market can spill over into another.
• Describe how changes in income and prices can affect consumption choices through the lens of cross-price elasticity of demand.
  • Cross-price elasticity of demand is a key factor in understanding how changes in income and prices can influence consumer behavior and consumption choices. If two goods are substitutes, an increase in the price of one will lead to an increase in demand for the other as consumers switch their purchases. Conversely, if the goods are complements, an increase in the price of one will lead to a decrease in demand for the other as they are typically consumed together. Understanding these cross-price relationships is crucial for businesses and policymakers to anticipate how changes in the economic environment will impact consumer decision-making.
• Evaluate how the concept of cross-price elasticity of demand can be used to make inferences about the market structure and competition between firms.
  • The cross-price elasticity of demand between products can provide valuable insights into the nature of competition and market structure. For example, if two goods have a high positive cross-price elasticity, indicating they are close substitutes, it suggests the market is highly competitive as consumers can easily switch between the products. Conversely, if the cross-price elasticity is low or negative, implying the goods are complements or unrelated, it may indicate a more monopolistic or oligopolistic market structure where firms have greater pricing power. By analyzing cross-price elasticities, economists and businesses can make inferences about the competitive dynamics and market forces shaping consumer demand and firm behavior.

Related terms

Substitute Goods:

Products that can be used in place of one another, such as Coke and Pepsi, where an increase in the price of one leads to an increase in demand for the other.

Complementary Goods:

Products that are used together, such as printers and printer ink, where an increase in the price of one leads to a decrease in demand for the other.

Price Elasticity of Demand:

A measure of the sensitivity of the quantity demanded of a good to changes in its own price.