1.2.3 Cross Elasticity of Demand

Question 1

define cross elasticity of demand

Answer 1

measures the responsiveness of quantity demanded of one good to a change in price of another related good

Question 2

what is the formula for XED

Answer 2

%change in quantity demanded of good A/ %change in price of good B

Question 3

what is the relationship between price and demand for substitute goods

Answer 3

as price of one good increases, demand for its substitute increases

Question 4

what is XED for substitute goods

Answer 4

positive

Question 5

give examples of goods in competitive demand

Answer 5

fizzy drinks, smartphones

Question 6

what does a high positive figure for XED indicate

Answer 6

the goods are strong substitutes for one another

Question 7

why is XED useful to know for substitutes

Answer 7

a firm can predict a significant fall in demand is XED is elastic and they decide to increase price (as consumers switch to the close substitute)

Question 8

will the graph for substitutes go up or down

Answer 8

up

Question 9

will the graph for strong substitutes look elastic or inelastic

Answer 9

elastic

Question 10

what is the relationship between price and demand for complementary goods

Answer 10

as price for one good falls, demand for its complement will increase as consumers can buy more of good A and therefore demand more of good B

Question 11

what is XED for complementary goods

Answer 11

negative

Question 12

what does a high negative figure for XED indicate

Answer 12

the goods are strong complements for each other

Question 13

why is XED useful to know for complements

Answer 13

(if firms sell both)
firms know that complementary goods can command high prices

Question 14

will the graph for complements go up or down

Answer 14

down

Question 15

will the graph for strong complements look elastic or inelastic

Answer 15

elastic

Question 16

what is the XED for goods that are unrelated or independent

Answer 16

0

Question 17

how can firms use data on cross elasticity of demand to increase revenue and profit (complements)

Answer 17

product bundling - e.g supermarket meal deals (works when XED is negative and you therefore know they are complements)

Question 18

how can firms use data on cross elasticity of demand to increase revenue and profit (substitutes)

Answer 18

interdependent pricing - might want data on XED to determine the extent to which raising their prices will cause a substitution effect and lost sales and revenue. if XED is low, firms are more likely to raise price and see TR and profit increase

Question 19

what are the limitations of XED data

Answer 19

• data may be unreliable (small sample, unrepresentative)
• data may change over time (e.g substitute may improve making it a stronger substitute, increasing XED)
• firms may find it difficult to adjust supply if close to or at full capacity