Cross Elasticity of Demand (XED)

Question 1

Cross elasticity of demand

Answer 1

The responsiveness of demand for one product in relation to a change in the price of another product

Question 2

Positive XED

Answer 2

• substitutes
• if really high number they are really close substitutes

Question 3

Negative XED

Answer 3

• complements
• if really low number they are really close complements

Question 4

The extent of product substitutability

Answer 4

• the price of one good increases the demand for the substitute of the good increases but this may not always be true

1. Brand loyalty
- May still buy from one good even if prices increase
- Better celebrity endorsements

2. Utility/ quality
- Higher quality
- Want to maximize utility

3. Consumer inertia
- May not be bothered to change a look for other substitutes
- Trust the quality of the good they choose more than the other

Question 5

Perfect complements

Answer 5

• when two goods cannot be consumed without the other
• these goods are the strongest compliments because only the consumption of both goods together will provide consumer satisfaction

Question 6

XED is useful

Answer 6

1. Strong positive XED
- XED > 0
- substitutes = should lower prices in order to increase demand and market share
- increase in profits, can invest in R&D
- if invest can eliminate number of close substitutes and reduce substitutability
- can form collusions with other firms selling close substitutes
- agree to fix their price and maximise profits

2. Strong negative XED
- XED < 0
- complements = should lower price of one good in order to increase demand for the other good
- may bundle complements together so the consumers by them both together

3. Weak XED
- shows that goods are weak compliments or substitutes
- useful as can tell firms to prioritize certain complements/ substitutes over time

Question 7

XED is not useful

Answer 7

1. Could be outdated
- technology has improved over time meaning there are more closed substitutes
- consumers are now able to find cheaper alternatives from abroad

2. XED is an estimate
- consumer trends and preferences always change
- may make misinformed decisions

3. only applicable for marginal price changes
- only applicable when price is changed by very small prices such as a pound
- in the real world prices rarely change by large amounts

4. Ceteris Paribus may not hold
- brand loyalty
- quality
- consumer preferences and trends
- consumer inertia
- population increase
- depends on whether you have enough factors of production to meet additional demand