Cross Price Elasticity Of Demand (XED)

Question 1

What is a substitute?

Answer 1

Substitutes are products in competitive demand
With substitutes an increase in the price of one good (center is paribus) will lead to an increase in demand for a rival product
The value of XED for two substitutes is always positive

Question 2

What is a complement?

Answer 2

Complements are products in joint demand
A fall in the price of one product causes an increase in demand for the complementary product
The value of XED for two complements is always negative

Question 3

Describe the relationship of cross price elasticity of demand

Answer 3

The stronger the relationship between two products, the higher the co-efficient of cross price elasticity of demand

Question 4

Describe the coefficients of substitutes

Answer 4

Close substitutes have a strong positive cross price elasticity of demand
i.e. A small change in relative price causes a big switch in consumer demand

Question 5

Describe the coefficient of complements

Answer 5

When there is a strong complementary relationship, the cross elasticity will be highly negative
An example might be games consoles and software games

Question 6

Describe the coefficients of unrelated products

Answer 6

Unrelated products have zero cross elasticity e.g. The effect of changes in taxi fares on the market demand of cheese

Question 7

What is cross price elasticity of demand?

Answer 7

Cross price elasticity (XED) measures responsiveness of demand for good X following a change in the price of related good Y