Cross Price Elasticity of Demand

AS Economics

Aims and Objectives

Aim: Level Understand cross price elasticity of demand Objectives: Define cross price elasticity of demand Calculate cross price elasticity of demand

E-D C-B

B-A*

Analyse differences in cross price elasticity of demand

Starter
If the price of Dairy Milk rises from 0.50 to 1.00 what would you do? Continue to buy Dairy Milk or buy another chocolate bar costing 0.50? If the price of strawberries fell by 100% what would happen to your demand for cream/sugar?

Cross Elasticity of Demand

Cross price elasticity (Cped) measures the responsiveness of demand for good x following a change in price of good y (a related good).

Cross Elasticity of Demand

CPed = % change in demand for good A --------------------------------% change in price of good B

Cross Elasticity of Demand

With Cped we make an important distinction between substitute products and complementary goods and services.

Identify Some Substitutes

Identify Some Complements

Cped - Substitutes
With substitute goods such as cars, an increase in the price of one will lead to an increase in demand for the rival product. Cped will be positive. Weak substitutes will have a low Cped. Close substitutes will have a high Cped.

Cped Substitutes
Price of Good X

P2 P1

A rise in the price of Good X leads to a small rise in the price for good Y. Cped will be positive but the coefficient of elasticity will be less than one.

Q1 Q2

Qty Demanded of Good Y

Cped - Complements
Goods that are in complementary demand.

Cped is negative.
Weak complements there is a low Cped Close complements there is a high Cped

Cped Complements
Price of Good X A fall in the price of good X leads to a large rise in demand for good Y. CPed will be negative and the coefficient will be more than one. D Complements are in JOINT DEMAND

P1 P2

Q1

Q2

Qty Demanded of Good Y

Goods With Zero CPed

Price of Good X

Goods A and B have no relationship.

P1

P2
P3

A fall in the price of good x leads to no change in the demand for good y. Cped = 0

Q1

Q2

Qty Demanded of Good Y

Product Coca Cola

Close Substitute

Weak Substitute

Good With No Relationship

Cheddar Cheese

Euro Star journey from London to Paris Filter Coffee

Ticket to a film at Cineworld

Product Laptop

Close Complement

Weak Complement

Good with no Relationship

An expensive bottle of wine Short weekend break in Barcelona Beef Joint

Importance of CPed for Firms

Firms can use CPed to predict: The impact of a rivals pricing strategy on demand for their own products. Pricing strategies for complementary goods:
Popcorn and cinema tickets are strong complements. Popcorn has a very high mark up, often costing more than the cinema ticket!

Importance of CPed for Governments

Governments can use CPed to predict: Effects of the national minimum wage on demand for younger and older workers (might younger workers be replaced?)

Higher indirect taxes on goods such as tobacco the impact on demand for nicotine patches and other substitutes.

Importance of CPed for Governments

Governments can use CPed to predict: Effects on demand for different modes of transport in London following the congestion charge or M6 toll road.

Rise in the price of natural gas- effect on the demand for coal used in power generation.

CPed Plenary
Define CPed Give the formula to work out CPed If there is a positive CPed are the products substitutes or complements? Why is it important for firms to know CPed?