Course: Business Economics

Internal Assignment Examination

Discuss cross elasticity of demand.

Answer:
The elasticity of demand is a degree of change in the quantity demanded of a product in response to
its determinants, such as price of the product, price of substitutes, and income of consumers. There
are three types of elasticity of demand:

Price Elasticity of Demand (PED):

It can be defined as the ratio of percentage change in quantity demanded to the
percentage change in price.

PED = Percentage change in quantity demanded

Percentage change in price

PED Value Type of PED Condition

Infinity Perfectly elastic demand Greater change in demand in response to smaller change in price.

0 Perfectly inelastic No change in demand in response smaller change in the price.

demand
>1 Relatively elastic demand A change in demand is greater than the change in price.
<1 Relatively inelastic A change in demand is less than the change in price.
demand
1 Unitary elastic demand A change in demand is equivalent to change in price.

Cross Elasticity of Demand (CED):-

It can be defined as a measure of proportionate change in the demand for goods as a result of change
in the price of related goods.

CED = Percentage change in quantity demanded of X

Percentage change in price of related good Y

CED Type of CED Condition Example

Value
 >1 Positive Increase in price of related product
results in an increase in the demand for
the main product and vice versa
<1 Negative Increase in the price of related product
results in decrease of the demand of
main product and vice versa
Substitute Goods. The quantity
demanded for tea increases with
an increase in price of coffee
Complementary Goods. The
demand for bread decreases with
the increase in price of butter.

0 Zero  Change in the price of related product  Independent Goods.

does not bring any change in the demand
for the main product

Income Elasticity of Demand (IED)

The Income elasticity of demand is the proportional change in the quantity demanded of good X
divided by the proportional change in the income of consumers.

IED = Percentage change in quantity demanded

Percentage change in Income

IED Type of IED Condition Example

Value
>1 Positive Change in income results in an increase in the demand for Normal Goods.
product and vice versa
<1 Negative Change in income results in an decrease in the demand for Inferior Goods.
product and vice versa

0 Zero  Change in the income does not bring any change in the  Utility Goods.
demand for product

There exists a high cross elasticity of demand between new and old cars since the demand for old
cars is highly elastic. Old cars will sell at relatively low prices compared to new cars as they have
been used for a while and this suggests how their demand is highly elastic. Old cars and new cars are
substitute goods. So when the price of new car increases, the demand for old car also increases.
Hence the value of cross elasticity of demand is positive.