how to calculate cross elasticity of demand
the next step is how to use the formula to make your calculations here s a step by step run through of how to do so understanding cross elasticity of demandthe cross elasticity of demand refers to how sensitive the demand for a product is to changes in the price of another product it measures how demand for one good changes when the price of another typically related good does cross elasticity is one of the main types of demand elasticity 1you can use the formula to make comparisons of products that are considered perfect substitutes for each other or those that are complementary to each other the cross elasticity of demand for substitute goods remains positive prices increase when demand for one good rises demand for complementary goods drops when the price rises for another good this is referred to as negative cross elasticity of demand unrelated products don t affect each other an increase in the price of eggs doesn t directly relate to an increase in demand for olives the cross elasticity of demand for substitute goods is always positive because the demand for one good increases when the price for the substitute good increases 2the quantity demanded for tea a substitute beverage increases as consumers switch to a less expensive yet substitutable alternative if coffee prices increase this is reflected in the cross elasticity of the demand formula because both the numerator percentage change in the demand for tea and denominator the price of coffee show positive increases items with a coefficient of 0 are unrelated items they re independent of each other items may be weak substitutes because the two products have a positive but low cross elasticity of demand this is often the case for product substitutes such as tea versus coffee items that are strong substitutes have a higher cross elasticity of demand such as different brands of tea a price increase in one company s green tea has a higher impact on another company s green tea demand toothpaste is an example of a substitute good the demand for a competitor s brand of toothpaste increases in turn if the price of one brand of toothpaste increases the cross elasticity of demand for complementary goods is negative an item closely associated with that item and necessary for its consumption decreases as the price for one item increases because the demand for the main good has also dropped 3the quantity demanded for coffee stir sticks drops as consumers drink less coffee and purchase fewer sticks because the price of coffee has increased the numerator quantity demanded of stir sticks is negative and the denominator the price of coffee is positive this results in a negative cross elasticity the usefulness of cross elasticity of demandcompanies use the cross elasticity of demand to establish prices to sell their goods products with no substitutes can be sold at higher prices because there s no cross elasticity of demand to consider but incremental price changes to goods with substitutes are analyzed to determine the appropriate level of demand desired and the associated price of the good complementary goods are also strategically priced based on the cross elasticity of demand printers may be sold at a loss with the understanding that the demand for future complementary goods such as printer ink should increase examples of cross elasticity of demandlet s take a look at two substitute goods chicken burritos from two restaurants suppose both restaurants sell their burritos for 6 each but restaurant a decides it wants to make more in profits so it raises the price to 8 most people don t want to spend the extra money and the two goods are equal substitutes so there s a very good chance that demand for restaurant b s chicken burritos will increase now let s take a look at complementary goods and how they re affected by the cross price elasticity of demand consider burgers and fries they aren t necessarily related but they tend to go hand in hand people who eat burgers also tend to eat fries demand for fries may increase if the price drops for burgers 