Cross Price Elasticity

of Demand
AS Economics

Cross Elasticity of Demand (CPed)

Cross

price elasticity (CPed) measures the

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

CPeD

With

= % change in qty D of product A

% change in price of product B

cross price elasticity we make an important

distinction between substitute products and
complementary goods and services.

Identify some Substitutes

Identify some Complements

Cross Price Elasticity for Substitutes

Product

Coca Cola
Camembert Cheese
Euro Star Journey
from London to Paris
Dowe Egberts Filter
Coffee
Ticket to a film at the
UGC Cinema in
Slough

Close
Substitute

Weak
Substitute

Good with no
relationship

Complementary Goods
Product
Personal Computer

A bottle of expensive
white wine
Short Break Weekend
in Barcelona

Close
Complement

Weak
Complement

Good with no
relationship

Cross Elasticity of Demand (CPed)

+ = Substitutes
Substitutes:

With substitute goods

such as brands of
razors, an increase in
the price of one good
will lead to an
increase in demand
for the rival product

Weak substitutes
inelastic CPed
Close substitutes
elastic CPed

Cross price elasticity

will be positive

Cross Elasticity of Demand (CPed)

- = Complements
Complements:
Goods

that are in
complementary demand
Weak complements
inelastic CPed
Close complements
elastic CPed

The cross price

elasticity of demand
for two
complements is
negative

The Diagrams!

Substitutes
Price of
Good S

Two Weak Substitutes

Demand

Goods S and T are weak

substitutes
A rise in the price of Good S
leads to a small rise in the
demand for good T

P2

The cross price elasticity of

demand will be positive but
the coefficient of elasticity will
be less than one

P1

Quantity demanded of
Good T

Ice cream and

lollies!

Complements
Price of
Good X
Goods X and Y are close
complements
A fall in the price of good X
leads to a large rise in the
demand for good Y
The cross price elasticity of
demand will be negative and
the coefficient of elasticity will
be more than one

Two Close Complements

Demand

P1
P2

Complements are said to be

in JOINT DEMAND

Foreign holidays
& air flights!

Quantity demanded of
Good Y

Goods with zero cross-price elasticity of

demand aka. INDEPENDENT
Price of
Good A

Demand
Goods A and B have no
relationship.

P1

A fall in the price of good A

leads to no change in the
demand for good B

P2

Therefore the cross-price

elasticity of demand is zero

Apples and
gloves!

P3

Quantity demanded of
Good B

Get your calculators ready

CPeD = % change in qty D of product A
% change in price of product B

Calculate the CPeD and state whether

the goods are complements or
substitutes?
1.
2.
3.
4.
5.

A 10% rise in the price of fish may cause

demand for chicken to increase by 2%.
The fall in the price of paper by 20% causes
the demand for pens to increase by 5%.
A 20% rise in the price of ice cream causes
demand for sweets to increase by 4%.
A 12% fall in the price of air fares leads to a
30% rise in the demand for foreign holidays.
A 10% rise in bikes will leave the demand for
cheese unaffected.

Answers

s
ood
g
e
t
titu
s
b
= su
e
tary
v
n
i
t
e
i
lem
Pos
p
m
= co
e
v
i
at
A 10% rise in the price of fish may cause demand
Neg for chicken to increase

by 2%.
+2/+10 = +0.2
The fall in the price of paper by 20% causes the demand for pens to
increase by 5%.
+5/-20 = -0.25
A 20% rise in the price of ice cream causes demand for sweets to
increase by 4%.
+4/+20 = +0.2
A 12% fall in the price of air fares leads to a 30% rise in the demand for
foreign holidays.
+30/-12 = -2.5
A 10% rise in bikes will leave the demand for cheese unaffected.
0/+10 = 0

Look at some figures for

interpretation
Real statistics!

Estimated Elasticity for

s
ood
g
e
t
titu
s
b
Alcohol
= su
ry
e
v
enta
iti
Pos

lem
p
m
= co
e
v
i
at
Neg

How can beer be a

good complement to
beer?

In your own words explain

the wine CPeD numbers

Importance of CPed for businesses

Firms can use CPed estimates to predict:

The impact of a rivals pricing strategies 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 i.e. popcorn costs
pennies to make but sells for more than a pound

If firms have a reliable estimate for XED they can

estimate the effect, say, of a two-for-one cinema ticket
offer on the demand for popcorn

Applications of Cross Elasticity (1)

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

Applications of Cross Elasticity (2)

Effect

on demand for different

modes of mass transport
following introduction of road
pricing schemes in urban
areas (e.g. the London
congestion charge and the M6
Toll Road)
Rise in the price of natural gas
effect on the demand for
coal used in power generation

Homework
Revise

for test next lesson to review

basic definitions, formulas, diagrams,
elastic & inelastic numbers
PeD
YeD
PeS
CPeD