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Cross Elasticity of Demand

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Ciaran Fitzpatrick

on 24 September 2012

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Transcript of Cross Elasticity of Demand

Cross Price Elasticity of Demand
XED Cross Price Elasticity of Demand XED
measures the responsiveness of consumers of one good to a change in the price of a related good Example:
Consider Apples & Pears, two fruits with close substitutes:
How will Demand for pears be affected by an increase in the price of apples?
Tells us the Percentage by which Quantity of Pears will change following a change in the price of apples. Formula:
Percentage Change in Quantity of Good A
DIVIDED BY
Percentage Change in the Price of Good B Example:
Apples increase in price from $2 to $2.5
Quantity of Pears rises from 30 to 50

Calculate the XED... Demand for pears is cross price elastic with apples (i.e. XED>1) Just like PED, the absolute value of XED can be:
Inelastic
Unit Elastic
Elastic Cross Price Elasticity of Demand (XED) Inelastic
0<XED<1 Consumers of Good A are relatively unresponsive to a change in the price of Good B
The % change in QA will be smaller than the % change in PB Unit Elastic
XED = 1 Consumers of Good A will respond proportionally to a change in the price of Good B
The % change in QA will be the same as the % change in PB Elastic
XED > 1 Consumers of Good A will be relatively responsive to a change in the price of Good B.
The % change in QA will be greater than the % change in PB. The XED for complementary goods will always be NEGATIVE
when the price of one complement goes up, the demand for the other will FALL. Complementary Goods Example:
Price of hot dogs rises, the demand for hot dog buns will decrease.
XED coefficient will be negative, reflecting the inverse relationship : The XED for substitutes will always be POSITIVE.
when the price of one substitute goes up, the demand for the other will RISE. Substitute Goods Example:
The price of beef rises, the demand for pork will rise.
XED coefficient will be positive, reflecting the direct relationship Measures the responsiveness of consumers of a good to changes in their income Income Elasticity of Demand
YED A country is going into a recession & incomes of households is declining.
Demand for new cars is falling
Demand for bicycles is increasing

YED is the measure of how responsive consumers demands for bicycles and cars is to changes in their incomes Example:
Incomes in Peru have declined by 4%
Bike sales have increased by 8%
Car sales have declined by 3%

Calculate the YED... Demand for bikes is income elastic Demand for cars is income inelastic Notice that YED can be negative (bikes)
OR
Positive (cars) Income Elasticity of Demand
(YED) Demand for the good is relatively unresponsive to changes in consumer income
Quantity will change by a smaller percentage than the change in income. Inelastic
0 < YED < 1 Unit Elastic
YED = 1 Demand for the good is proportionally responsive to income changes
Quantity will change by the same percentage as the change in income Elastic
YED > 1 Demand for the good is relatively responsive to changes in income
Quantity will change by a larger percentage than consumers’ income A normal good is one with a POSITIVE YED coefficient.

There is a direct relationship between income and demand. Normal Good Example:
As incomes fell, car sales fell as well.
If incomes were to rise, car sales would begin to rise.

Cars are a normal good. An inferior good is one with a NEGATIVE YED coefficient.
This is a good that people will buy more of as income falls, and less of as income rises. Inferior goods Example:
Bicycle transportation is an inferior good, because Americans demanded MORE bicycles as their incomes fell.
If income were to rise, bicycle sales would begin to fall.
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