Cross-Price Elasticity of Demand

Cross-price elasticity of demand measures how the quantity demanded of one good changes in response to a price change in another.

It is calculated as the percentage change in the quantity demanded of the first good divided by the percentage change in the price of the second.

A positive cross-price elasticity value denotes substitute goods.

For instance, if the price of tea rises by 10 percent and the demand for coffee increases by 8 percent, this indicates a positive cross-price elasticity.

This suggests that when tea becomes expensive, more people turn to coffee.

Conversely, a negative cross-price elasticity denotes complementary goods.

For example, a 5 percent increase in the price of smartphones leads to a 7 percent decrease in the demand for phone cases, indicating a negative cross-price elasticity.

This implies that as smartphones become more expensive, fewer people buy phone cases.

However, a cross-price elasticity value of zero or close to zero means that the two goods are unrelated.

In essence, this concept helps economists and businesses understand the relationships between different products in the market.