Cross Elasticity of Demand (XED)
A-level Economics
What it is. How it is calculated. What it is used for. How it affects demand and supply diagrams.
Definition of XED - “measures the relationship between the demand for a good with respect to the price of another good.”
How it is calculated: % change Qty Demanded for Good A / % change in Price of Good B
What is XED used for?
It is used to show us the relationship between two goods. The relationship is broadly categorised as 1) a complement good 2) a substitute good 3) an unrelated good.
Complementary Goods - also known as goods in joint demand.
An example of complementary goods are tennis racquets and tennis balls. It is likely that when you buy a tennis racquet you’ll buy some tennis balls to go with it. Another example is strawberries and cream.
Substitute Goods
An example of substitute goods will be an Xbox One compared with a PS4. One is a direct substitute to another. If the price of the Xbox One increases, people are more likely to substitute the purchase of the Xbox by buying the PS4.
Understanding XED Figures:
If XED is positive: the two goods are substitutes
If XED is negative: the two goods are complementary
If XED is 0: there is no relationship between the two goods
How does XED affect demand?
Let’s imagine that you are a firm and you are selling a good. Let’s call this good, Good A.
Then:
If the price of a substitute increases, this will be beneficial to the demand for your good. Therefore, demand for your good will shift to the right. If the price of a substitute decreases, then the demand for your good will shift to the left.
If the price of a complement to your product increases, this will negatively affect the demand for your product. It will mean the demand curve for your product will shift to the left. If the price of a complement decreases, then this will be a good thing for the product you sell. The demand curve for your product will shift to the right.
XED SUMMARY
XED Positive and Elastic (Above 1) e.g. XED = +5 : The goods are strong substitutes
XED Positive and Inelastic (0-1) : e.g. XED = +0.5The goods are weak substitutes
XED Negative and Elastic (Above 1) e.g. XED = -5 : The goods are strong complements
XED Negative and Inelastic (0-1) e.g. XED = -0.5 : The goods are weak complements
XED = 0 : No relationship
DIAGRAMS
The diagram above shows how XED affects complementary goods. If Good B is a complement to Good A, then if Good B decreases in price, the demand for Good A will increase as shown in the diagram above. For example, if Xbox games decrease in price, then there should be an increase in demand for Xboxes.
The diagram above shows how XED affects substitute goods. If two goods are substitutes then they have a positive XED calculation. If Good B increases in price, then the demand for Good A will increase. This is because these two goods are competiting with one another. If the price of a Playstation goes up then more people will want to buy Xboxes.
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