Definition
Cross-price Elasticity is defined as the percentage change in the quantity demanded of one good in response to a percentage change in the price of another good. This measure demonstrates the degree to which the demand for a good is sensitive to the price changes of another good. If the goods are substitutes (e.g., beef and pork), an increase in the price of one will likely increase the demand for the other. Conversely, if the goods are complements (e.g., printers and ink cartridges), an increase in the price of one will usually decrease the demand for the other.
Examples
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Substitute Goods:
- Beef and Pork: When the price of beef increases, consumers may switch to pork, thereby increasing the demand for pork.
- Tea and Coffee: An increase in the price of tea may lead to a higher demand for coffee as consumers opt for the cheaper alternative.
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Complementary Goods:
- Printers and Ink Cartridges: If the price of ink cartridges rises, the demand for printers might decrease as the cost of using a printer becomes more expensive.
- Cars and Fuel: An increase in fuel prices might reduce the demand for cars, especially fuel-inefficient models.
Frequently Asked Questions
Q1: What role does cross-price elasticity play in business decision making?
- A: It helps businesses in designing pricing strategies. By understanding the degree of substitution or complementarity between products, companies can adjust their prices strategically to optimize sales and profit margins.
Q2: How is cross-price elasticity calculated?
- A: Cross-price elasticity is calculated using the formula: \[ \text{Cross-price Elasticity} = \frac{% \text{Change in Quantity Demanded of Good A}}{% \text{Change in Price of Good B}} \]
Q3: What does a positive cross-price elasticity signify?
- A: Positive cross-price elasticity indicates that the goods are substitutes. An increase in the price of one leads to an increase in the demand for the other.
Q4: What does a negative cross-price elasticity indicate?
- A: Negative cross-price elasticity signifies that the goods are complements. An increase in the price of one good leads to a decrease in the demand for the other.
Q5: Can cross-price elasticity be zero?
- A: Yes, if cross-price elasticity is zero, it suggests that the goods are independent, implying no correlation in their demand.
Related Terms
- Price Elasticity of Demand: Measures the responsiveness of the quantity demanded to a change in price.
- Income Elasticity of Demand: Measures the responsiveness of the quantity demanded to changes in consumer income.
- Elasticity: A general term that measures how one variable responds to changes in another variable.
References and Online Resources
- Investopedia on Cross Elasticity of Demand
- Khan Academy: Elasticity and Its Application
- Coursera: Microeconomics Principles
Suggested Books for Further Studies
- “Microeconomics” by Robert S. Pindyck and Daniel L. Rubinfeld
- “Intermediate Microeconomics and Its Application” by Walter Nicholson and Christopher M. Snyder
- “Principles of Economics” by N. Gregory Mankiw
Fundamentals of Cross-Price Elasticity: Microeconomics Basics Quiz
### What does cross-price elasticity measure?
- [x] The extent to which the price of a specified good is affected by the price of another complementary or substitute good.
- [ ] The percentage change in quantity demanded due to a percentage change in price of the same good.
- [ ] The total revenue generated from selling a combination of goods.
- [ ] The rate of inflation in an economy.
> **Explanation:** Cross-price elasticity measures how the price of one good affects the demand for another good, either complementary or substitute.
### Which of the following pairs of goods is most likely to have a negative cross-price elasticity?
- [x] Printers and ink cartridges
- [ ] Tea and coffee
- [ ] Beef and pork
- [ ] Pens and pencils
> **Explanation:** Printers and ink cartridges are complementary goods. An increase in the price of one leads to a decrease in the demand for the other, reflecting a negative cross-price elasticity.
### If the cross-price elasticity of demand between two goods is positive, what does this indicate?
- [x] The goods are substitutes.
- [ ] The goods are complements.
- [ ] The goods are independent.
- [ ] There is no correlation between the goods.
> **Explanation:** A positive cross-price elasticity indicates that the goods are substitutes because an increase in the price of one increases the demand for the other.
### Which of the following is an example of complementary goods?
- [ ] Tea and coffee
- [ ] Beef and chicken
- [ ] Pens and erasers
- [x] Cars and fuel
> **Explanation:** Cars and fuel are complementary goods. An increase in the price of fuel often leads to a decrease in the demand for cars, especially those that are fuel-inefficient.
### What is the formula for calculating cross-price elasticity?
- [ ] \\(\text{Cross-price Elasticity} = \frac{\text{\% Change in Quantity Demanded}}{\text{\% Change in Income}}\\)
- [x] \\(\text{Cross-price Elasticity} = \frac{\text{\% Change in Quantity Demanded of Good A}}{\text{\% Change in Price of Good B}}\\)
- [ ] \\(\text{Cross-price Elasticity} = \frac{\text{\% Change in Quantity Demanded}}{\text{\% Change in Price of the same good}}\\)
- [ ] \\(\text{Cross-price Elasticity} = \text{\% Change in Revenue} \times \text{\% Change in Quantity Demanded}\\)
> **Explanation:** The correct formula for calculating cross-price elasticity is the percentage change in quantity demanded of Good A divided by the percentage change in price of Good B.
### If an increase in the price of beef leads to a higher demand for chicken, what is the cross-price elasticity between beef and chicken?
- [ ] Negative
- [x] Positive
- [ ] Zero
- [ ] Undefined
> **Explanation:** The cross-price elasticity is positive because chicken is a substitute for beef; an increase in the price of beef leads to a higher demand for chicken.
### If two goods are independent, what is their cross-price elasticity?
- [x] Zero
- [ ] Positive
- [ ] Negative
- [ ] Undefined
> **Explanation:** If two goods are independent, their cross-price elasticity is zero, meaning changes in the price of one good have no effect on the demand for the other.
### How can businesses use cross-price elasticity in making pricing decisions?
- [x] By analyzing how changes in the prices of related goods affect their product's demand.
- [ ] By predicting future market trends and stock prices.
- [ ] By determining the optimal level of production capacity.
- [ ] By calculating the cost of production for complementary goods.
> **Explanation:** Businesses can use cross-price elasticity to analyze how changes in the prices of related goods impact their own product's demand and strategize accordingly.
### If a good has a cross-price elasticity of -1.5 with another good, what type of relationship do they share?
- [ ] The goods are substitutes with inelastic demand.
- [x] The goods are complements.
- [ ] The goods are independent with zero elasticity.
- [ ] The goods are Giffen goods.
> **Explanation:** A cross-price elasticity of -1.5 indicates that the goods are complements, meaning that an increase in the price of one good results in a significant decrease in the demand for the other.
### What does a high absolute value of cross-price elasticity indicate about the relationship between two goods?
- [x] A strong relationship where price changes significantly impact demand.
- [ ] A weak relationship with minimal impact on demand.
- [ ] That one good is a necessity and the other is a luxury.
- [ ] That the goods are independent of each other.
> **Explanation:** A high absolute value of cross-price elasticity indicates a strong relationship, where changes in the price of one good significantly impact the demand for the other.
Thank you for learning about cross-price elasticity with detailed examples and quiz questions to reinforce your understanding. Keep exploring more economic theorems and applications for enhanced comprehension!
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