Cross-price elasticity of demand measures how the quantity demanded of one good responds to a change in the price of another good. It is calculated as the percentage change in the quantity demanded of one good divided by the percentage change in the price of the other good.
– If the cross-price elasticity is positive, it indicates that the two goods are substitutes. An increase in the price of one good leads to an increase in the quantity demanded for the other.
– If the cross-price elasticity is negative, it suggests that the goods are complements. An increase in the price of one good results in a decrease in the quantity demanded for the other.
Understanding cross-price elasticity helps businesses and policymakers analyze how changes in the price of one product can impact the demand for related products in the market.
The Correct Answer and Explanation is:
Correct Answer:
Cross-price elasticity of demand measures how the quantity demanded of one good responds to a change in the price of another good.
Explanation :
Cross-price elasticity of demand (XED) is a crucial concept in economics that reveals the relationship between two goods based on how the demand for one responds to price changes in the other. It is mathematically expressed as: XED=% change in quantity demanded of Good A% change in price of Good B\text{XED} = \frac{\% \text{ change in quantity demanded of Good A}}{\% \text{ change in price of Good B}}
This measure helps determine whether two goods are substitutes or complements:
- Substitute goods have a positive cross-price elasticity. This means when the price of Good B increases, consumers switch to Good A, raising its demand. For example, if the price of coffee rises, consumers may buy more tea, assuming tea is a substitute. This behavior shows a positive correlation between the price of one good and the demand for the other.
- Complementary goods have a negative cross-price elasticity. When the price of Good B rises, demand for both Good B and its complement Good A falls. For instance, if the price of printers increases, the demand for printer ink may drop, since both are used together. This indicates a negative correlation.
Understanding cross-price elasticity is essential for businesses and policymakers. Firms use it to anticipate the impact of pricing strategies on related products. For example, a smartphone company might lower the price of phones to boost demand for accessories. Policymakers can assess the wider effects of taxation or subsidy policies. A tax on sugary drinks, for example, might shift demand to sugar-free alternatives, depending on their elasticity.
In summary, cross-price elasticity provides insight into market dynamics, allowing better decision-making around pricing, product development, and policy formulation by understanding how goods interact in the eyes of consumers.
