2.20 : Cross-Price Elasticity of Demand

At its core, cross price elasticity of demand quantifies the responsiveness of the quantity demanded for one product in response to a price change in another. It is calculated by dividing the percentage change in quantity demanded of one good by the percentage change in price of another.

Substitute Goods: A positive cross price elasticity indicates that the goods are substitutes. The magnitude of this value reveals the strength of their substitutability. For example, a significant increase in the price of e-books might lead to a sharp rise in physical book purchases, highlighting a strong substitute relationship.

Complementary Goods: Conversely, a negative cross price elasticity signifies complementary goods. The degree of this value can reveal the depth of their complementarity. For instance, an increase in the price of coffee machines might slightly reduce the demand for coffee beans, indicating a complementary but not inseparable connection.

Independence of Goods: A zero or near-zero cross price elasticity suggests no significant relationship between the demand for two goods, indicating they cater to different needs.

The strength and nature of these relationships can evolve. Shifts in consumer preferences, income levels, and technological advancements can alter cross price elasticity values over time, highlighting the fluidity of market dynamics.