The Cross-Price Elasticity Of Demand- Definition And Overview In 2021
by Mashum Mollah Business Development 03 July 2021
The change of ratio in the demanded quantity of an item due to the value change in another related item’s price refers to the cross-price elasticity of demand. The cross-price elasticity is always positive for substitute gods, whereas, for complement goods, the cross-price elasticity is always negative.
Thus, this economic concept explores the relationship between two products in terms of the price change mechanism in one of them. It simply shows how the demand for a product rises or falls when the cost of its related product increases or decreases.
Overview And Definition Of Cross-Price Elasticity
You need to calculate the change of value in the demanded quality of one product and then divide it with the change of ratio in the cost of another related product to measure the cross-price elasticity. Thus, the formula of calculating cross-price elasticity becomes;
Exy = Change of value in the number of A good /Change of value in the cost of B good
Here, the quantity of A goods is referred to as Qx, and the cost of B goods is referred to as Py
If you measure the cross-price elasticity of demand to be positive, then it means the demand of Y good is bound to go up if the cost of A good increases. It means that both A and B goods are substitutes, and so if one of them gets expensive, people don’t find it problematic to switch to another one. For example, if the cost of coffee goes up, then the demand for tea automatically increases.
However, if you measure the cross-price elasticity of demand to be negative, then it means if the value of Y good increases, then the demand for A goods will fall. It means both these goods are complementary, and they are so related to one another that if one’s price goes up, then people cannot afford to have the corresponding product. So, for example, if the value of pen ink increases, then the demand for ink pens will automatically decrease.
How Does The Cross-Price Elasticity Of Demand Differ From The Cross-Price Elasticity Of Supply?
The Cross-price elasticity of demand measures the demand changes of two products when one of them undergoes a price increase. On the contrary, the cross-price elasticity supply measures the proportional change in supplied quantity when goods’ goods price increases or decreases. That means the cross-price elasticity of demand is related to only the increase of product cost. In contrast, the cross-price elasticity of supply relates to both the increase and decrease in cost.
Benefits Of Cross-Price Elasticity Of Demand
This economic concept acts as the most important strategic tool for many companies when they want to measure whether it is the right time or not to increase the selling price of their products. In addition, they can also gauge whether or not to substitute one product with another for acquiring a better revenue margin.
You can also analyze the total price change amount in goods with its substitutes for deciding the most suitable level of demand and price of a product. Furthermore, you get to strategically price the substitute products, too, with the help of cross-price elasticity of demand valuation. For example, you might want to sell the printers at a low cost if you hope that the demand for printer paper or printer ink, or printer toner will increase shortly.
Common Mistakes In The Cross-Price Elasticity Measurement
You must never forget that the judgments people make about cross-price elasticity measurement are objective. There is no absolute value that will be true in all conditions. The parameters that make a product superior or inferior to one another and make them complementary, or substitute goods, are changeable. It depends upon the market conditions and how they fluctuate and not on any prior assumption that people often make while calculating.
The mistakes that people often make in the calculation of cross-price elasticity are the signs. If the quantity and price show changes in the opposite direction, then the goods will be complementary, and the coefficient will be negative. On the other hand, if the result is positive, then the goods will be determined as substitutes for one another, and the coefficient will also be positive. Thus, only the absolute value for cross-price and cross-income can indicate the amount of elasticity in the goods.
Price elasticity is also different from cross-price elasticity in terms of terminology. Because when the price elasticity of demand is positive, you can simply say that the demand is elastic, and when it is negative, you can say that demand is non-elastic. However, in ross-price elasticity, you have to mention that the demand is elastic or non-elastic in terms of another product because that is the key here.
What Is Unrelated Cross-Price Elasticity?
Apart from the positive cross-price elasticity and negative cross-price elasticity, another concept is related to this phenomenon, which is unrelated cross-price elasticity. However, unlike the former two, this concept does not denote two products as complementary or substitutes for one another. Instead, it refers to a situation when the formula precedes a zero result. Simply put, in these situations, the valuation of A goods can increase as much as it wants, but it will have no impact on the demand for Y goods.
It means that products that do not have an apparent or immanent relationship with one another fall in the category of unrelated cross-price elasticity. For example, if the valuation of pen ink increases or decreases, it will have no impact on the demand for milk. Similarly, if the cost of milk increases or decreases, the demand for a pen will not suffer anyhow. Hence, two random goods that are not all related to each other fall in the category of unrelated cross-price elasticity.
You must have understood by now that how important the concept of cross-price elasticity is in economic situations. It helps companies decide which products to sell at which price for generating profit and revenue. Identifying the complementary products, looking at your pricing strategy, and having a solid grasp of your organizational system are some of the most prominent factors in deciding the usefulness of cross-price elasticity of demand.