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cross elasticity of demand


Degree to which demand for one product is affected by the price of another product.
Demand for frozen orange juice concentrate may increase when the price of fresh orange
juice (a substitute product) increases. Demand for hotel rooms in a ski resort may
decrease when the price of a lift ticket (a complementary product) increases. An increase
that causes an increase is the result of positive elasticity. An increase that causes a
decrease is the result of negative elasticity. Products with no impact on each other have
zero cross elasticity. Marketers need to understand the cross elasticity factors that affect
their products and competitors' products.
cross elasticity of demand
In economics, the cross elasticity of demand and cross price elasticity of demand
measures the responsiveness of the quantity demanded of a good to a change in the price
of another good.
It is measured as the percentage change in quantity demanded for the first good that
occurs in response to a percentage change in price of the second good. For example, if, in
response to a 10% increase in the price of fuel, the quantity of new cars that are fuel
inefficient demanded decreased by 20%, the cross elasticity of demand would be
-20%/10% = -2.
The formula used to calculate the coefficient cross elasticity of demand is

or:

In the example above, the two goods, fuel and cars, are complements - that is, one is used
with the other. In these cases the cross elasticity of demand will be negative. In the case
of perfect complements, the cross elasticity of demand is infinitely negative.
Where the two goods are substitutes the cross elasticity of demand will be positive, so
that as the price of one goes up the quantity demanded of the other will increase. For
example, in response to an increase in the price of fuel, the demand for new cars that are
fuel efficient hybrids for example will also rise. In the case of perfect substitutes, the
cross elasticity of demand is equal to infinity.

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Where the two goods are independent, the cross elasticity demand will be zero: as the
price of one good changes, there will be no change in quantity demanded of the other
good. In case of perfect independence, the cross elasticity of demand is zero.
When goods are substitutable, the diversion ratio --- which quantifies how much of the
displaced demand for product j switches to product i --- is measured by the ratio of the
cross-elasticity to the own-elasticity multiplied by the ratio of product i's demand to
product j's demand. In the discrete case, the diversion ratio is naturally interpreted as the
fraction of product j demand which treats product i as a second choice,[1] measuring how
much of the demand diverting from product j because of a price increase is diverted to
product i can be written as the product of the ratio of the cross-elasticity to the ownelasticity and the ratio of the demand for product i to the demand for product j. In some
cases, it has a natural interpretation as the proportion of people buying product j who
would consider product i their `second choice.'