The cross elasticity of demand means responsiveness of the quantity demanded of a good to a change in:
price of other goods
Understanding Cross Elasticity of Demand
The question asks about the meaning of the cross elasticity of demand. This is a concept in economics that measures how the quantity demanded of one good changes when the price of a different, related good changes. It helps us understand the relationship between different products in the market.
Defining Cross Elasticity of Demand
The cross elasticity of demand (often denoted as \(E_{xy}\) or \(CED\)) quantifies the responsiveness of the quantity demanded of good X to a change in the price of good Y.
The formula for cross elasticity of demand is:
\( E_{xy} = \frac{\text{% Change in Quantity Demanded of Good X}}{\text{% Change in Price of Good Y}} \)
Or, using calculus for instantaneous change:
\( E_{xy} = \frac{\partial Q_x}{\partial P_y} \times \frac{P_y}{Q_x} \)
Where:
- \(Q_x\) is the quantity demanded of good X
- \(P_y\) is the price of good Y
The sign of the cross elasticity of demand tells us the relationship between the two goods:
- If \(E_{xy} > 0\), goods X and Y are substitutes (e.g., tea and coffee). An increase in the price of Y leads to an increase in the quantity demanded of X.
- If \(E_{xy} < 0\), goods X and Y are complements (e.g., cars and petrol). An increase in the price of Y leads to a decrease in the quantity demanded of X.
- If \(E_{xy} = 0\), goods X and Y are unrelated. A change in the price of Y has no effect on the quantity demanded of X.
Analyzing the Options
Let's look at each option in the context of what elasticity measures:
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consumer's income: The responsiveness of the quantity demanded of a good to a change in consumer's income is measured by the income elasticity of demand, not the cross elasticity of demand.
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producer's income: Producer's income is not a standard variable used to measure the responsiveness of demand for a good.
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its own price: The responsiveness of the quantity demanded of a good to a change in its own price is measured by the price elasticity of demand (or own-price elasticity of demand), not the cross elasticity of demand.
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price of other goods: As defined above, the responsiveness of the quantity demanded of a good to a change in the price of other goods is precisely what the cross elasticity of demand measures.
Based on the definition and the analysis of options, the cross elasticity of demand specifically relates to how demand for a good changes when the price of a *different* good changes.
Conclusion
The cross elasticity of demand is a measure of the responsiveness of the quantity demanded of a good to a change in the price of other goods. This distinguishes it from price elasticity of demand (responsiveness to own price) and income elasticity of demand (responsiveness to income).
| Type of Elasticity | Responsiveness Measured | Change in |
|---|---|---|
| Price Elasticity of Demand | Quantity Demanded of Good X | Price of Good X |
| Income Elasticity of Demand | Quantity Demanded of Good X | Consumer's Income |
| Cross Elasticity of Demand | Quantity Demanded of Good X | Price of Good Y (Other Goods) |
Revision Table: Key Elasticities of Demand
| Elasticity Concept | What it Measures | Formula Basis | Key Determinant(s) |
|---|---|---|---|
| Price Elasticity of Demand | Response of quantity demanded to own price change | % Change in Q / % Change in P (of the same good) | Availability of substitutes, necessity vs. luxury, proportion of income spent |
| Income Elasticity of Demand | Response of quantity demanded to income change | % Change in Q / % Change in Income | Good is normal (necessity or luxury) or inferior |
| Cross Elasticity of Demand | Response of quantity demanded of one good to price change of another good | % Change in \(Q_x\) / % Change in \(P_y\) | Relationship between goods (substitutes, complements, unrelated) |
Additional Information on Cross Elasticity and Related Goods
Understanding the sign and magnitude of the cross elasticity of demand is crucial for businesses and policymakers.
- For Substitutes: If two goods, like Coca-Cola and Pepsi, are substitutes, an increase in the price of Coca-Cola will lead people to buy more Pepsi. The cross elasticity of demand between Coca-Cola and Pepsi would be positive (\(E_{xy} > 0\)). The higher the positive value, the stronger the substitute relationship.
- For Complements: If two goods, like printers and ink cartridges, are complements, an increase in the price of printers will likely lead to a decrease in the demand for ink cartridges (since fewer printers are sold). The cross elasticity of demand between printers and ink cartridges would be negative (\(E_{xy} < 0\)). The more negative the value, the stronger the complementary relationship.
- For Unrelated Goods: If two goods, like cars and bananas, are unrelated, a change in the price of cars will have no significant effect on the demand for bananas. The cross elasticity of demand would be close to zero (\(E_{xy} \approx 0\)).
Firms use cross elasticity of demand analysis to understand competitive markets, pricing strategies, and the impact of competitor actions. For example, a firm selling a good with a high positive cross elasticity with a competitor's product knows that a price cut by the competitor will significantly reduce demand for its own product.
Important Questions from Demand analysis
The supply curve of cars is expected to shift rightwards with:
i. An increase in the price of cars
ii. A decrease in fuel prices
The supply curve of a normal good is ____________ sloping. It depicts ___________ on the x-axis and ___________ on the y-axis.
The demand curve gives the quantity demanded by the consumer at each ____________.
Which of the following statements is INCORRECT in the context of demand function?
Marginal Product is defined as:
