What is the cross elasticity for shoes and when?

Definition: The measure of responsiveness of the demand for a good towards the change in the price of a related good is called cross price elasticity of demand. It is always measured in percentage terms.

Description: With the consumption behavior being related, the change in the price of a related good leads to a change in the demand of another good. Related goods are of two kinds, i.e. substitutes and complementary goods. In case the two goods are not related, the Coefficient of Cross Elasticity is zero.

Watch the video to learn more about Cross Elasticity of Demand

Also See: Elasticity, Microeconomics, Consumer Theory, Income Elasticity of Demand, Price Elasticity of Demand, Demand Elasticity

Understanding Cross-Price Elasticity

While explaining cross-price elasticity, there are three categories of product relationships to examine.

1. First, there are products that are closely related to one another – sometimes known as substitute products. These products compete for the same customers in the market.
2. Second, there are products that are consumed together. The demand for one product directly affects the consumption of related products. These products are known as complementary products.
3. The final group belongs to products that are entirely unrelated to one another. These products do not affect the consumption of one another.
4. By having a clear understanding of the concepts behind product relationships, business owners can strategically compete in their industry or stock their inventories accordingly. For example, lowering the price of printers could lead to increased purchases of toners and ink. The more printers consumers buy, the more revenues are generated by selling complementary products.

Cross-Price Elasticity Formula

Where:

• Qx = Average quantity between the previous quantity and the changed quantity, calculated as (new quantityX + previous quantityX) / 2
• Py = Average price between the previous price and changed price, calculated as (new pricey + previous pricey) / 2
• Δ = The change of price or quantity of product X or Y

Note: In cross-price elasticity, unlike in income elasticity, the ΔQx and ΔPy are calculated by finding the averages between the change in either price or quantity demanded.

Cross-Price Elasticity of Substitute Products

For substitute products, an increase in the price of a substitute product increases the demand for the competing product. This is often because consumers always try to maximize utility. The less they spend on something, the higher the perceived satisfaction.

Similarly, when the competing product price is reduced, the mirroring effect is depicted by an increase in demand for the substitute product. In either of these scenarios, the change will either drive a negative or a positive cross-price elasticity. For cross-price elasticity, where there is an increase in the price of the competing products, there will be a positive coefficient.

Practical Example

Two competing airlines – A and B – are a perfect example of substitute products. If Airline A decides to increase their flights’ round-trip ticket price by even a small margin, consumers will likely notice the difference. As a result, more people will opt for Airline B because it is cheaper.

Categories of Substitute Products

Substitute products can be categorized as either close or weak.

Close Substitutes

A close substitute is realized when a minimal increase in price leads to a large demand increase of the substitute product. The graph below shows this interpretation.

Weak Substitutes

For a weak substitute, a large increase in the price of product X will lead to only a small increase in demand for product Y. See the graph below for the interpretation.

Cross-Price Elasticity of Complementary Products

Complementary products have the opposite effect. If the price of one product increases, the demand for the complementary product decreases. To consumers, the increased joint cost will force them to buy less.

Practical Example

An example of a complementary product is an eBook reader. If the price of an eBook reader drops, the consumption of eBooks and audiobooks will increase because more consumers can afford the reader.

Categories of Complementary Products

Complementary products can either be close or weak complements.

Close Complements

In the case of a strong complement product, a minimal price decrease leads to a large increase in demand for the complement product. The graph below shows this impact.

Weak Complements

For weak complementary products, a large price decrease leads to a small increase in demand for the complementing products. The graph below shows this shift.

Cross-Price Elasticity of Unrelated Products

Unrelated products do not affect one another. This means the cross-effect elasticity is zero, and the graph would be represented by a vertical line.

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Cross elasticity of demand refers to an economic concept that usually measures the responsiveness in the demanded quantity of one good when the price of another product changes. Also referred to as the cross-price elasticity of demand, the measurement is calculated by taking the percentage difference in the demanded quantity of one good and then diving it by the percentage difference in the price of another product.

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How is Cross Elasticity of Demand Used?

Cross elasticity on demand also measures the sensitivity of the demand for a product or service to the variation of the price of a different good or service. As such, the subject seeks to determine how much the consumption of product changes when the value and cost of a different product also changes. For instance, how much increase in the price of vehicles there is when the price of gasoline declines. Or better yet, how much the decrease in the purchase of printers there will be if the price of the printer tub goes up. The cross elasticity of demand can be calculated with any products or services. Below, you'll learn more about how the relationship between the products impacts whether they are substitutes, complementariness, or independent.

Calculation of cross elasticity

To calculate the cross elasticity, it was evaluated in the following way: X, Y = Percentage Variation of the quantity demand of X/Percentage variation of the price of product Y. In arithmetic terms, the following formula will be used: Where: Qx = amount of x Qy = amount of y Px = price of x Py = price of y = variation

When the cross-elasticity of demand is positive, the product, Y, is substituted for X. In this case, before experiencing an increase in price Y, the quantity demand of X will increase. The above illustration implies that consumers can be a great substitute such that when the price of product Y increases, they reduce the purchasing power of Y to replace them to a more significant purchase amount of X.

Example

Let us look at this example closely: butter can substitute margarine. This is at least for many people. In this instance, if the price of butter goes up, the amount of margarine demanded is expected to increase as well.

Complementary Goods

When the cross-elasticity is negative, the products, as well as services, are complementary. This implies that they are consumed together- for instance, bread and butter. Because most individuals like to consume the products, they will reduce the purchase of these items thereby reducing the purchase of bread.

Independent goods

When the cross elasticity is zero, the goods, as well as services, are interconnected and independent. That implies that buyers don't consider these goods as substitutes or complements. Therefore, their demands are independent. Check out this example. Shoes and milk are goods that satisfy entirely different needs. There's no expected reaction in the industry of shoes prior to a variation in the milk industry.

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