Download - 3.5 Cross Price Elasticity
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Cross Price Elasticityof Demand
AS Economics
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Cross Elasticity of Demand (CPed)
Cross price elasticity (CPed) measures theresponsiveness of demand for good X followinga change in the price of good Y (a related good)
CPeD = % change in qty D of product A
% change in price of product B
With cross price elasticity we make an importantdistinction betweensubstitute products andcomplementary goods and services.
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Identify some Substitutes
http://images.google.co.uk/imgres?imgurl=http://www.istartedsomething.com/wp-content/uploads/2006/11/winlogocompression.jpg&imgrefurl=http://www.istartedsomething.com/20061108/microsoft-low-quality-logos/&h=316&w=359&sz=17&hl=en&start=2&tbnid=8pXQq9O2MWTB7M:&tbnh=107&tbnw=121&prev=/images%3Fq%3Dmicrosoft%2Blogo%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://www.perdue.com/files/Easy%2520Sunder%2520Dinner%2520Roast%2520Chicken.jpg&imgrefurl=http://www.perdue.com/recipes/recipe_detail.html%3Fid%3D81&h=300&w=367&sz=95&hl=en&start=16&tbnid=QUI2Z-UQax74KM:&tbnh=100&tbnw=122&prev=/images%3Fq%3Droast%2Bchicken%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://my.telegraph.co.uk/VirtualContent/90408/20070810085337.jpg&imgrefurl=http://my.telegraph.co.uk/papaguinea/august_2007/&h=375&w=500&sz=18&hl=en&start=1&tbnid=o-jiRjNJ1xWk8M:&tbnh=98&tbnw=130&prev=/images%3Fq%3Dcup%2Bof%2Btea%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://www.themillsfansite.com/reviews/review_images/28-6-2006-frosties.jpg&imgrefurl=http://www.themillsfansite.com/reviews/index.php%3Fm%3D6%26y%3D2006&h=260&w=290&sz=18&hl=en&start=11&tbnid=FksoceyyaOG7aM:&tbnh=103&tbnw=115&prev=/images%3Fq%3Dfrosties%2Blogo%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://www.costpernews.com/wp-content/uploads/2007/05/google_logo.jpg&imgrefurl=http://www.costpernews.com/2007/05/03/what-if-google-bought-dow-jones-google-street-journal/&h=1500&w=3600&sz=277&hl=en&start=2&tbnid=-BCryA-2oHT9GM:&tbnh=63&tbnw=150&prev=/images%3Fq%3Dgoogle%2Blogo%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://uk.wrs.yahoo.com/_ylt=Al_rmiKeuPLNl0kz1uuLD7VNBQx.;_ylu=X3oDMTBpZm5udGl1BHBvcwM1BHNlYwNzcgR2dGlkAw--/SIG=1f65d05sq/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dbraeburn%252Bapples%2526fr%253Dyfp-t-501%2526ei%253DUTF-8%26w=125%26h=121%26imgurl=www.apples-cherries.com%252Ffarm%252Fimages%252Fproducts%252FBraeburn-apples.jpg%26rurl=http%253A%252F%252Fwww.friske.com%252Fhcrisp.htm%26size=3.1kB%26name=Braeburn-apples.jpg%26p=braeburn%2Bapples%26type=jpeg%26no=5%26tt=251%26oid=d2d5541cc6378c78%26ei=UTF-8 -
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Identify some Complements
http://uk.wrs.yahoo.com/_ylt=AnPwPUEo.EMRUdfZSWoo1N5NBQx.;_ylu=X3oDMTBpc2VvdmQ2BHBvcwM3BHNlYwNzcgR2dGlkAw--/SIG=1f8s19mec/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dchopsticks%2526ei%253DUTF-8%2526fr%253Dyfp-t-501%2526x%253Dwrt%26w=1355%26h=385%26imgurl=www.colleenmcallahan.net%252Fwsbredesign%252Fchopsticks.jpg%26rurl=http%253A%252F%252Fwww.colleenmcallahan.net%252Fwsbredesign%252Fware.html%26size=37.7kB%26name=chopsticks.jpg%26p=chopsticks%26type=jpeg%26no=7%26tt=77,743%26oid=6d47b65beab8fada%26ei=UTF-8http://uk.wrs.yahoo.com/_ylt=Aj1uzxzFhM7L0INOwzu5Ch1NBQx.;_ylu=X3oDMTBpc2ozM2gzBHBvcwM0BHNlYwNzcgR2dGlkAw--/SIG=1f71imp23/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dscone%2526fr%253Dyfp-t-501%2526ei%253DUTF-8%26w=239%26h=200%26imgurl=ukstudentlife.com%252FBritain%252FFood%252FCooking%252FScone%252FScone.jpg%26rurl=http%253A%252F%252Fparentheticalremarks.blogspot.com%252F2005%252F04%252Fidiot-box.html%26size=12.5kB%26name=Scone.jpg%26p=scone%26type=jpeg%26no=4%26tt=43,669%26oid=5d882d9a2c66b090%26ei=UTF-8http://images.google.co.uk/imgres?imgurl=http://www.laptoppicker.com/archives/sony-vaio-n-laptop.jpg&imgrefurl=http://www.laptoppicker.com/archives/laptop-bargains.html&h=311&w=359&sz=21&hl=en&start=4&tbnid=EciFWIo8lvmJVM:&tbnh=105&tbnw=121&prev=/images%3Fq%3Dlaptop%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://my.telegraph.co.uk/VirtualContent/90408/20070810085337.jpg&imgrefurl=http://my.telegraph.co.uk/papaguinea/august_2007/&h=375&w=500&sz=18&hl=en&start=1&tbnid=o-jiRjNJ1xWk8M:&tbnh=98&tbnw=130&prev=/images%3Fq%3Dcup%2Bof%2Btea%26gbv%3D2%26svnum%3D10%26hl%3Den -
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Cross Price Elasticity for Substitutes
Product CloseSubstitute
WeakSubstitute
Good with norelationship
Coca Cola
Camembert Cheese
Euro Star Journeyfrom London to Paris
Dowe Egberts FilterCoffee
Ticket to a film at theUGC Cinema inSlough
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Complementary Goods
Product CloseComplement
WeakComplement
Good with norelationship
Personal Computer
A bottle of expensivewhite wine
Short Break Weekendin Barcelona
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Cross Elasticity of Demand (CPed)+ = Substitutes
Substitutes:With substitute goods
such as brands ofrazors, an increase in
the price of one goodwill lead to anincrease in demandfor the rival product
Weak substitutesinelastic CPedClose substitutes
elastic CPed
Cross price elasticity
will be positive
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Cross Elasticity of Demand (CPed)- = Complements
Complements:
Goods that are in
complementary demand
Weak complementsinelastic CPed
Close complements
elastic CPed
The cross price
elasticity of demandfor two
complements is
negative
http://images.google.co.uk/imgres?imgurl=http://www1.istockphoto.com/file_thumbview_approve/881749/2/istockphoto_881749_burger_bun_1.jpg&imgrefurl=http://www.istockphoto.com/file_closeup/%3Fid%3D881749%26refnum%3D465664&h=380&w=253&sz=19&hl=en&start=1&tbnid=QKKfzHFdyyNkAM:&tbnh=123&tbnw=82&prev=/images%3Fq%3Dburger%2Bbun%26gbv%3D2%26svnum%3D10%26hl%3Den -
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The Diagrams!
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SubstitutesPrice of
Good S
Quantity demanded of
Good T
Demand
Two Weak Substitutes
P1
P2
Goods S and T are weaksubstitutes
A rise in the price of Good Sleads to a small rise in thedemand for good T
The cross price elasticity ofdemand will be positive butthe coefficient of elasticity willbe less than one
Ice cream andlollies!
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ComplementsPrice of
Good X
Quantity demanded of
Good Y
Deman
d
Two Close Complements
P2P1
Goods X and Y are closecomplements
A fall in the price of good Xleads to a large rise in the
demand for good Y
The cross price elasticity ofdemand will be negative andthe coefficient of elasticity willbe more than one
Complements are said to bein JOINT DEMAND
Foreign holidays &air flights!
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Goods with zero cross-price elasticity ofdemand aka. INDEPENDENT
Price of
Good A
Quantity demanded of
Good B
Demand
P1
P2
P3
Goods A and B have norelationship.
A fall in the price of good A
leads to no change in thedemand for good B
Therefore the cross-priceelasticity of demand is zero
Apples andgloves!
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Get your calculators ready
CPeD = % change in qty D of product A
% change in price of product B
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Calculate the CPeD and state whetherthe goods are complements or
substitutes?
1. A 10% rise in the price of fish may causedemand for chicken to increase by 2%.
2. The fall in the price of paper by 20% causes
the demand for pens to increase by 5%.3. A 20% rise in the price of ice cream causes
demand for sweets to increase by 4%.
4. A 12% fall in the price of air fares leads to a
30% rise in the demand for foreign holidays.5. A 10% rise in bikes will leave the demand for
cheese unaffected.
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Answers
A 10% rise in the price of fish may cause demand for chicken to increaseby 2%.
+2/+10 = +0.2
The fall in the price of paper by 20% causes the demand for pens toincrease by 5%.
+5/-20 = -0.25
A 20% rise in the price of ice cream causes demand for sweets toincrease by 4%.
+4/+20 = +0.2
A 12% fall in the price of air fares leads to a 30% rise in the demand for
foreign holidays.+30/-12 = -2.5
A 10% rise in bikes will leave the demand for cheese unaffected.
0/+10 = 0
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Look at some figures forinterpretation
Real statistics!
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Estimated Elasticity for
Alcohol
Estimated elasticities for the UK, 1993-96
Change in quantity of
Change in price of
Beer Wine Spirits
Beer -0.76 -0.6 -0.59
Wine -0.17 -1.69 0.66
Spirits -0.21 0.77 -0.86
Source: Crawford and Tanner (IFS, Fiscal Studies 1999)
In your own words explain
the wine CPeD numbers
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Importance of CPed for businesses
Firms can use CPed estimates to predict:
The impact of a rivals pricing strategies on demand for
their own products:
Pricing strategies for complementary goods:Popcorn and cinema tickets are strong
complements. Popcorn has a very high mark up i.e.popcorn costs pennies to make but sells for morethan a pound
If firms have a reliable estimate for XED they canestimate the effect, say, of a two-for-one cinematicket offer on the demand for popcorn
http://uk.wrs.yahoo.com/_ylt=AmpozhXvee1Q9NU0xtOlTRRNBQx.;_ylu=X3oDMTBpZm5udGl1BHBvcwM1BHNlYwNzcgR2dGlkAw--/SIG=1ebda9fcc/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dpopcorn%2526fr%253Dyfp-t-501%2526ei%253DUTF-8%26w=133%26h=120%26imgurl=www.celebratetheday.biz%252Ffoilballoons%252Ffood%252Fpopcorn_38.JPG%26rurl=http%253A%252F%252Fwww.celebratetheday.biz%252Ffood.html%26size=4.4kB%26name=popcorn_38.JPG%26p=popcorn%26type=jpeg%26no=5%26tt=322,556%26oid=e59676038f76c96c%26ei=UTF-8http://uk.wrs.yahoo.com/_ylt=AmpozhXvee1Q9NU0xtOlTRRNBQx.;_ylu=X3oDMTBpZm5udGl1BHBvcwM1BHNlYwNzcgR2dGlkAw--/SIG=1ebda9fcc/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dpopcorn%2526fr%253Dyfp-t-501%2526ei%253DUTF-8%26w=133%26h=120%26imgurl=www.celebratetheday.biz%252Ffoilballoons%252Ffood%252Fpopcorn_38.JPG%26rurl=http%253A%252F%252Fwww.celebratetheday.biz%252Ffood.html%26size=4.4kB%26name=popcorn_38.JPG%26p=popcorn%26type=jpeg%26no=5%26tt=322,556%26oid=e59676038f76c96c%26ei=UTF-8 -
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Applications of Cross Elasticity (1)
Effects of the national minimum wage ondemand for younger and older workers(might younger workers be replaced?)
Higher indirect taxes on goods such astobacco the impact on demand fornicotine patches and other substitutes
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Applications of Cross Elasticity (2)
Effect on demand fordifferent modes of masstransport followingintroduction of road pricingschemes in urban areas (e.g.the London congestioncharge and the M6 TollRoad)
Rise in the price of naturalgas effect on the demandfor coal used in power
generation
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Homework
Revise for test next lesson to reviewbasic definitions, formulas, diagrams,elastic & inelastic numbers
PeD
YeD
PeSCPeD