Cross price elasticity is relative to two products, unlike price elasticity, which is just relative to a single product. Most often, cross price elasticity is used when discussing two goods which are either complementary or supplementary. If Ec, the coefficient of cross-price elasticity, calculated for Good X and Good Y, is a negative number, then we know that the two goods are complements, meaning that the two are often bought together (for example, hot dogs and hot dog buns or hamburger meat and hamburger buns.) However, if the coefficient of cross price elasticity for Goods X and Y is a positive number, then we know that the two goods are substitutes, meaning that the two are often bought in competition (for example, hot dogs and hamburger meat.) We say that two products that are complements are in joint demand, while two products that are substitutes are in competitive demand. The closer two substitutes are, the higher their positive value for Ec will be. In addition, the stronger a complementary relationship between two goods, the larger their negative value for Ec will be. Finally, we can also consider products that are unrelated, such as hot dogs and the Windows 10 OS. These products will have a cross price elasticity coefficient very near 0, because a change in price in one of these products should not affect a change of quantity demanded in the other.
I like how this post clarified cross price elasticity, especially in relation to supplementary and complementary goods. It is interesting to think about how the demand of one good has and impact on the demand for another good although they are separate. This reminds me on Amazon when you go to buy your item, it sometimes says "often bought with", then it gives you a list of a few items which would be complementary goods. Therefore, because of this marketing Amazon has, it may increase the demand for one of those recommended good even though the consumer only intended buying their original good. Having these complimentary goods in cross price elasticity overall helps the production side.
ReplyDeleteI like your explanation of the change in product prices when comparing two complementary goods. I think it is very interesting, just like Katherine stated, how companies can increase their revenue just by recommending a complementary good to a product you are already planning on purchasing. I think it is also interesting to see how products compare when they are substitute goods. The competitive demand between the products can drastically increase or decrease the price of a certain good, based solely on the success of the alternative product.
ReplyDeleteYour blog post very clearly explained the concept of cross elasticity of demand. An example of how the cross elasticity of demand can be applied is if Frito-Lay was considering whether or not to lower the price of Cheetos. Frito-Lay must identify if the price cut will increase or decrease total revenue and how the increased sales of Cheetos will come at the expense of Doritos. Put simply, Frito-Lay must determine how sensitive the sales of Doritos are to a change in the price of Cheetos. A low cross elasticity would indicate that Doritos and Cheeots are weak substitutes for each other and that a lower price for Cheetos would have little effect on Doritos sales.
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