Economics
Cross Price Elasticity of Demand Formula
The cross price elasticity of demand formula measures the responsiveness of the quantity demanded for one good to a change in the price of another good. It is calculated by dividing the percentage change in the quantity demanded of one good by the percentage change in the price of the other good. A positive cross price elasticity indicates that the two goods are substitutes, while a negative value indicates they are complements.
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eBook - PDFEconomics for Investment Decision Makers
Micro, Macro, and International Economics
- Christopher D. Piros, Jerald E. Pinto(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
This cross-price elasticity of demand measures how sensitive the demand for good X is to changes in the price of some other good, Y, holding all other things constant. For some pairs of goods, X and Y, when the price of Y rises, more of good X is demanded. That is, the cross-price elasticity of demand is positive. Those goods are defined to be substitutes. Substitutes are defined empirically. If the cross-price elasticity of two goods is positive, they are substitutes, irrespective of whether someone would consider them similar. This concept is intuitive if you think about two goods that are seen to be close substitutes, perhaps like two brands of beer. When the price of one of your favorite brands of beer rises, what would you do? You would probably buy less of that brand and more of one of the cheaper brands, so the cross-price elasticity of demand would be positive. Alternatively, two goods whose cross-price elasticity of demand is negative are defined to be complements. Typically, these goods would tend to be consumed together as a pair, such as gasoline and automobiles or houses and furniture. When automobile prices fall, we might expect the quantity of autos demanded to rise, and thus we might expect to see a rise in the demand for gasoline. Ultimately, though, whether two goods are substitutes or complements is an empirical question answered solely by observation and statistical analysis. If, when the price of one good rises, the demand for the other good also rises, they are substitutes. If the demand for that other good falls, they are complements. And the result might not immediately resonate with our intuition. For example, grocery stores often put something like coffee on sale in the hope that customers will come in for coffee and end up doing their weekly shopping there as well.
eBook - PDF- William Boyes, Michael Melvin(Authors)
- 2015(Publication Date)
- Cengage Learning EMEA(Publisher)
A change in any one of these “determinants of demand” will cause the demand curve to shift, and a measure of elasticity exists for each. 20-2a The Cross-Price Elasticity of Demand The cross-price elasticity of demand measures the degree to which goods are substitutes or complements (for a discussion of substitutes and complements, see the chapter “Scarcity and Opportunity Costs”). The cross-price elasticity of demand is defined as the percentage change in the quantity demanded of one good divided by the percentage change in the price of a related good, everything else held constant. When the cross-price elasticity of demand is positive, the goods are substitutes; when the cross-price elasticity of demand is negative, the goods are complements. If a 1 percent increase in the price of a movie ticket leads to a 5 percent increase in the quan-tity of movies that are downloaded off the Internet, movies at the theater and down-loaded movies are substitutes. If a 1 percent rise in the price of a movie ticket leads to a 5 percent drop in the quantity of popcorn consumed, movies and popcorn are comple-ments. Complements are items used together while substitutes are items used in place of each other. 20-2b The Income Elasticity of Demand The income elasticity of demand measures the magnitude of consumer responsiveness to income changes. The income elasticity of demand is defined as the percentage change in the quantity demanded for a product divided by the percentage change in income, everything else held constant (Figure 3). Goods whose income elasticity of demand is greater than zero are normal goods . Products that are often called necessities have lower income elasticities than products known as luxuries. Gas, electricity, health-oriented drugs, and physicians’ services might be consid-ered necessities. Their income elasticities are about 0.4 or 0.5. On the other hand, people tend to view dental services, automobiles, and private education as luxury goods.
eBook - PDF- Steven A. Greenlaw, Timothy Taylor(Authors)
- 2015(Publication Date)
- Openstax(Publisher)
Again, how much it shifts depends on how large the (negative) income elasticity is. Cross-Price Elasticity of Demand A change in the price of one good can shift the quantity demanded for another good. If the two goods are complements, like bread and peanut butter, then a drop in the price of one good will lead to an increase in the quantity demanded of the other good. However, if the two goods are substitutes, like plane tickets and train tickets, then a drop in the price of one good will cause people to substitute toward that good, and to reduce consumption of the other good. Cheaper plane tickets lead to fewer train tickets, and vice versa. The cross-price elasticity of demand puts some meat on the bones of these ideas. The term “cross-price” refers to the idea that the price of one good is affecting the quantity demanded of a different good. Specifically, the cross-price elasticity of demand is the percentage change in the quantity of good A that is demanded as a result of a percentage change in the price of good B. Cross-price elasticity of demand = % change in Qd of good A % change in price of good B Substitute goods have positive cross-price elasticities of demand: if good A is a substitute for good B, like coffee and tea, then a higher price for B will mean a greater quantity consumed of A. Complement goods have negative cross- price elasticities: if good A is a complement for good B, like coffee and sugar, then a higher price for B will mean a lower quantity consumed of A. Chapter 5 | Elasticity 119 Elasticity in Labor and Financial Capital Markets The concept of elasticity applies to any market, not just markets for goods and services. In the labor market, for example, the wage elasticity of labor supply—that is, the percentage change in hours worked divided by the percentage change in wages—will determine the shape of the labor supply curve.
eBook - PDF- Steven A. Greenlaw, Timothy Taylor, David Shapiro(Authors)
- 2017(Publication Date)
- Openstax(Publisher)
Again, how much it shifts depends on how large the (negative) income elasticity is. Cross-Price Elasticity of Demand A change in the price of one good can shift the quantity demanded for another good. If the two goods are complements, like bread and peanut butter, then a drop in the price of one good will lead to an increase in the quantity demanded of the other good. However, if the two goods are substitutes, like plane tickets and train tickets, then a drop in the price of one good will cause people to substitute toward that good, and to reduce consumption of the other good. Cheaper plane tickets lead to fewer train tickets, and vice versa. The cross-price elasticity of demand puts some meat on the bones of these ideas. The term “cross-price” refers to the idea that the price of one good is affecting the quantity demanded of a different good. Specifically, the cross-price elasticity of demand is the percentage change in the quantity of good A that is demanded as a result of a percentage change in the price of good B. Cross-price elasticity of demand = % change in Qd of good A % change in price of good B Substitute goods have positive cross-price elasticities of demand: if good A is a substitute for good B, like coffee and tea, then a higher price for B will mean a greater quantity consumed of A. Complement goods have negative cross- price elasticities: if good A is a complement for good B, like coffee and sugar, then a higher price for B will mean a Chapter 5 | Elasticity 123 lower quantity consumed of A. Elasticity in Labor and Financial Capital Markets The concept of elasticity applies to any market, not just markets for goods and services. In the labor market, for example, the wage elasticity of labor supply—that is, the percentage change in hours worked divided by the percentage change in wages—will reflect the shape of the labor supply curve.
eBook - PDFMicroeconomics
Theory and Applications
- Edgar K. Browning, Mark A. Zupan(Authors)
- 2019(Publication Date)
- Wiley(Publisher)
Note that cross-price elasticity will be positive when the goods are substitutes (as are BMW and Mercedes cars) and negative when the goods are complements (for example, gasoline and cars). Indeed, the major use of this elasticity is to measure the strength of the complementary or sub- stitute relationship between goods. The concept of cross-price elasticity is widely used in antitrust cases. How a market is defined and how competitive it is depend on the avail- ability of substitutes. One way to ascertain substitutability is with a measure of the cross- price elasticity of demand. Elasticity of Supply The price elasticity of supply, or elasticity of supply, is a measure of the responsiveness of the quantity supplied of a commodity to a change in the commodity’s own price. It is defined as the percentage change in quantity supplied, Q s , divided by the percentage change in price. Using the Greek letter (epsilon) to represent price elasticity of supply, we can express it as (in point elasticity form): ( / ) ( / ) Q Q P P s s . Any upward-sloping supply curve—the increasing per-unit cost case—has a positive elas- ticity of supply because price and quantity supplied move in the same direction. If per- unit production costs are constant, the supply curve is horizontal, and the price elasticity of supply is infinity. For example, the supply of dimes in terms of nickels is a horizontal curve with a height of 2 at most banks. (Banks are willing to provide you an additional dime so long as you give them 2 nickels per dime.) As the price of dimes rises from 1.99 nickels (a rate at which banks would be unwilling to sell you any dimes in exchange for nickels) to 2 nickels (a rate at which banks would become willing to supply you quite a few dimes in exchange for nickels), the percentage change in quantity supplied (from zero to a lot of dimes) is infinite relative to the percentage change in price (from 1.99 to 2 nickels per dime).
eBook - PDF- Irvin Tucker(Author)
- 2018(Publication Date)
- Cengage Learning EMEA(Publisher)
ChAPTEr 5 • Price Elasticity of Demand 103 5–1 PRICE ELASTICITY OF DEMAND In Chapter 3, when you studied the demand curve, the focus was on the law of demand. This law states there is an inverse relationship between the price and the quantity demanded of a good or service. In this chapter, the emphasis is on measuring the relative size of changes in the price and the quantity demanded. Now we ask: By what percentage does the quantity demanded rise when the price falls by, say, 10 percent? 5–1a The Price Elasticity of Demand Midpoints Formula 1 Economists use a price elasticity of demand formula to measure the degree of consumer responsiveness, or sensitivity, to a change in price. Price elasticity of demand is the ratio of the percentage change in the quantity demanded of a product to a percentage change in its price. Price elasticity of demand explains how strongly consumers react to a change in price. Think of quantity demanded as a rubber band. Price elasticity of demand measures how “stretchy” the rubber band is when the price changes. Suppose a university’s enroll-ment drops by 20 percent because tuition rises by 10 percent. Therefore, the price elas-ticity of demand is 2 (−20 percent/+10 percent). The number 2 means that the quantity demanded (enrollment) changes 2 percent for each 1 percent change in price (tuition). Note there should be a minus sign in front of the 2 because, under the law of demand, price and quantity move in opposite directions. However, economists drop the minus sign because we know from the law of demand that quantity demanded and price are inversely related. The number 2 is an elasticity coefficient , which economists use to measure the degree of elasticity. The elasticity formula is E d uni003D.bold percentage change in quantity demanded percentage change in price where E d is the elasticity of demand coefficient. Here you must take care. There is a prob-lem using this formula .
No longer available |Learn more- (Author)
- 2014(Publication Date)
- College Publishing House(Publisher)
____________________ WORLD TECHNOLOGIES ____________________ Various research methods are used to determine price elasticity, including test markets, analysis of historical sales data and conjoint analysis. Definition PED is a measure of responsiveness of the quantity of a good or service demanded to changes in its price. The formula for the coefficient of price elasticity of demand for a good is: The above formula usually yields a negative value, due to the inverse nature of the relationship between price and quantity demanded, as described by the law of demand. For example, if the price increases by 5% and quantity demanded decreases by 5%, then the elasticity at the initial price and quantity = −5%/5% = −1. The only classes of goods which have a PED of greater than 0 are Veblen and Giffen goods. Because the PED is negative for the vast majority of goods and services, however, economists often refer to price elasticity of demand as a positive value (i.e., in absolute value terms). This measure of elasticity is sometimes referred to as the own-price elasticity of demand for a good, i.e., the elasticity of demand with respect to the good's own price, in order to distinguish it from the elasticity of demand for that good with respect to the change in the price of some other good, i.e., a complementary or substitute good. The latter type of elasticity measure is called a cross -price elasticity of demand. As the difference between the two prices or quantities increases, the accuracy of the PED given by the formula above decreases for a combination of two reasons. First, the PED for a good is not necessarily constant; as explained below, PED can vary at different points along the demand curve, due to its percentage nature. Elasticity is not the same thing as the slope of the demand curve, which is dependent on the units used for both price and quantity.
eBook - PDFMicroeconomics
A Global Text
- Judy Whitehead(Author)
- 2020(Publication Date)
- Routledge(Publisher)
This is to distinguish the responsiveness of the quantity demanded of a good to its own price rather than to the price of another good (cross price elasticity). It may be defined as: proportionate change in Q x η P = proportionate change in P x Using this formula the price elasticity of demand for good x can be written as: d Q x / Q x η P = d P x / P x Re-writing: d Q x P x η P = · d P x Q x 60 THE PRICE ELASTICITY OF DEMAND 3.2 Price elasticity of demand may be identified as elastic, inelastic or unitary elastic depending on the value of η P as follows: • If η P > 1 in absolute terms, demand is said to be price elastic. • If η P < 1 in absolute terms, demand is said to be price inelastic. • If η P = 1 in absolute terms, demand is said to be unitary elastic. It should be noted that price elasticity of demand for normal goods carries a negative value. That is because of the negative relationship between price and quantity (i.e. as price goes up, quantity goes down). However, typically, the value for price elasticity ( η P ) is written without the negative sign as the negative sign is understood. Where computation is involved the negative sign must be used. Consequences of the value of price elasticity Where the demand for a commodity is price elastic ( η P > 1 in absolute terms), the percentage change in the quantity demanded is greater than the percentage change in price and in the opposite direction. The significance is that if price is reduced by a certain proportion (say 10 per cent), the quantity demanded is increased by a greater proportion (say 15 per cent). Thus a price reduction leads to increased consumer expenditure on the good and consequently increased revenue for the seller of the good. A price increase, on the other hand, leads to a reduction in revenue for the seller of the good.
eBook - PDFEconomics
A Contemporary Introduction
- William A. McEachern(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 94 Part 2 Introduction to the Market System be represented as Δp and the change in quantity as Δq. The formula for calculating the price elasticity of demand E D between the two points is the percentage change in quan- tity demanded divided by the percentage change in price, or E D 5 Δq 4 Δp (q1q9)/2 (p1p9)/2 Again, the same elasticity results whether going from the higher price to the lower price or the other way around. This is sometimes called the midpoint formula, because the bases for computing percentages are midway between the two points on the curve. Elasticity expresses a relationship between two amounts: the percentage change in quantity demanded and the percentage change in price. Because the focus is on the per- centage change, we don’t need to be concerned with how output or price is measured. For example, suppose the good in question is apples. It makes no difference in the elasticity formula whether we measure apples in pounds, bushels, or even tons. All that matters is the percentage change in quantity demanded. Nor does it matter whether we measure price in U.S. dollars, Mexican pesos, Zambian kwacha, or Vietnamese dong. All that matters is the percentage change in price. Finally, the law of demand states that price and quantity demanded are inversely related, so the change in price and the change in quantity demanded move in opposite directions. In the elasticity formula, the numerator and the denominator have opposite signs, leaving the price elasticity of demand with a negative sign.
eBook - PDFMicroeconomics
A Contemporary Introduction
- William A. McEachern(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
Copyright 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 94 Part 2 Introduction to the Market System be represented as Δ p and the change in quantity as Δ q . The formula for calculating the price elasticity of demand E D between the two points is the percentage change in quan-tity demanded divided by the percentage change in price, or E D 5 Δ q 4 Δ p ( q 1 q 9 )/2 ( p 1 p 9 )/2 Again, the same elasticity results whether going from the higher price to the lower price or the other way around. This is sometimes called the midpoint formula , because the bases for computing percentages are midway between the two points on the curve. Elasticity expresses a relationship between two amounts: the percentage change in quantity demanded and the percentage change in price. Because the focus is on the per-centage change , we don’t need to be concerned with how output or price is measured. For example, suppose the good in question is apples. It makes no difference in the elasticity formula whether we measure apples in pounds, bushels, or even tons. All that matters is the percentage change in quantity demanded. Nor does it matter whether we measure price in U.S. dollars, Mexican pesos, Zambian kwacha, or Vietnamese dong. All that matters is the percentage change in price. Finally, the law of demand states that price and quantity demanded are inversely related, so the change in price and the change in quantity demanded move in opposite directions.
eBook - PDF- Steven A. Greenlaw, David Shapiro, Daniel MacDonald(Authors)
- 2022(Publication Date)
- Openstax(Publisher)
This issue reaches beyond governments and taxes. Every firm faces a similar issue. When a firm considers raising the sales price, it must consider how much a price increase will reduce the quantity demanded of what it sells. Conversely, when a firm puts its products on sale, it must expect (or hope) that the lower price will lead to a significantly higher quantity demanded. 5.1 Price Elasticity of Demand and Price Elasticity of Supply LEARNING OBJECTIVES By the end of this section, you will be able to: • Calculate the price elasticity of demand • Calculate the price elasticity of supply Both the demand and supply curve show the relationship between price and the number of units demanded or supplied. Price elasticity is the ratio between the percentage change in the quantity demanded (Qd) or supplied (Qs) and the corresponding percent change in price. The price elasticity of demand is the percentage 112 5 • Elasticity Access for free at openstax.org change in the quantity demanded of a good or service divided by the percentage change in the price. The price elasticity of supply is the percentage change in quantity supplied divided by the percentage change in price. We can usefully divide elasticities into three broad categories: elastic, inelastic, and unitary. Because price and quantity demanded move in opposite directions, price elasticity of demand is always a negative number. Therefore, price elasticity of demand is usually reported as its absolute value, without a negative sign. The summary in Table 5.1 is assuming absolute values for price elasticity of demand. An elastic demand or elastic supply is one in which the elasticity is greater than one, indicating a high responsiveness to changes in price. Elasticities that are less than one indicate low responsiveness to price changes and correspond to inelastic demand or inelastic supply. Unitary elasticities indicate proportional responsiveness of either demand or supply, as Table 5.1 summarizes.
- Berkeley Hill(Author)
- 2013(Publication Date)
- Pergamon(Publisher)
An example is butter and margarine. When the price of butter rises, consumers will buy more margarine. Fig. 3.9 shows that a rise in the price of a competi- Demand and Supply 59 FIG. 3.9 Effect on the Demand Curve of a Price Rise of a Competitive Good I σ E o α> o Quantity of margarine demanded per week tive good shifts the demand curve of margarine (i.e. the curve showing quantities of margarine demanded at different prices of margarine) to the right. The sensitivity of demand for margarine to the price of competitive goods, called the Cross Elasticity of Demand, is given by the formula: PERCENTAGE CHANGE IN QUANTITY CROSS ELASTICITY OF = OF GOOD A DEMANDED DEMAND FOR GOOD A ( E D x ) PERCENTAGE CHANGE IN PRICE OF GOODB The actual figure for butter and margarine is about 4- 0.23 The ^Όχ of competitive goods is positive, since a rise in price of one will cause more of the other to be bought. (ii) Complementary goods: Complementary goods are those which are usually used together. An example is oil and petrol for cars. If more petrol is bought in any one year, more oil is also bought because cars use both together. Such goods are sometimes called Joint Demand goods. If the price of petrol rises but that of oil is unaltered, not only will less petrol be bought but less oil too. Cross elasticities of joint demand goods are negative. The effect on the demand curve for oil of a rise in the price of petrol is to shift it to the left, as in Fig. 3.10. There is a link between the cross elasticity of demand between two competitive goods and the price elasticities of demand of each good. Goods which are sensitive to prices of competitors will also tend to have Movement to right caused by a rise in the price of butter 60 An Introduction to Economics for Students of Agriculture FIG. 3.10 Effect on the Demand Curve of a Price Rise of a Complementary Good Ö *o <υ o Quantity of oil demanded per week shallow demand curves i.e.
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