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ECON 1010 (102)
Lecture 14

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Department
Economics
Course
ECON 1010
Professor
Sarrah Vakili
Semester
Winter

Description
Lecture 14: Cross Price Elasticity of Demand Cross price elasticity (CPed) measures the responsiveness of demand for good X following a change in the price of good Y (a related good).With cross price elasticity we make an important distinction between substitute products and complementary goods and services Substitutes: With substitute goods such as brands of cereal or washing powder, an increase in the price of one good will lead to an increase in demand for the rival product. Cross price elasticity for two substitutes will be positive. For example, in recent years, the prices of new cars have been either falling or relatively flat. As the price of new cars relative to people’s incomes has declined, this should increase the market demand for new cars and (ceteris paribus) reduce the demand for second hand cars. We can see that there has been a very marked fall in the prices of second hand cars. Complements: With goods that are in complementary demand, such as the demand for DVD players and DVD videos, when there is a fall in the price of DVD players we expect to see more DVD players bought, leading to an expansion in market demand for DVD videos. The cross price elasticity of demand for two complements is negative. The stronger the relationship between two products, the higher is the co-efficient of cross- price elasticity of demand. For example with two close substitutes, the cross-price elasticity will be strongly positive. Likewise when there is a strong complementary relationship between two products, the cross-price elasticity will be highly negative. Unrelated products have a zero cross elasticity. How can businesses make use of the concept of cross price elasticity of demand? Pricing strategies for substitutes: If a competitor cuts the price of a rival product, firms use estimates of cross-price elasticity to predict the effect on the quantity demanded and total revenue of their own product. For exam
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