Tuesday, September 23, 2014

Elasticity 2 - XED, Cross Price Elasticity of Demand

Elasticity - XED

XED - (Cross Price Elasticity of Demand) - measures the responsiveness of the demand of one good to a change in the price of another.

Formula -

The sign (+ or - ) determines how we interpret XED for a product:

XED > 0, the two goods are substitutes, if one becomes more expensive then consumers switch to                       the other.

XED < 0, the two goods are compliments, or jointly demanded: if one becomes more expensive and                    people buy less, they will also buy less of the other one.

XED = 0, the two goods are unrelated

XED is positive, or XED >  0 

Notice, this is not a demand curve,,, this is a representation using a graph to show the relationship between two competitive goods. As coffee (P to P1) becomes more expensive consumers switch to drinking tea. (Q to Q1), apply the same to the Coke and Pepsi graph.

XED < 0, or XED is negative
Notice, this is not a demand curve,,,, The price of sugar rises and the quantity of tea demanded will fall. 

2009B - AP Microeconomics Exam FRQ, #2 

Answer - if XED is > 1 or positive, then the goods are substitutes, and therefore if the price of  bananas increases (due to crop failure), then the demand for peanuts will increase. Also the equilibrium price and quantity of peanuts will both increase.

Elasticity Cheat Sheet