Saturday, October 3, 2015

XED (Cross Price Elasticity) Compliments

XED (Cross Price Elasticity)

XED - the responsiveness of the Qd of a good (Good A) to a change in the price of another good, (Good B). Cross price elasticity determines whether the goods are substitutes or complements.

Formula

Understand:  That you will be given a price change of one good (Good A) and then compare it with the quantity change of another good (Good B) and will use this formula for computations.

Understand: That it is more likely that you should be able to recognise that a negative XED (less than zero) is a compliment.

Complements are like bread and butter or hamburgers and fries or Korean fried chicken and beer. Two goods that are consumed/used together.

If the price of Korean Fried chicken increases then we would expect a less quantity demanded of Korean fried chicken. Less fried chicken mean less beer consumed as they are consumed together.

So, price of good A (Korean Fried Chicken) increases and therefore the amount of beer consumed decreases (good B) Price increases and Qd decreases.

again the formula
So, 6 - 8/8    or    -.25    which is -1
5- 4/4             .25

So, no absolute value for XED (like PED) and less than 0 (negative) means that the two goods are compliments.

(Obviously, the opposite holds true - If the price decreases (good A) then the Qd of good B will increase.)

Weakly related or strongly related compliments I haven't seen tested in the AP exam but the reference was there in a couple of questions.

To know: Compliments

1) XED - (Cross price elasticity) - definition - the responsiveness of the Qd of a good (Good A) to a change in the price of another good, (Good B). Cross price elasticity determines whether the goods are substitutes or complements.

2) No absolute value for XED

3) XED < 0, then compliments

4) Negative = Compliment

5)  Price increases and Qd decreases or Price decreases and Qd increases.

Examples: I have only found one example.

Answer is (D) X is an inferior good and is a compliment to Y.

as the cross-price elasticity is negative, we understand that means the two goods are compliments