## Saturday, October 3, 2015

### XED Cross Price Elasticity - Substitutes

XED Cross Price Elasticity - Substitutes

XED - responsiveness of the Qd of a good (Good A) to a change in the price of another good (Good B). Cross 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 will compare it with the quantity change of another good (Good B).

Understand: You should be able to recognise that a positive XED (more than zero) is a substitute.

Substitutes are like Coke and Pepsi, Beef and Chicken. Goods that are substituted for one another.

If the price of Coke increases then people will switch to the cheaper good (Pepsi)

Price of Coke Increases and the Quantity Demand for Pepsi Increases
Notice the positive relationship.

Opposite is also true, if the price of Coke decreases the Quantity demanded for Pepsi decreases

again the formula:

8 - 6/6     OR    .333 = 1.333
5 - 4/4                .25

SO, no absolute value for XED (like PED) and more than zero (positive) and therefore a substitute.

Weakly related or strongly related substitutes I haven't seen tested in the AP Exam but references were there in some questions.

To Know: Substitutes

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

2) No absolute value for XED

3) XED > 0 -  Substitutes

4) Positive = Substitutes

5) Price of Good A increase the Quantity Demand of Good B increases or the price of good A decreases and the Quantity Demand of good B decreases

Examples -

Look at (b) (ii) one point is earned for explaining that peanuts and bananas are substitutes and since the price of bananas increased it would cause the demand for peanuts to increase.

Also look at (c) (i) One point is earned for stating that the substitution effect causes the quantity of bananas demanded to decrease.

The Substitution Effect - one of the three reasons the demand curve slopes down - as the price of one good rises, consumers will switch to the cheaper good.