XED Cross-Price Elasticity of Demand
This second type of elasticity measures the responsiveness of consumers of a particular good to a change in the price of a related good.” Cross Price Elasticity -XED
The formula: XED = %ΔQA %ΔPB %ΔQAis the percentage change in quantity of good A. %ΔPBis the percentage change price of good B. The XED Coefficient
Substitutes XED measures how much demand for a good decreases when the price of a substitute falls. We will see the coefficient as positive – meaning there is substitution relationship Compliments XED tells us how much demand will increase for a good when the price of a compliment falls. We will see the coefficients as negative– meaning there is a complementary relationship. Compliments and Substitutes
The range of values is important. The sign tells us the relationship between the goods. • If the value of XED is positive, then goods are substitutes for each other, e.g. Coke and Pepsi. • The larger the value, the closer the relationship. • If the value of XED is negative, then goods are complements for each other, e.g. DVD players and DVDs. • The larger the value, the closer the relationship. • If the value of XED is zero, then the goods are unrelated, e.g. strawberries and mobile phones. Page 54 in Blue Book XED VALUES AND THE STRENGTH OF THE RELATIONSHIP BETWEEN PRODUCTS
Firms need to be aware of XED – • To help them understand competitor’s price changes and the effect on demand • To be aware of their own complementary goods and the effect on one price change versus their other products. Why is it important?
The HOMEWORK! Trade and grade!
The Answers: 8. XED= % change in the quantity of one good over % change in the price of a related good. Therefore, XED=-5/15 =- 0.33. Since the XED is negative, the good must be complements. An example of complementary goods is charcoal and charcoal barbeques. If the charcoal prices rise, we would expect barbeque sales to fall. (2 marks) 9. (1000-600)/600 = 0.67/-0.2 =-3.35 (20-25)/25 The two goods must be complementary goods, because the XED coefficient is negative. An example is footballs and football shoes. The two goods in this example are cross-price elastic, since the absolute value of the XED coefficient is greater than one. (2 marks) 10. -0.8 = %ΔQ = %ΔQ/0.25 (5-4)/4 To find the % change in tennis rackets, simplify the equation: -0.8x 0.25 = -0.2 So a 25% increase in the price of tennis balls led to a decrease in demand for tennis rackets of 20%. (2 marks)
Camel Demand Soars in India – A Case Study • Camels and oil related? XED Coefficient? • We should see a substitute relationship. Like hybrid cars replace gas guzzling SUVs in the USA, camels in India can replace gas guzzling tractor for farming. Because it is a substitute relationship there would positive coefficient value. (2 marks) • Cross Price elasticity for camels and oil when oil rises ($110-$130) and quantity of camels increase from 250, 000 to 350,000. • (+100,000/250,000) x 100= 40%40% = +2.22 • ( +20/$110) x 100 + 18% 18% • Oil price increases 18%, and during same time period quantity of camels increase by 40%. There is a substitute relationship going on. • (2 marks) • Other factors that may affect camels as the “beast of burden”. • Life span and health of camels – their food is not abundant. • Lifestyle of people • Other uses for camels that may affect it as a farm work substitute for tractors (or other oil using equipment • Tractors that don’t run on oil? (2 marks)
Income elasticity of demand is a measure of how much the demand for a product changes when there is a change in the consumer’s income.” Income Elasticity of Demand-YED
The formula: YED = %ΔQd of the product %Δ in income of the consumer The YED Coefficient
The sign tells us the type of good that is being considered. • Necessity goods are products that have low-income elasticity, essential products, e.g. bread. • Superior goods are products that have high-income elasticity, non-essential products, e.g. foreign holidays. • Inferior goods are products that have negative income elasticity, because the demand decreases as income increases, e.g. cheap wine or non-brand name jeans. Page 55 in Blue Book The Range of Values for Income Elasticity of Demand
Therange of values is important. • For normal goods, the value of YED is positive, i.e. as income increases the demand for the good increases. • If the value is between zero and 1, then the YED is said to be income inelastic. • If the value is greater than 1, then the YED is said to be income elastic. • NOTE: Engel Curve Figure 4.9 (potatoes fall as income of a country rises – instead they want pasta!) Page 55- 56 in Blue Book The Range of Values for Income Elasticity of Demand
Homework for Wednesday Page 54 Workpoint 4.5 Page 56 Workpoint 4.6 Read over pp56-61 Page 61 – “You be the journalist” Write and submit a typed article regarding the Headline listed , the economic concept and the suggested diagram. (refer to p 17 if you need an example of how to do this!)