3.5 cross price elasticity

7/31/2019 3.5 Cross Price Elasticity

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Cross Price Elasticityof Demand

AS Economics


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Cross Elasticity of Demand (CPed)

Cross price elasticity (CPed) measures theresponsiveness of demand for good X followinga change in the price of good Y (a related good)

CPeD = % change in qty D of product A

% change in price of product B

With cross price elasticity we make an importantdistinction betweensubstitute products andcomplementary goods and services.


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Identify some Substitutes
http://images.google.co.uk/imgres?imgurl=http://www.istartedsomething.com/wp-content/uploads/2006/11/winlogocompression.jpg&imgrefurl=http://www.istartedsomething.com/20061108/microsoft-low-quality-logos/&h=316&w=359&sz=17&hl=en&start=2&tbnid=8pXQq9O2MWTB7M:&tbnh=107&tbnw=121&prev=/images%3Fq%3Dmicrosoft%2Blogo%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://www.perdue.com/files/Easy%2520Sunder%2520Dinner%2520Roast%2520Chicken.jpg&imgrefurl=http://www.perdue.com/recipes/recipe_detail.html%3Fid%3D81&h=300&w=367&sz=95&hl=en&start=16&tbnid=QUI2Z-UQax74KM:&tbnh=100&tbnw=122&prev=/images%3Fq%3Droast%2Bchicken%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://my.telegraph.co.uk/VirtualContent/90408/20070810085337.jpg&imgrefurl=http://my.telegraph.co.uk/papaguinea/august_2007/&h=375&w=500&sz=18&hl=en&start=1&tbnid=o-jiRjNJ1xWk8M:&tbnh=98&tbnw=130&prev=/images%3Fq%3Dcup%2Bof%2Btea%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://www.themillsfansite.com/reviews/review_images/28-6-2006-frosties.jpg&imgrefurl=http://www.themillsfansite.com/reviews/index.php%3Fm%3D6%26y%3D2006&h=260&w=290&sz=18&hl=en&start=11&tbnid=FksoceyyaOG7aM:&tbnh=103&tbnw=115&prev=/images%3Fq%3Dfrosties%2Blogo%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://www.costpernews.com/wp-content/uploads/2007/05/google_logo.jpg&imgrefurl=http://www.costpernews.com/2007/05/03/what-if-google-bought-dow-jones-google-street-journal/&h=1500&w=3600&sz=277&hl=en&start=2&tbnid=-BCryA-2oHT9GM:&tbnh=63&tbnw=150&prev=/images%3Fq%3Dgoogle%2Blogo%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://uk.wrs.yahoo.com/_ylt=Al_rmiKeuPLNl0kz1uuLD7VNBQx.;_ylu=X3oDMTBpZm5udGl1BHBvcwM1BHNlYwNzcgR2dGlkAw--/SIG=1f65d05sq/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dbraeburn%252Bapples%2526fr%253Dyfp-t-501%2526ei%253DUTF-8%26w=125%26h=121%26imgurl=www.apples-cherries.com%252Ffarm%252Fimages%252Fproducts%252FBraeburn-apples.jpg%26rurl=http%253A%252F%252Fwww.friske.com%252Fhcrisp.htm%26size=3.1kB%26name=Braeburn-apples.jpg%26p=braeburn%2Bapples%26type=jpeg%26no=5%26tt=251%26oid=d2d5541cc6378c78%26ei=UTF-8


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Identify some Complements
http://uk.wrs.yahoo.com/_ylt=AnPwPUEo.EMRUdfZSWoo1N5NBQx.;_ylu=X3oDMTBpc2VvdmQ2BHBvcwM3BHNlYwNzcgR2dGlkAw--/SIG=1f8s19mec/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dchopsticks%2526ei%253DUTF-8%2526fr%253Dyfp-t-501%2526x%253Dwrt%26w=1355%26h=385%26imgurl=www.colleenmcallahan.net%252Fwsbredesign%252Fchopsticks.jpg%26rurl=http%253A%252F%252Fwww.colleenmcallahan.net%252Fwsbredesign%252Fware.html%26size=37.7kB%26name=chopsticks.jpg%26p=chopsticks%26type=jpeg%26no=7%26tt=77,743%26oid=6d47b65beab8fada%26ei=UTF-8http://uk.wrs.yahoo.com/_ylt=Aj1uzxzFhM7L0INOwzu5Ch1NBQx.;_ylu=X3oDMTBpc2ozM2gzBHBvcwM0BHNlYwNzcgR2dGlkAw--/SIG=1f71imp23/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dscone%2526fr%253Dyfp-t-501%2526ei%253DUTF-8%26w=239%26h=200%26imgurl=ukstudentlife.com%252FBritain%252FFood%252FCooking%252FScone%252FScone.jpg%26rurl=http%253A%252F%252Fparentheticalremarks.blogspot.com%252F2005%252F04%252Fidiot-box.html%26size=12.5kB%26name=Scone.jpg%26p=scone%26type=jpeg%26no=4%26tt=43,669%26oid=5d882d9a2c66b090%26ei=UTF-8http://images.google.co.uk/imgres?imgurl=http://www.laptoppicker.com/archives/sony-vaio-n-laptop.jpg&imgrefurl=http://www.laptoppicker.com/archives/laptop-bargains.html&h=311&w=359&sz=21&hl=en&start=4&tbnid=EciFWIo8lvmJVM:&tbnh=105&tbnw=121&prev=/images%3Fq%3Dlaptop%26gbv%3D2%26svnum%3D10%26hl%3Denhttp://images.google.co.uk/imgres?imgurl=http://my.telegraph.co.uk/VirtualContent/90408/20070810085337.jpg&imgrefurl=http://my.telegraph.co.uk/papaguinea/august_2007/&h=375&w=500&sz=18&hl=en&start=1&tbnid=o-jiRjNJ1xWk8M:&tbnh=98&tbnw=130&prev=/images%3Fq%3Dcup%2Bof%2Btea%26gbv%3D2%26svnum%3D10%26hl%3Den


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Cross Price Elasticity for Substitutes

Product CloseSubstitute

WeakSubstitute

Good with norelationship

Coca Cola

Camembert Cheese

Euro Star Journeyfrom London to Paris

Dowe Egberts FilterCoffee

Ticket to a film at theUGC Cinema inSlough


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Complementary Goods

Product CloseComplement

WeakComplement

Good with norelationship

Personal Computer

A bottle of expensivewhite wine

Short Break Weekendin Barcelona


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Cross Elasticity of Demand (CPed)+ = Substitutes

Substitutes:With substitute goods

such as brands ofrazors, an increase in

the price of one goodwill lead to anincrease in demandfor the rival product

Weak substitutesinelastic CPedClose substitutes

elastic CPed

Cross price elasticity

will be positive


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Cross Elasticity of Demand (CPed)- = Complements

Complements:

Goods that are in

complementary demand

Weak complementsinelastic CPed

Close complements

elastic CPed

The cross price

elasticity of demandfor two

complements is

negative
http://images.google.co.uk/imgres?imgurl=http://www1.istockphoto.com/file_thumbview_approve/881749/2/istockphoto_881749_burger_bun_1.jpg&imgrefurl=http://www.istockphoto.com/file_closeup/%3Fid%3D881749%26refnum%3D465664&h=380&w=253&sz=19&hl=en&start=1&tbnid=QKKfzHFdyyNkAM:&tbnh=123&tbnw=82&prev=/images%3Fq%3Dburger%2Bbun%26gbv%3D2%26svnum%3D10%26hl%3Den


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The Diagrams!


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SubstitutesPrice of

Good S

Quantity demanded of

Good T

Demand

Two Weak Substitutes

P1

P2

Goods S and T are weaksubstitutes

A rise in the price of Good Sleads to a small rise in thedemand for good T

The cross price elasticity ofdemand will be positive butthe coefficient of elasticity willbe less than one

Ice cream andlollies!


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ComplementsPrice of

Good X


Good Y

Deman

d

Two Close Complements

P2P1

Goods X and Y are closecomplements

A fall in the price of good Xleads to a large rise in the

demand for good Y

The cross price elasticity ofdemand will be negative andthe coefficient of elasticity willbe more than one

Complements are said to bein JOINT DEMAND

Foreign holidays &air flights!


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Goods with zero cross-price elasticity ofdemand aka. INDEPENDENT

Price of

Good A


Good B

Demand

P1

P2

P3

Goods A and B have norelationship.

A fall in the price of good A

leads to no change in thedemand for good B

Therefore the cross-priceelasticity of demand is zero

Apples andgloves!


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Get your calculators ready

CPeD = % change in qty D of product A

% change in price of product B


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Calculate the CPeD and state whetherthe goods are complements or

substitutes?

1. A 10% rise in the price of fish may causedemand for chicken to increase by 2%.

2. The fall in the price of paper by 20% causes

the demand for pens to increase by 5%.3. A 20% rise in the price of ice cream causes

demand for sweets to increase by 4%.

4. A 12% fall in the price of air fares leads to a

30% rise in the demand for foreign holidays.5. A 10% rise in bikes will leave the demand for

cheese unaffected.


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Answers

A 10% rise in the price of fish may cause demand for chicken to increaseby 2%.

+2/+10 = +0.2

The fall in the price of paper by 20% causes the demand for pens toincrease by 5%.

+5/-20 = -0.25

A 20% rise in the price of ice cream causes demand for sweets toincrease by 4%.

+4/+20 = +0.2

A 12% fall in the price of air fares leads to a 30% rise in the demand for

foreign holidays.+30/-12 = -2.5

A 10% rise in bikes will leave the demand for cheese unaffected.

0/+10 = 0


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Look at some figures forinterpretation

Real statistics!


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Estimated Elasticity for

Alcohol

Estimated elasticities for the UK, 1993-96

Change in quantity of

Change in price of

Beer Wine Spirits

Beer -0.76 -0.6 -0.59

Wine -0.17 -1.69 0.66

Spirits -0.21 0.77 -0.86

Source: Crawford and Tanner (IFS, Fiscal Studies 1999)

In your own words explain

the wine CPeD numbers


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Importance of CPed for businesses

Firms can use CPed estimates to predict:

The impact of a rivals pricing strategies on demand for

their own products:

Pricing strategies for complementary goods:Popcorn and cinema tickets are strong

complements. Popcorn has a very high mark up i.e.popcorn costs pennies to make but sells for morethan a pound

If firms have a reliable estimate for XED they canestimate the effect, say, of a two-for-one cinematicket offer on the demand for popcorn
http://uk.wrs.yahoo.com/_ylt=AmpozhXvee1Q9NU0xtOlTRRNBQx.;_ylu=X3oDMTBpZm5udGl1BHBvcwM1BHNlYwNzcgR2dGlkAw--/SIG=1ebda9fcc/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dpopcorn%2526fr%253Dyfp-t-501%2526ei%253DUTF-8%26w=133%26h=120%26imgurl=www.celebratetheday.biz%252Ffoilballoons%252Ffood%252Fpopcorn_38.JPG%26rurl=http%253A%252F%252Fwww.celebratetheday.biz%252Ffood.html%26size=4.4kB%26name=popcorn_38.JPG%26p=popcorn%26type=jpeg%26no=5%26tt=322,556%26oid=e59676038f76c96c%26ei=UTF-8http://uk.wrs.yahoo.com/_ylt=AmpozhXvee1Q9NU0xtOlTRRNBQx.;_ylu=X3oDMTBpZm5udGl1BHBvcwM1BHNlYwNzcgR2dGlkAw--/SIG=1ebda9fcc/**http%3A//uk.images.search.yahoo.com/search/images/view%3Fback=http%253A%252F%252Fuk.images.search.yahoo.com%252Fsearch%252Fimages%253Fp%253Dpopcorn%2526fr%253Dyfp-t-501%2526ei%253DUTF-8%26w=133%26h=120%26imgurl=www.celebratetheday.biz%252Ffoilballoons%252Ffood%252Fpopcorn_38.JPG%26rurl=http%253A%252F%252Fwww.celebratetheday.biz%252Ffood.html%26size=4.4kB%26name=popcorn_38.JPG%26p=popcorn%26type=jpeg%26no=5%26tt=322,556%26oid=e59676038f76c96c%26ei=UTF-8


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Applications of Cross Elasticity (1)

Effects of the national minimum wage ondemand for younger and older workers(might younger workers be replaced?)

Higher indirect taxes on goods such astobacco the impact on demand fornicotine patches and other substitutes


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Applications of Cross Elasticity (2)

Effect on demand fordifferent modes of masstransport followingintroduction of road pricingschemes in urban areas (e.g.the London congestioncharge and the M6 TollRoad)

Rise in the price of naturalgas effect on the demandfor coal used in power

generation


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Homework

Revise for test next lesson to reviewbasic definitions, formulas, diagrams,elastic & inelastic numbers

PeD

YeD

PeSCPeD

3.5 cross price elasticity

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