It is an economic term that assesses the responsiveness of one good’s quantity required when the price of another good varies. This statistic, also known as cross-price elasticity of demand, is determined by dividing the percentage change in the amount requested for one item by the percentage change in the price of the other good.

Cross Elasticity of Demand Formula

Cross elasticity of demand= % change in quantity demanded for good 2 / %       change to price of good 1.

                                                % ΔQ₂/Q₂

Cross elasticity of demand= _________

                                                % ΔP₁P₁

Cross Elasticity of Demand EA, B
=	% increase in quantity demanded of A/
% increase in price of product B

Percentage changes in the above formula are calculated using the mid-point formula which divides actual change by average of initial and final values.

The formula to calculate cross elasticity thus becomes:

EA, B =	Qf − Qi	÷	Pf − Pi
(Qf + Qi) ÷ 2	(Pf + Pi) ÷ 2

Where,
Q_f and Q_i are the final and initial quantities demanded of product A, respectively; and
P_f and P_i are the final and initial prices of product B.

The cross elasticity of demand in economics refers to how sensitive demand for one product is to changes in the price of another.

Because demand for one product rises as the price of the substitute good rises, the cross elasticity of demand for substitute goods is always positive. If the price of coffee rises, for example, the demand for tea (a substitute beverage) rises as customers move to a less priced yet substitutable alternative. This is represented in the demand formula’s cross elasticity, since both the numerator (% change in tea demand) and denominator (coffee price) show positive increases.

Products having a coefficient of 0 are unconnected and are goods that are unrelated to one another. Goods may be weak substitutes, which means that the two things have a positive but low cross-elasticity of demand. This is frequently true for product substitutes, such as tea vs coffee. Products with high cross-elasticity of demand are powerful substitutes. Consider various tea brands; a price rise in one firm’s green tea has a greater influence on the demand for green tea in another firm.

Toothpaste is an example of a substitute good; if the price of one brand of toothpaste increases, the demand for a competitor’s brand of toothpaste increases in turn. Alternatively, the demand for complementary products has a negative cross elasticity. When the price of one thing rises, the price of the product closely related to that product and required for its consumption falls because demand for the main good falls.

For example, if the price of coffee rises, the demand for coffee stir sticks falls because consumers take less coffee and use fewer sticks. The formula has a negative numerator (the amount necessary of stir sticks) and a positive denominator (the price of coffee). As a result, the cross elasticity is negative.

A positive cross elasticity of demand indicates that when the price of product B rises, so will the demand for good A. This signifies that items A and B are suitable substitutes. As a result, if B becomes more costly, consumers will gladly switch to A. As an example, consider the price of milk. People may convert to 2 percent milk if the price of full milk rises. Similarly, if the price of 2% milk rises, whole milk becomes more popular.

A negative cross elasticity of demand suggests that when the price of product B rises, demand for good A falls. This implies that A and B are complementary items, such as a printer and printer ink. If the printer’s price rises, so will the demand for it. Less toner will be sold as a result of fewer printers being sold.

1.Firms use the cross elasticity of demand to set pricing for their commodities. Because there is no cross-elasticity of demand to consider, products with no substitutes can be offered at higher prices. Incremental price adjustments for products with alternatives, on the other hand, are assessed to identify the right amount of demand desired and the related price of the commodity.

2. Furthermore, complementary commodities are strategically priced depending on demand cross-elasticity. Printers, for example, may be sold at a loss with the expectation that demand for future supplementary items, such as printer ink, will grow.

3. Unrelated or independent goods refers to a situation in which two items have a zero cross-price elasticity coefficient. This suggests that the study reveals no link between consumption and demand patterns. As a result, a price adjustment in one product is unlikely to impact demand in the other.

Key Notes:

1) The cross elasticity of demand is an economic term that assesses how responsive one good’s demand is when the price of another commodity varies.

2) Because demand for one product rises as the price of the substitute good rises, the cross elasticity of demand for substitute goods is always positive.

• Alternatively, the demand for complementary items has a negative cross elasticity.

First, there are goods that are closely comparable – frequently referred to as substitute goods. In the market, these goods compete for the same consumers.

Second, some goods are consumed jointly. The consumption of related products is directly affected by the demand for one product. These are referred to as complementary goods.

The last category includes products that are completely unconnected to one another. These goods have no effect on one another’s consumption.

Company owners may strategically compete in their sector or stock their inventory if they comprehend the fundamentals behind product linkages. Lowering the price of printers, for example, may result in higher sales of toner and ink. The more printers people purchase, the more income is made through the sale of complementary goods.

Types of Cross Elasticity of Demand

There are three types of cross elasticity of demand:

1.Positive Cross Elasticity Of Demand:

The cross elasticity of demand for substitute goods is positive. If the price of tea rises, the demand for coffee will rise as well. Similarly, as the price of tea falls, so will the demand for coffee.

When two goods may be substituted for one another, the cross elasticity of demand is positive. In other words, when the price of Y rises, the demand for X rises as well. For example, when the price of tea rises, so will the demand for coffee.

2. Negative Cross Elasticity Of Demand:

The cross elasticity of demand for complementary products is negative. When the price of an automobile grows, so does the demand for gasoline. Similarly, a decrease in the price of an automobile will raise demand for gasoline. Because price and demand fluctuate in opposing directions, the demand cross elasticity is negative. The cross elasticity of demand for complementary items is negative. Because both commodities are desired jointly, a corresponding increase in the price of one commodity leads to a proportionate decrease in the demand for the other.

3. Zero:

When two goods are unrelated, the cross elasticity of demand is 0. For example, a rise in the price of an automobile has little effect on the demand for fabric. As a result, the cross elasticity of demand is zero.