Cross Elasticity of Demand is the degree of responsiveness of quantity demanded of commodity X to a little change in the price of commodity Y. Cross elasticity of demand is applicable mainly to goods that are close substitute as well as complementary goods. For example the demand for Milo will increase as a result of an increase in the price of Bournvita, all other things being equal.
Mathematically, cross elasticity of demand can be expressed as
% change in quantity demanded of commodity X
% change in price of commodity Y
TYPES OF CROSS ELASTICITY OF DEMAND
Positive Cross Elasticity of Demand: With substitute goods, the cross elasticity of demand is always positive, ( ie greater than zero), which means it is Elastic. This positive relationship is high with close substitutes and low with substitutes not very close.
Negative Cross Elasticity of Demand: With complementary (or jointly demanded goods), eg car and petrol, the cross elasticity of demand is always negative ( ie less than zero), which means it is Inelastic. Here, too, a high negative cross elasticity of demand indicates that the goods involves are highly complementary and, vice versa, i.e, a low negative cross elasticity of demand means that the goods concerned are not highly complementary.
- Briefly explain cross elasticity of demand
- Differentiate between complementary goods and substitute goods in relation to cross elasticity of demand
The table below shows the response of quantity demanded to changes in price for two pairs of commodities. Use the table to answer the questions that follow:
Commodities Changes in Commodities Changes in Quantity
Old# New# Old kg New kg
Bread 25 40 Yam 1000 3000
Liter of petrol 50 100 Car 400 250
Calculate the cross elasticity of demand for : (i) Bread and Yam, (ii) Petrol and Car.
- Cross elasticity of demand for bread and yam
Let x = yam, y = bread
Old demand = 1000kg, New demand = 3000kg
Change in demand = 3000 – 1000 = 2000kg
2000 x 100
= 1000 1 = 200%
Old price = #25, New price = #40
Change in price = 40 – 25 = #15
15 x 100
25 1 =60%
CE = 200
60 = 3.3%
- Cross elasticity of demand for petrol and car
Let x = car, y = petrol
Old demand = 400, New demand = 250
Change in demand = 400 – 250 = 150cars
150 x 100
400 1 = 37.5%
Old price = #50, New price = #100
Change in price = 100 – 50 = #50
50 x 100
50 1 = 100%
CE = 37.5
100 = 0.4%
- How would you deduce complementary goods from a calculation of cross elasticity?
- WAEC June 2000 Question No 2.
GENERAL EVALUATION QUESTIONS
- What are capital goods
- Explain five reasons why a joint stock company is preferable to a one-man business.
- State the law of Diminishing returns.
- Define Labour as a factor of production.
- What are the factors affecting the size of a firm?
- Distinguish between fixed and variable cost
1. When the coefficient of cross elasticity of demand is less than zero, it indicates…..? (a) complementary goods (b) composite goods (c) derived goods (d) competitive goods
- The proportionate change in quantity demanded of commodity A in response to a change in price of commodity B is…………… (a) arc elasticity of demand (b) price elasticity of demand (c) cross elasticity of demand (d) income elasticity of demand
- The cross elasticity of demand for close substitute goods is always……. (a) inelastic (b) zero (c) elastic (d) indeterminable
- The numerical value that shows the proportionate change in demand to a change in price of goods is known as …………. (a) coefficient of multiplier (c) coefficient of elasticity (c) coefficient of accelerator (d) coefficient of indexation
- The measurement of cross elasticity of demand for complementary goods is…. (a) inelastic (b) zero (c) elastic (d) indeterminable
- How is cross elasticity of demand measured?
- Shoe the nature of cross elasticity of demand for : (i) substitute goods, (ii) complementary goods