CROSS ELASTICITY OF DEMAND

 Demand is also influenced by prices of other goods and services. The cross elasticity measures the responsiveness of quantity demanded to changes in price of other goods and services. Cross elasticity of demand is defined as the percentage change in quantity demanded of one good caused by a 1 percentage change in the price of some other good.

                                                          e_c = % ∆Q_x/% ∆P

Cross elasticity is used to classify the relationship between goods. 

• If cross elasticity is greater than zero, an increase in the price of y causes an increase in the quantity demanded of x, and the two products are said to be substitutes. 
• When the cross-elasticity is greater than zero, the goods or services involves are classified as complements.
•  Increases in the price of y reduces the quantity demanded of that product. 
• Diminished demand for y causes a reduced demand for x. 

Bread and butter, cars and tires, and computers and computer programs are examples of pairs of goods that are complements.

• The coefficient is positive if A and B are substitutes because the price change and the quantity change are in the same direction. 
• The coefficient is negative is A and B are complements, because changes in the price of one commodity cause opposite changes in the quantity demanded of the other. 
• Other things such as consumer taste for both commodities, consumer incomes and the price of the other commodity are held constant.

Many companies produce several related products. Where a company’s products are related, the pricing of one good can influence the demand for other products. Gillette makes both razors and razor blades. Ford sells several competing makes of automobiles. Gillette probably will sell more razor blades if it lowers the price of its razors.
The closer two commodities are as substitutes for each other, the greater is the size of the cross elasticity coefficient. Close substitutes have high cross elasticity of demand; poor substitutes have low cross elasticity.
In general, a rise in the price of a commodity increases the demand for its substitutes and diminishes the demand for its complements