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PRICE ELASTICITY | INCOME ELASTICITY | CROSS ELASTICITY OF DEMAND

| Nikita V Soni

Introduction

In microeconomics there are many concepts that allow any economist detailed knowledge of the working market: Price Elasticity of Demand, Income Elasticity of Demand and Cross Elasticity of Demand. In this booklet, these three essential concepts will be explained and interpreted for a better understanding and also as to why people utilize these specific theories. These three closely-related concepts that offer the economist insight on demand activities for a prosperous consumer, producer and competitor.

CROSS ELASTICITY OF DEMAND

Definition: The cross elasticity of demand is a microeconomic concept that measures how the change in price in one product affects the change in demand of another. Cross elasticity of demand depends on whether the products are substitutes, which are two different brands of the same product, or complements, which are two separate products that are related to each other, like a computer system with its compatible software and hardware.

Formula: Utilizing this formula can help the makers of products devise pricing and marketing strategies This number is reached by dividing the percentage change of price in the one product into the percentage change of demand for the other.
XED = % change in QD good A % change in price good B

Lets say that a Brand A Automotives price increased by 20 percent. In the same period of time Brand B Automotives sales rose 30 percent Therefore: XED = 30%/20% XED = -1.5 When two products are substitutes, is usually a positive number. Raise in price of one brand of the product should lead to a higher demand for a competing brand. If one brand drops prices, the demand for a competing brand will drop. In that case, the dividing the two negatives still produces a positive number. When the two products are complements, it is usually a negative number. If the price rises, the demand for the drop. In that a positive number would be divided into a negative number, which produces a negative result. A XED result at or near zero likely means that the two products in question are unrelated.

Industries/companies that use cross-price elasticity of demand use the data to build marketing strategies and plan responses to the competitor.

REFERNCE: http://www.wisegeek.com/what-is-the-cross-elasticity-of-demand.htm

Conclusion

To conclude, these theories aid businesses and industries make crucial decisions whereby quick and well planned strategies can be implemented. From the house hold economist that must budget and plan his/her income to achieve the best quantity of demand on essential goods and luxury items, while still taking into account the price fluctuation in the markets, these concepts help one to prosper. The Cross Elasticity gives important insight on complementary items and substitutes. This information is best used when competitors try to have a foresight on leading groups of consumer demand.