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Cross price elasticity of demand (XED)

Cross price elasticity of demand 

           %DQD of good A/%DP of good B
       

      Cross price elasticity of demand (XED): the responsiveness of the quantity demanded of a good to the changes in price of a different good.
Allows us to compare the degree of which two goods are either substitutes or complements to each other.

When XED is negative, goods A and B are complements.
XED < -1, close complements. A small fall in the price of A causes a large rise in demand for B.  (e.g. iPhones and iOS apps)
Producers with close complementary goods may control the prices of one good to increase the revenue of the other.
XED between -1 and 0, weak complements. A large drop in the price of A causes only a small rise in the demand for B. (e.g. tea and sugar)
When XED is positive, goods A and B are substitutes.
XED > 0, weak substitutes, large rise in the price of A causes only a small rise in demand for B. (e.g. apples and pears)
XED > 1, close substitutes, small rise in the price of A causes large rise in demand for B. (e.g iPhones and Samsung phones)
Producers with these goods may engage in price wars and follow each other’s price cuts.
Inelastic goods are weak substitutes/complements and elastic goods are close substitutes/complements.
Producers of substitutes may look to differentiate their products from other substitutes, and make their substitute seem different. They may do this by changing the
>  Quality (e.g. Tesco’s Finest/’organic’)
>  Branding
>  Bundling with extras
>  Advertising

They may also attempt to merge/takeover a substitute, by buying a competing company. (e.g. Facebook purchasing Instagram)


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