CROSS ELASTICITY OF DEMAND

WEEK EIGHT

CROSS ELASTICITY OF DEMAND

CONTENT

• Definition
• Types (Positive and Negative)
• Measurement of Income Elasticity of Demand

DEFINITION: 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.

EVALUATION

1. Briefly explain cross elasticity of demand
2. Differentiate between complementary goods and substitute goods in relation to cross elasticity of demand

Illustration: 

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

                                   Price                                                           Demanded      

                                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.

SOLUTION:

1. 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%

1. 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%

EVALUATION

1. How would you deduce complementary goods from a calculation of cross elasticity?
2. WAEC June 2000 Question No 2.

READING ASSIGNMENT

1. Comprehensive Economics Page 124 – 127
2. Fundamentals of Economics Page 227 – 236

GENERAL EVALUATION QUESTIONS

1. What are capital goods
2. Explain five reasons why a joint stock company is preferable to a one-man business.
3. State the law of Diminishing returns.
4. Define Labour as a factor of production.
5. What are the factors affecting the size of a firm?
6. Distinguish between fixed and variable cost

WEEKEND ASSIGNMENT

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
2. 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
3. The cross elasticity of demand for close substitute goods is always……. (a) inelastic (b) zero (c) elastic (d) indeterminable
4. 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
5. The measurement of cross elasticity of demand  for complementary goods is…. (a) inelastic (b) zero (c) elastic (d) indeterminable

SECTION B

1. How is cross elasticity of demand measured?
2. Shoe the nature of cross elasticity of demand for : (i) substitute goods, (ii) complementary goods