Cross Elasticity of Demand

The cross eleasticity of demand (XED) is the responsiveness of a change in demand following a change in price of another.

Using XED we can identify if goods are substitutes, complimentary or unrelated. 

Substitutes are goods that are in direct competition with each other. For example X-Box and Playstation.

Comlimentary goods are goods that are commonly used and bought together. For example bread and butter.

Unrelated goods are goods that have no impact on each others demand. For example hair clippers and toasters.

The formula for XED is as follows:

When identifying the relationship between 2 goods the following rule applies:

• If two goods are substitutes then XED is always positive. 
• If two goods are compliments then XED is always negative.
• If two goods are unrelated then XED is always 0.

Substitutes always have a positive XED.

Close substitute means that if the price for one good rises a small amount then there is a large increase in demand for the other. A stong substitute will have a large positive value (greater than 1).

Weak substitute means that if the price for one good rises a small amount then there is a minimal increase in demand for the other. A weak substitute will have a small positive value (less than 1).

Complimentary goods always have a negative XED.

Strong compliment means that a small rise in the price for one good leads to a large decrease in the demand in another. Strong compliments have a large negative value (greater than -1).

Weak compliment means that a small rise in the price for one good will have a minimal decrease in the demand for another good. Weak compliments have a small negative value (less than -1).