In economics, the cross elasticity of demand or cross-price elasticity of demand measures the responsiveness of the demand for a good to a change in the price of another good. It is measured as the percentage change in demand for the first good that occurs in response to a percentage change in price of the second good. For example, if, in response to a 10% increase in the price of fuel, the demand of new cars that are fuel inefficient decreased by 20%, the cross elasticity of demand would be: 20%/10%=-2
A
negative cross elasticity denotes two products that are complements, while a
positive cross elasticity denotes two substitute products. These two key
relationships may go against one's intuition, but the reason behind them is
fairly simple: assume products A and B are complements, meaning that an increase in the demand for A is
caused by an increase in the quantity demanded for B. Therefore, if the price
of product B decreases, then the demand curve for product A shifts to the
right, increasing A's demand, resulting in a negative value for the cross elasticity of demand. The exact
opposite reasoning holds for substitutes.
The
formula used to calculate the coefficient cross elasticity of demand is EA,B=%
Change in quantity demanded of product A/% Change in price of product B