CROSS ELASTICITY OF DEMAND (CED)
This measures the strength of the relationship between changes in the price of one good and the demand for another good, eg what is the effect on the demand fo tea if coffee prices rise.
Formula: % change in Demand A/ % change in Price B
Example one Price of apples rise by 10% Demand for bananas rise by 15%
CED: +15%/+10% = +1.5
Example two: price of bread rises by 20% Demand for butter falls by 15%
CED: -15%/+20% = - 0.75
Analysis: the sign of the coefficient will give a clue as to the relationship between the goods
+ sign: substitute goods (an increase in the price of apples has led to an increase in the demand for bananas)
- sign: complementary goods (an increase in the price of bread has led to the demand for butter falling)
Example one: positive cross elasticity of demand ( a 1% increase in the price of apples leads to a 1.5% increase in the price of bananas - elastic)
Example two: negative cross elasticity of demand (a 1% increase in the price of bread will lead to a 0.75 fall in the demand for butter - inelastic)
If CED = 0 there is no relationship between the products, ie a change in price of one good will have no affect on the demand for another good
INFLUENCES ON CED
closeness of substitutes/complementary goods
APPLICATIONS OF CED
firm's pricing strategy and production plans
domestic inflation and the demand for imports
Looking at this site will give examples of the CED for different forms of public transport with respect to the price of petrol