After you have worked through this section of the learning unit, you should be able to:

  • describe cross elasticity and the measurement of cross elasticity
  • distinguish between the cross elasticity of complements and substitutes

A change in the price of one good can shift the demand for another good. If the two goods such as bread and peanut butter are complements, then a drop in the price of one good will lead to an increase in the demand for the other good.

However, if the two goods, such as plane tickets and train tickets, are substitutes, then a drop in the price of one good will cause people to substitute that good and reduce consumption of the other good. Cheaper plane tickets lead to fewer train tickets, and vice versa.

The cross-elasticity of demand puts some meat on the bones of these ideas. Specifically, the cross-elasticity of demand is the responsiveness of quantity demanded of one good to a change in the price of another good.

Cross elasticity of demand is calculated as the percentage change in the quantity of good A that is demanded as a result of a percentage change in the price of good B.

$$\text{Cross-elasticity } e_c = {\text{% change in } Q_d \text{ of good A} \over \text{% change in P of good B}}$$