Financing and Marketing Management

Unit 11 - Elasticity

11.4. Cross elasticity
Here, a change in the price of one good causes a change in the demand for another. Cross elasticity of Demand for X and Y

= proportionate change in purchases of commodity x

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 Proportionate change in the price of commodity y

This type of elasticity arises in the case of inter-related goods such as substitutes and complementary goods. The two commodities will be complementary, if a fall in the price of Y increases the demand for X and conversely, if a rise in the price of one commodity decreases the demand for the other. They will be substitute or rival goods if a reduction in the price of Y decreases the demand for X, and also if a rise in price of one commodity (say tea) increases the demand for the other commodity (say coffee). The cross elasticity of complementary goods is positive and that between substitutes, it is negative. It should, however, be remembered that cross elasticity will indicate complementarities or rivalry only if the commodities in question figure in the family budget in small proportions. Cross elasticity of demand can be used to indicate boundaries between industries. Goods with high cross elasticity constitute one industry, whereas goods with low cross elasticity constitute different industries. It is not to be supposed that cross elasticity represents reciprocal relationship. It is not a two-way street. The cross elasticity of a tea with respect to coffee is not the same as that of coffee with respect to tea. The tastes of the consumer, his money income and all prices except of the commodity Y are assumed to remain constant.