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Cross elasticity of demand

It measures the responsiveness of the quantity demanded of a commodity to a change in price of related commodities (substitutes and complementary), other things remaining constant. In other words, we study the changes in demand for one commodity in response to the changes in the price of other goods.
 
Symbolically, Cross elasticity of demand (Ec) can be represented as
 
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Description: 18746.png 
 
Substitute Products
 
In case of the substitute products, rise in price of one product will increase the demand of the other product and vice versa. In case of rise in the price of coffee, consumer will opt for substitute products like tea. In the graph given below the demand curve slopes upward showing more quantity of tea will be demanded in case of price rise of coffee. So there is direct relationship between price of a product and demand of substitute products.
 
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Substitute Products:

In case of the substitute products, rise in price of one product will increase the demand of the other product and vice versa. In case of rise in the price of coffee, consumer will opt for substitute products like tea. In the graph given below the demand curve slopes upward showing more quantity of tea will be demanded in case of price rise of coffee. So there is direct relationship between price of a product and demand of substitute products.
 
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So,
Ec > 0 (positive): Demand for a good rises in response to a rise in the price of another. It shows that the two goods are substitutes. Example - Tea and coffee
 
Ec = ∞: It shows that the two goods are perfect substitutes of each other.
 
Ec < 0 (negative): Demand for a good rises in response to a decrease in the price of another. It shows that the two goods are complementary. Example - Tea and sugar
 
Ec = 0: It shows that the two goods are totally unrelated.

 

Note: One need not base the classification of goods on the above rule. While goods between which cross elasticity is positive can be called substitutes, the goods between which cross elasticity is negative are not always complementary. This is because negative cross elasticity is also found when the income effect on the price change is strong.





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