cross-price elasticity of demand
/ XED /
Goods don't live alone; they have relatives. Raise the price of one thing and the demand for a different thing may move too. Petrol up, and people drive less, so demand for tyres softens. Coffee up, and some switch to tea, so demand for tea rises. Cross-price elasticity of demand measures exactly this ripple: how the quantity demanded of one good responds to a change in the price of another good.
It is the percentage change in the quantity demanded of good A divided by the percentage change in the price of good B. The clever part is what the sign tells you. If the number is positive — B gets dearer and people buy more of A — the two are substitutes, rival goods you swap between (tea and coffee, Uber and taxis). If the number is negative — B gets dearer and people buy less of A too — they are complements, goods used together, so making one pricey drags the other down with it (cars and petrol, printers and ink, game consoles and games). And if it's around zero, the two goods are basically unrelated (the price of shoelaces and the demand for bananas). The bigger the number's size, the stronger the relationship.
This is gold for business and for competition policy. A company watches the cross-price elasticity between its product and rivals' to judge how fiercely a competitor's price cut will steal its customers, and between its own products to price a printer cheap while making money on the ink (a razor-and-blades strategy). Regulators use it to define a market: if two products have a high positive cross-elasticity, they truly compete and a merger between them may concentrate power; if it's near zero, they're in separate markets. The familiar caution holds — these relationships shift with circumstances, and a strong number measured in one period may weaken in another.
When the price of butter jumps, sales of margarine rise — a positive cross-elasticity marks them as substitutes. When the price of game consoles falls, sales of games climb — a negative cross-elasticity marks them as complements.
Positive sign → substitutes; negative sign → complements; near zero → unrelated.
Mind the sign — it carries the whole meaning here, unlike own-price elasticity where people drop the minus. Positive means substitutes, negative means complements; reporting just the size would throw away the most important part.