Cross elasticity of demand (exy)
The cross elasticity of demand measures the responsiveness of demand for good X to a change in price of good Y. It is the ratio of a percentage change in the demand for good X to a percentage change in price of good Y, other factors remaining constant. Point cross elasticity is given by
Exy = (ΔQx/Qx)/ (ΔPy/Py)
where DQx and DPy refer respectively to the change in quantity demanded of good X to a change in the price of good Y.
Arc cross price elasticity of demand is measured with the following formula:
Exy = (ΔQx/ΔPy) X (Py1 + Py2 / Px2 + Px1 )
where subscripts 1 and 2 refer to the original and to the new levels of income and quantity, respectively, or vice versa.
The elasticity coefficients give significant results about the type of goods.
(a) If value of Exy is positive the two goods are substitutes (like Coca cola and Pepsi), because an increase in price of Y (Py) leads to an increase in quantity of X (Qx) as X is substituted for Y in consumption.
(b) If Exy is negative, goods X and Yare complementary (like petrol and cars), because an increase in Py leads to a reduction in Qx and Qy.
(c) If Exy is zero or close to zero then the two goods are totally unrelated or independent goods (like books and beer).
The concept is used to anticipate the effect on the sales of a firm to a change in price of their rivals. For example, the MUL can measure the effect of a change in the prices of Santro or Matiz on the demand for Zen.
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