Answer to Question #147754 in Microeconomics for TINA

Question

“There is a high cross elasticity of demand between new and old cars”. Discuss the statement by explaining the features of cross elasticity of demand. Also compare and contrast cross elasticity with other types of elasticities of demand.

Answer 1

Cross elasticity of demand is the ratio of proportionate change in the quantity demanded of commodity Y to proportionate change in the price of related commodity X.

When goods are a substitute for each other, then cross elasticity is positive. For instance, an increase in the price of new cars leads to an increase in the demand for old cars. Cross elasticity can be expressed as;

$Ce=\frac{proportionate change in the quantity of commodity Y}{proportionate change in the price of commodity X}$

In the case of complementary goods, the cross elasticity of demand is negative. This means that a rise in the price of a commodity will cause a fall in the quantity demanded of another.

Cross elasticity is zero when two goods are not related to one another. For example, an increase in the price of cars does not affect the demand for groceries.

Comparison between Cross elasticity and income elasticity of demand

Income elasticity is a relative change in the demand of one good or following a change in the consumer's income. Cross elasticity is the relative change in demand for one good or service following a change in the price of another good or service.

Income elasticity of demand is used to determine the difference between normal goods and inferior goods. Normal goods are those that their demand will increase following an increase in income. An example of a normal good is organic food. Inferior goods are those that demand decreases as income goes up. An example of an inferior good is clothing.

Cross elasticity of demand is used to determine whether two goods are substitutes or complements to each other. Substitutes are two goods that are similar to one another while compliments are goods that can be used together.