What Is Cross Elasticity? - Definition & Formula

Instructor: Brianna Whiting

Brianna has a masters of education in educational leadership, a DBA business management, and a BS in animal science.

In this lesson, we will learn about cross elasticity. We will define the term and learn how to measure it with a basic formula, as well as discussing other key terms such as substitutes and complements, before closing with a brief quiz.

Cross Elasticity Scenario

Take a minute to image you are a small business owner that sells toys. Christmas is right around the corner, and that means your business is about to get really busy. In preparation, you do a little research to find out which toys are sure to be on children's Christmas lists this year. You find that Sewing Suzy is projected to be the number one demanded toy for little girls, and so you order several cases in order to be prepared for the holiday rush.

However, as Christmas draws nearer, you begin to realize that Sewing Suzy is not selling as well as you had hoped. Instead, Painting Patty is disappearing off shelves everywhere. You see, shortly before Christmas, there was a huge increase in price for Sewing Suzy, and thus consumers opted for a cheaper doll, Painting Patty. You wonder, 'How did this happen?' We will answer this question as we explore the term cross elasticity.

Cross Elasticity Defined

To begin, I should mention that cross elasticity is also known as cross elasticity of demand. No matter what you choose to call it, lets explain what economists are referring to when they talk about cross elasticity: It is the measurement of the response for the demand of one good when there is a change in price of another good.

In other words, if one good changes in price, cross elasticity measures how much another good will be demanded in response to that change in price. For example, if there is an increase in price for Hill Soda, customers might change to another alternative, such as Blue Cow to get their caffeine fix. This would mean that there would be more Blue Cow demanded in response to the increase in Hill Soda.

Cross Elasticity Formula

How much of a change has occurred can be measured using the cross elasticity formula:

% change in the quantity demanded of good B / % change in price of good A

So, let's now apply this to an example. Let's use the Hill Soda and Blue Cow example from earlier. If there was a 10% increase in the price of Hill Soda, which lead to a 65% increase in demand for Blue Cow, we can calculate cross elasticity by plugging in the numbers.

65/10= 6.5

Thus, the cross elasticity of Hill Soda and Blue Cow is 6.5

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