User:Hanyue1009/Cross elasticity of demand

A Numerical Example of Cross Elasticity of Demand

Consider the following scenario: there are two products on the market: tea and coffee. A 10 percent increase in the price of tea is accompanied by a 4 percent increase in the quantity sought for coffee, and the cross elasticity of demand is equal to 4/10 = +0.4. Unrelated items will have a cross-elasticity of demand of 0, indicating no demand for them. Apple computers are in high demand, yet the price of apples has no effect on that demand. In the case of substitute goods, the demand for them will be positively cross-elastic. Complements will have a negative cross-elasticity of demand, indicating that they are substitute.

Weak Substitutes and Close Substitutes

Assume that the price of tea rises from $1.20 to $1.70, and we observe an increase in the demand for coffee in the market from 200 to 220 as a result of this increase. We can work out that the percent change in Q.D. = (220-200)/200 = 20/200 = 10%; percent change in price =(1.7-1.2)/1.2 = 0.5/1.2 = 41.67%. The cross elasticity of demand of coffee and tea is 10/41.67=0.24. Tea and coffee are weak substitutes with low cross elasticity. If tea prices rise, some consumers will switch to coffee. However, the taste of a drink is usually more essential than a slight price difference.

Costa and Starbucks are example of close substitutes. They are alternative brands of coffee. For example, when the price of Costa coffee increased from $2.30 to $2.7 and it results in an increase in quantity demanded of Starbucks coffee from 200 to 310. We can work out that the percent change in Q.D. = (310-200)/200 = 110/200 = 55%; percent change in price =(2.7-2.3)/2.3 = 0.4/2.3 = 17.39%. The cross elasticity of demand of coffee and tea is 55/17.39=3.16.The cross elasticity of demand of Costa and Starbucks is high. Advertising aims to enhance brand loyalty and reduce brand switching, even if prices rise (Deighton et al. 1994).

Reference:

Deighton, J., Henderson, C. M., & Neslin, S. A. (1994). The Effects of Advertising on Brand Switching and Repeat Purchasing. Journal of Marketing Research, 31(1), 28–43. https://doi.org/10.2307/3151944