This calculator can aid you in determining the connection between the quantity sold of one product and the price of a different product. With this handy tool, you can quickly find out how two products correlate with each other. They could be complementary or substitute goods. Or perhaps they are completely uncorrelated products.
Whatever the case, the cross-price elasticity calculator can be of help. In this article, you can learn how to use this tool and which formula should be used when calculating cross-price elasticity. We will also provide some examples of relevant calculations for better understanding. Are you eager to find out more about cross-price elasticity? Let’s jump right into it!
Cross-Price Elasticity – What Is It?
As said before, cross-price elasticity is a measure of the responsiveness of one product to changes in the price of another. Actually, it is the percentage change in demand for a product, caused by a price change in another related product.
It can be calculated by dividing the percentage change in demand for a product by the percentage change in its own price. Likewise, this can be calculated by dividing the percentage change in quantity demanded of a product when there is a change in its own price, by the percentage change in quantity demanded of that product when there is no change in its own price.
For example, if the cross-price elasticity for two products A and B is 1, this means that if the price of “A” increases from $2 to $3, then it would cause an increase from 100 to 150 units sold. The cross-price elasticity between A and B would be 1.
Let’s check another example to help you understand how it works in practice. We will assume that your company is involved in the production of office chairs. Let’s say you sold a chair for $130 until now, but you have decided to cut the price to $90. This will affect the demand (it will increase) for your office chairs. The quantity sold will also increase due to the price reduction. That’s because more buyers will want to purchase your chairs.
What Is Cross Elasticity Of Demand?
Cross elasticity of demand is the measure of responsiveness in the quantity demanded for a good or service to changes in the price of another good or service. It is a measure of how much consumers will buy one product if the price of another product changes.
That said, it is measured by calculating the percentage change in demand for one good when there is a percentage change in price for another good. The cross-price elasticity of demand can be calculated by dividing the percentage change in quantity demanded for one good by the percentage change in price for that good. We will check the formula in the section below.
Formula: How to Calculate Cross Price Elasticity
Now that you know what cross-price elasticity is, you should also know how it’s calculated. Apply this formula:
CPE = (price₁A + price₂A) / (quantity₁B + quantity₂B) * ΔquantityB / ΔpriceA
“A” and “B” are products. So, you will need the following metrics:
- the initial price of the first product
- the final price of this product
- the change in its price
- the initial demand for the second product
- the final demand for this product, and
- the change in demand for this product.
The calculation consists of 5 steps. Here they are!
Step 1
After choosing product A, you should know the initial price of this product. We will assume that you want to buy Pepsi; let’s say 1 item of that product (1 can of Pepsi) can be bought for $0.69.
Step 2
Next, you should select product B and determine the initial quantity sold. If we take Coke, for example, approximately 680 million items (cans) are sold daily in the United States only.
Step 3
At this stage, it is necessary to determine the final price of Coke (product B). We will assume that Pepsi decided to reduce the price of their products to $0.59.
Step 4
Keep track of the change in the demand for Coke cans. In our example, we will assume that it dropped to 600 million items.
Step 5
Now that you have all details required to calculate cross-price elasticity, the last thing you need to do is use this formula:
CPE = (price₁A + price₂A) / (quantity₁B + quantity₂B) * ΔquantityB / ΔpriceA
CPE = (0.69 + 0.59) / (680,000,000 + 600,000,000) * 80,000,000 / 0.10
CPE = 1.28 / 1,280,000,000 * * 80,000,000 / 0.10
CPE = 0.0625 * 12.8
CPE = 0.8
So, cross-price elasticity is 0.8 in our example. Because it’s a positive value, we can conclude that both Pepsi and Coke are substitute goods.
Interpretation of the Cross-Price Elasticity Results
There could be 3 different situations when it comes to the CPE result. This coefficient can be equal to zero, positive, or negative. Let’s explain each of these results.
Elasticity is very close or equal to zero
This means that product A and product B are not correlated either. If the price of one of these products changes over time (whether it increases or drops), it will not affect the demand for the second product.
A negative cross-price elasticity
It’s characteristic of complementary products. This means when the demand for one product tends to decrease, the price of the complementary product will go up.
A great example is a correlation between an espresso maker and the pods it uses. If the price of the espresso maker goes up, fewer customers will be interested in buying the pods, which results in a decrease in demand.
A positive cross-price elasticity
It is typical for substitute products. What does it mean? Simply put, when the price of one product rises, there will be an increase in the demand for a similar or substitute product. This phenomenon is particularly obvious when two rival companies strive to own the entire market share by monopolizing the market.
For example, let’s check how it works when it comes to the iPhone and Samsung Galaxy. If the price of the iPhone tends to rise, more and more customers will start buying Samsung Galaxy, so the demand for this product will increase.