Give the importance of value of Cross elasticity of demand for substitutes and complements?

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sciencesolve | Teacher | (Level 3) Educator Emeritus

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Since demand of one good represents the trigger for the demand of another good, the change of price of one good leads to the change of price of the related good. Hence, the cross elasticity of demand represents the measure of the level of responsiveness of a quantity demanded of a good with respect to the change in price of complementary or substitute good.

The evaluation of cross elasticity of demand is possible by means of the following formula:

`E_(xy) = ((Q_(x_2) - Q_(x_1))/[(Q_(x_2)+ Q_(x_1))/2])/((P_(y_2) - P_(y_1))/[(P_(y_2)+ P_(y_1))/2])`

The cross price elasticity is positive and goods are considered substitutes if both, the price of good y and the quantity demanded for the good x, are increasing.

The goods are considered complements if cross price elasticity is negative.

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