Cross elasticity of demand

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In economics, the cross elasticity of demand and cross price elasticity of demand
measures the responsiveness of the demand of a good to a change in the price of another
good.

It is measured as the percentage change in demand for the first good that occurs in
response to a percentage change in price of the second good. For example, if, in response
to a 10% increase in the price of fuel, the demand of new cars that are fuel inefficient
decreased by 20%, the cross elasticity of demand would be −20%/10% = −2.

The formula used to calculate the coefficient cross elasticity of demand is

or:

Two goods that complement each other show a negative cross elasticity of demand: as the
price of good Y rises, the demand for good X falls

In the example above, the two goods, fuel and cars(consists of fuel consumption), are
complements; that is, one is used with the other. In these cases the cross elasticity of
demand will be negative, as shown by the decrease in demand for cars when the price of
fuel increased. In the case of perfect complements, the cross elasticity of demand is
negative infinity.

Where the two goods are substitutes the cross elasticity of demand will be positive, so
that as the price of one goes up the demand of the other will increase. For example, in
response to an increase in the price of carbonated soft drinks, the demand for non-
carbonated soft drinks will rise. In the case of perfect substitutes, the cross elasticity of
demand is equal to infinity.

Where the two goods are independent, the cross elasticity of demand will be zero: as the
price of one good changes, there will be no change in demand for the other good.

When goods are substitutable, the diversion ratio—which quantifies how much of the
displaced demand for product j switches to product i—is measured by the ratio of the
cross-elasticity to the own-elasticity multiplied by the ratio of product i's demand to
product j's demand. In the discrete case, the diversion ratio is naturally interpreted as the
fraction of product j demand which treats product i as a second choice,[1] measuring how
much of the demand diverting from product j because of a price increase is diverted to
product i can be written as the product of the ratio of the cross-elasticity to the own-
elasticity and the ratio of the demand for product i to the demand for product j. In some
cases, it has a natural interpretation as the proportion of people buying product j who
would consider product i their "second choice".