XED formula and classification
Relationship between two goods.
Cross Price Elasticity of Demand (XED):
Measures how demand for good A responds to a change in the price of good B.
Classification:
| XED | Relationship | Example |
|---|---|---|
| XED > 0 | Substitutes | Tea and coffee; Coke and Pepsi |
| XED < 0 | Complements | Cars and petrol; printers and ink |
| XED ≈ 0 | Unrelated | Apples and laptops |
Magnitude. A LARGE |XED| means CLOSE relationship.
- XED = 1.5 between two soft drinks → very close substitutes.
- XED = 0.2 between coffee and energy drinks → weak substitutes.
Worked example. Cinema ticket price falls 20%. Popcorn sales rise 30%. XED for popcorn w.r.t. cinema tickets = +30% / −20% = −1.5. Negative → COMPLEMENTS (confirmed: people buy popcorn at cinemas).
Applications.
Competition / antitrust. Regulators use XED to identify firms in the same "market" for merger reviews. Two firms whose products have HIGH POSITIVE XED compete directly, so merging them may reduce competition.
Pricing strategy. If two of a firm's own products are complements (e.g. razors and blades), discounting one increases sales of the other. If two competitors' products are substitutes, a competitor's price cut hurts your sales.
Bundling. Strong complements (XED very negative) are often bundled (e.g. Microsoft Office). Strong substitutes are rarely sold together by the same firm.
- XED > 0: substitutes.
- XED < 0: complements.
- |XED| measures closeness.
- Used in antitrust + pricing strategy.