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Concept of Elasticity for Substitute and Complementary Goods

Question

Explain how economists use the concept of elasticity to distinguish between substitute goods and complementary goods.

Category:

Elasticity

[CIE AS level May June 2017]

Preview Answer


Step ➊ : Define ‘Cross elasticity of demand’ in the introduction.


Economists use the concept of Cross elasticity of demand (XED) to distinguish between substitutes and complementary goods. XED is a numerical measure of the responsiveness of the quantity demanded for one product following a change in the price of another related product, ceteris paribus. The values of XED can be positive or negative. This value depends on whether products are substitutes or complements.

The formula for cross elasticity of demand used is as follows :

XED =

% change in quantity demanded of product A

% change in the price of product B


Step ➋ : Explain how cross elasticity of demand is used to distinguish between substitute goods and complementary goods


Products that are substitutes for each other will have positive values for the XED whereas products that complements will have negative values of XED. This is illustrated in an example using the diagram below.

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