High Cross Elasticity of Demand

Cross elasticity of demand measures the responsiveness of demand for one good to a change in the price of another good. When the numerical value of cross elasticity between two goods is very high, it means that the two goods are closely related. Here's what it means in detail:

Substitute Goods

When the cross elasticity of demand is very high, it means that the two goods are substitute goods. Substitute goods are two goods that can be used in place of each other. For example, if the price of coffee increases significantly, consumers may switch to tea as a substitute. In this case, the cross elasticity of demand between coffee and tea will be very high.

Strong Relationship

A high cross elasticity of demand indicates a strong relationship between two goods. This relationship can be positive or negative. A positive relationship means that when the price of one good increases, the demand for the other good also increases. For example, if the price of coffee increases, the demand for creamer may also increase. A negative relationship means that when the price of one good increases, the demand for the other good decreases. For example, if the price of cigarettes increases, the demand for lighters may decrease.

Price Sensitivity

A high cross elasticity of demand indicates that consumers are very price sensitive when it comes to these goods. Consumers are more likely to switch to a substitute good when the price of one good increases. This means that firms that produce these goods must be careful when setting prices. If the price of one good is too high, consumers will switch to the substitute, and the firm will lose revenue.

Conclusion

In conclusion, a high cross elasticity of demand between two goods indicates that the two goods are closely related, and consumers are very price sensitive when it comes to these goods. Firms must be careful when setting prices for these goods to avoid losing revenue to substitute goods.