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Cross-Price Elasticity

Cross-price elasticity is defined as the percentage change in demand on a good if the price of another good changes with one percent:

Here, e12 is the cross-price elasticity between good 1 and good 2; Q1 and ΔQ1 are quantity demanded and quantity change for good 1, whereas p2 and Δp2 are price and price change on good 2. Again, goods are grouped depending on their cross-price elasticity.

Suppose the price of good 2 rises by one percent. If that leads to a decrease in the demand for good 1 (e12 < 0) then good 1 and good 2 are probably goods that go together in some way: complements. If, instead, it leads to an increase in the demand for good 1 (0 < e12) then good 1 is probably something one can buy instead of good 2: a substitute.

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