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DISCOUNT WINDOW: The means by which the central bank (the Federal Reserve in the United States) makes discount loans to banks. It is through the discount window that banks can obtain the reserves that the might meet their liquidity needs and satisfy reserve requirements. The criteria to manage the discount window are dictated by the discount policy, which includes setting the discount rate and the terms of discount lending. This policy is a way to influence money supply since it can change the volume of the discount loans throughout the banking system.

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CROSS ELASTICITY OF DEMAND:

The relative response of a change in the demand for one good to a change in the price of another good. More specifically the cross elasticity of demand is percentage change in the demand for one good due to a percentage change in the price of another good. This notion of elasticity captures the other prices demand determinant. Three other notable elasticities are the price elasticity of demand, the price elasticity of supply, and the income elasticity of demand.
The cross elasticity of demand quantifies the theoretical relationship between the price of one good and the demand for another good as identified by the other prices demand determinant. A positive cross elasticity indicates a substitute good and a negative cross elasticity exists for a complement good.

Suppose, for example, that the price of a pecan pie increases by 10 percent (say $1.00 to $1.10 per slice). This increase in price is likely to cause the demand of hot fudge sundaes to change. The cross elasticity of demand answers the question: Does demand increase or decrease, and if so, by how much? If the demand increases by 10 percent (say from 100 hot fudge sundaes to 110 hot fudge sundaes), then pecan pie is a substitute good for hot fudge sundaes. If the demand decreases by 10 percent (say from 100 hot fudge sundaes to 90 hot fudge sundaes), then pecan pie is a complement good for hot fudge sundaes. If the demand does not change, then pecan pie is an independent good relative to hot fudge sundaes.

A Summary Formula

The cross elasticity of demand is often summarized by this handy formula:
cross elasticity
of demand
=percentage change
in demand for good 1
percentage change
in price of good 2
In theory, the cross elasticity of demand is specified in terms of the "percentage change in demand." The reason is that other prices affect demand not quantity demanded.

However, in practice, the cross elasticity of demand is calculated as the percentage change in "quantity" resulting from the percentage change the price of another good. In other words, the calculation is based on the change in quantity from one value to another.

Substitute and Complement

AlternativeCoefficient (C)
Substitute GoodC > 0
Complement GoodC < 0
Independent GoodC = 0
Other prices affect the demand for a good in one of three ways. An increase in the price of another good causes an increase in demand, a decrease in demand, or no change in demand. The result is either a substitute good, a complement good, or an independent good.
  • Substitute Good: A substitute good exists if an increase in the price of one good causes an increase in demand for the other good. This is seen as a positive value for the cross elasticity of demand, or a coefficient of elasticity of C > 0.

  • Complement Good: A complement good exists if an increase in the price of one good causes a decrease in demand for the other good. This is seen as a negative value for the cross elasticity of demand, or a coefficient of elasticity of C < 0.

  • Independent Good: An independent good exists if a change in the price of one good has no affect on the demand for another good. This is seen as a zero value for the cross elasticity of demand, or a coefficient of elasticity of C = 0.

Although some goods might intuitively appear to be substitute, complement, or independent goods, economists generally let cross elasticity calculations make the actual determination. One of the more important applications of these calculations is in the area of market control',500,400)">market control and antitrust laws. Because government frowns on markets controlled by a single firm, it is very important to know if the buyers of the good produced by one firm have any reasonable substitute alternatives. If there are NO close substitutes, that is, all cross elasticities are approximately zero, then the firm producing the good probably falls into the monopoly category of market structures and is subject to antitrust scrutiny.

Three Other Elasticities

The cross elasticity of demand is one of four common elasticities used in the analysis of the market. The other three are price elasticity of demand, price elasticity of supply, and income elasticity of demand.
  • Price Elasticity of Demand: On one side of the market is the price elasticity of demand. This is the relative response of quantity demanded to changes in the price. It is specified as the percentage change in quantity demanded to a percentage change in price.

  • Price Elasticity of Supply: On the other side of the market is the price elasticity of supply. This is the relative response of quantity supplied to changes in the price. It is also analogously specified as the percentage change in quantity supplied to a percentage change in price.

  • Income Elasticity of Demand: This is the relative response of demand to changes in income, or the percentage change in demand due to a percentage change in income. This elasticity quantifies the buyers' income demand determinant.

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Recommended Citation:

CROSS ELASTICITY OF DEMAND, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2022. [Accessed: June 29, 2022].


Check Out These Related Terms...

     | elasticity | elastic | inelastic | price elasticity of demand | price elasticity of supply | income elasticity of demand | coefficient of elasticity | elasticity alternatives | elasticity determinants |


Or For A Little Background...

     | other prices, demand determinant | substitute good | complement good | market | price | quantity | demand | law of demand | demand curve | determinants | cause and effect | variables |


And For Further Study...

     | elasticity and demand slope | elasticity and supply intercept | demand elasticity and total expenditure | utility and demand | consumer demand theory |


Related Websites (Will Open in New Window)...

     | Antitrust Division, U.S. Department of Justice |


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