Cross-price elasticity of demand measures the responsiveness of the demand for a particular good to changes in the price of another good. Marketing professionals use cross-price elasticity of demand to estimate the impact that price changes in a variety of other goods will have on the demand for their own goods. One example is how changes in gasoline prices will impact the volume of cars sold. Cross-price elasticity of demand is relatively easy to calculate once you have the necessary data.
Items you will need
- Historical price data for the outside good
- Historical volume data for your company’s good
- Microsoft Excel
Pull price data for the outside good you are interested in from the Bureau of Labor Statistics’ Consumer Price Index website. The Consumer Price Index tracks pricing data for a wide range of goods as well as for broader industries (retail products, industrial goods, etc.). You should pull price data for two different periods (i.e. January 2008 and June 2008).
Pull historical volume data for your company’s good for the same two periods as the pricing data you found in Step 1. The volume data should be available in your company’s internal sales tracking system.
Calculate the cross-price elasticity of demand for the two goods using Microsoft Excel. Use the following formula: [(P1B + P2B) / (Q1A + Q2A)] x [(Q2A - Q1A) / (P2B - P1B)] P1B is the price of the outside good in period 1 P2B is the price of the outside good in period 2 Q1A is the quantity of your company’s good in period 1 Q2A is the quantity of your company’s good in period 2
Analyze the cross-price elasticity of demand that you have calculated. A number greater than 2 (or less than negative 2) suggests that a change in the price of the outside good will have a meaningful impact on demand for your company’s good. A positive number means that an increase in the price of the outside good leads to increased demand for your company’s good. A negative number means that an increase in the price of the outside good leads to a decrease in demand for your company’s good.
A positive cross-price elasticity of demand means that the two goods are substitutes; that is, consumers are willing to purchase the outside good in place of your company’s good, and vice versa. One example of substitute goods is Coke vs. Pepsi. A negative cross-price elasticity of demand suggests that the goods are complements, since consumers need to purchase the two goods together. One example of complement goods is gasoline and cars. Finally, if the two goods are perfectly independent, the cross-price elasticity of demand will be zero, and changes in the price of one good will have no impact on demand for the second good.