Cross Elasticity Demand

The calculations for cross elasticity of demand are meant to show how demand is responsive for a product to the changes experienced in another product. Products can be related. The calculation that is done in XED gives an indication of the kind of relationship that these products have with one another which is done by obtaining a quotient. The percentage of change in the quantity demanded (A) is divided by the percentage change in the price of another commodity (B).

A positive XED value indicates that the goods being related by the evaluation are substitutes. One example is where is the price of one brand of ice cream goes up from around 50 rupees to about 60 rupees, and the demand for another brand goes up from 1m to 2m on an annual basis, the XED can be derived as +100/20 = +5.

The positive sign gives the indication that the goods involved are substitutes. Coefficients of greater than one further gives the indication of the two being close substitutes to one another.

In the case where the XED has a negative sign, the indication gives the impression that the goods are complementary using a similar equation for the calculation. This is experienced when the price of one product increases while the price of another decreases.
Similarly, when the coefficient is below one, the implication is that the two do not exist as perfectly complimentary to one another. When the coefficient is above one, the goods being considered are complimentary to one another.

The Need to Know the XED
The knowledge of the firm’s XED with the related products gives the firm the ability t produce a map of its market. The mapping process provides an opportunity that firms need in looking at the number of rivals it has to deal with and how close the rivals are. The firm gains an allowance in measuring the importance of the complementary products within the market in relation to the products it produces. With such knowledge, the firm is able to develop strategies aimed at reducing the amount of exposure to the risks that come with changes in price by related firms. Such changes include the rise in price as implemented by a complementary good and the fall in prices set for goods considered to be its substitutes. The risks that come through dealing with complementary goods or substitutes need to be minimized in a number of ways. The numbers of ways include:

Horizontal Integration Mechanism
Horizontal integration has the connotation of merging with rivals. For example, industrial giants may merge with the aim of controlling what goes on in the market. Therefore, horizontal integration takes place when different firms that produce similar kinds of products or services decide to merge with one another. In some cases, one company may want to completely take over the operations of another firm and completely control what goes on in that firm.

Vertical Integration Mechanism
The vertical integration mechanism is a strategy meant for merging with those who deal in complementary products. A good example is where a record producer may merge or take over a store that deals in records or alternatively a radio station.

The use of alliances and collusions
Joint alliances can be initiated between companies that exist as competitors of one another where there is combining of resources to increase the odds for the organization to be driven out of the market by peculiar activities within the market that drive out businesses.

The companies involved may choose to collude with one another by doing things like entering into agreements where they fix prices so that they can be able to avoid instances where there are fights over prices. The likelihood of such an occurrence is in oligopolistic structures which involve few competitors within the market set-up.