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Monday, 11 June 2018

Cross price effect

Cross Price Effect

When demand of a good is affected due to change in price of its complementary or substitute good, it is called cross price effect.

In case of substitute good, relation between price of substitute good and demand of good is positive or direct.

In case of complementary good, relationship is negative or opposite.

Substitute and complementary goods


Substitute Goods

When a good can be used in place of other then such good is known as substitute good. Ask yourself, which good you would like to use if you don't have tea?. Coffee, right?. Yes tea and coffee are substitute goods.

If prices of coffee starts to rise in the market , demand for tea will increase because some buyers will shift to tea and consumer base of tea will increase.

If price of coffee starts to reduce, demand for tea will decrease because some buyers will shift to coffee from tea.

Complementary Goods

These goods are incomplete without each other. Each good fulfill demand of another good. Car and petrol, inkpen and ink are known examples. There would be no use of petrol if car does not exists and vice-versa.

We are taking example of inkpen and ink to understand the impact on demand due to change in price of a complementary good.

If ink become expensive for people ,they will not buy inkpen more. They will shift to a cheaper option. When price of ink rises, demand for inkpen decrease and vice-versa.

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