Cross Elasticity of Demand (CED) is the responsiveness of demand for one product to a change in the price of another product. Many products are related, and CED indicates just how they are related.
The following equation enables CED to be calculated.
% Change in (∆) Quantity Demanded of Good B / % Change in (∆) Price of Good A
Substitutes: When CED is positive, the related goods are substitutes.
For example, if the price of Coca Cola increases from Rs. 50 to Rs. 60 per can, and the demand for Pepsi increases from 1 million to 2 million cans per year, the CED between the two products is: +100/+20 = (+) 5
The positive sign means that the two goods are substitutes, and because the coefficient is greater than one, they are regarded as close substitutes.
Complements: When CED is negative, the goods are complementary products. The equation is the same as for substitutes.
For example, if the price of Cinema Tickets increases from Rs. 50.00 to Rs. 70.50, and the demand for Popcorn decreases from 1000 tubs to 700 tubs, the CED between the two products will be: -30/+50 = (-) 0.6
The negative sign means that the two goods are complements, and the coefficient is less than one, indicating that they are not particularly complementary.