Cross Price Effect on Demand Curve

The effect on the demand for a given commodity because of a change in the price of a related commodity is known as Cross Price Effect. In simple terms, the cross price effect originates from substitute goods and complementary goods. The effect of change in the prices of substitute goods and complementary goods can be explained as follows:

A. Change in Price of Substitute Goods

An increase or decrease in the price of substitute goods has a direct impact on the demand for a given commodity.

1. Increase in Price of Substitute Goods: When there is an increase in the price of substitute goods (say, coffee), the demand for the given commodity (say, tea) will also increase from OQ to OQ_1, with the same price OP. It results in a rightward shift in the demand curve of the given commodity (tea) from DD to D₁D₁.

2. Decrease in Price of Substitute Goods: When there is a decrease in the price of substitute goods (say, coffee), the demand for the given commodity (say, tea) will also decrease from OQ to OQ_1, with the same price OP. It results in a leftward shift in the demand curve of the given commodity (tea) from DD to D₁D₁.

B. Change in Price of Complementary Goods

An increase or decrease in the price of complementary goods has an inverse impact on the demand for a given commodity.

1. Increase in Price of Complementary Goods: When there is an increase in the price of complementary goods (say, butter), the demand for the given commodity (say, bread) will decrease from OQ to OQ_1, with the same price OP. It results in a leftward shift in the demand curve of the given commodity (bread) from DD to D₁D₁.

2. Decrease in Price of Complementary Goods: When there is a decrease in the price of complementary goods (say, butter), the demand for the given commodity (say, bread) will increase from OQ to OQ_1, with the same price OP. It results in a rightward shift in the demand curve of the given commodity (bread) from DD to D₁D₁.

Substitute Goods and Complementary Goods are two economic concepts describing the relationship between two or more different products in terms of their demand and consumption patterns. Substitute goods are the goods that can be used in place of one another; however, Complementary goods are the goods that can be used together. It is essential to understand the relationship between substitute goods and complementary goods, especially for organisations and policymakers. It is so because the relationship between these goods helps businesses and policymakers in predicting consumer behaviour, setting prices, and developing marketing strategies.

Geeky Takeaways:

• Substitute Goods are those goods which are used in place of one another to fulfill a specific need or want. For example, Coke and Coca-Cola.
• Complementary Goods are those goods which are used together to fulfill a specific need or want. For example, TV and remote.
• Cross Demand helps in determining the demand of a given commodity when the price of other related commodities changes.
• A commodity’s demand is only affected by a change in the price of related goods and not the price of unrelated goods.