Question

Assume a fall in the price of Pepsi from $2 per litre to $1.75 per litre causes the quantity of Coke sold to fall from 6,000 litres to 4,500 litres. Calculate, interpret and explain the XED for Coke and Pepsi.

Answer 1

XED is 2

demand will likely be based on price

Explanation:

You want the XED for Coke and Pepsi, given that a decrease in price of Pepsi from $2 to $1.75 per liter causes demand for Coke to fall from 6,000 to 4500 liters.

XED

XED is the abbreviation for "cross-elasticity of demand." It is the ratio of the percentage change in the demand for one good to the percentage change in price for another.

XED = (∆Q/Q)/(∆P/P)

XED = ((4500 -6000)/(6000))/((1.75 -2.00)/(2.00)) = (2/6000)(-1500/-0.25)

XED = 2

The XED is positive for substitute goods, and negative for complementary goods (bought together).

Interpretation

The relatively large positive XED for Coke and Pepsi indicates these brands are nearly interchangeable. Consumers will tend to choose one over the other based on price. Apparently, the price of $1.75 per liter of Pepsi is sufficiently low to cause a switch from Coke.

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