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Major determinant of Cross-elasticity of Demand

When it comes to Cross-elasticity of demand, we must first illustrate the concept of elasticity of demand. We can say that elasticity of demand is the foundation of the theory of cross-elasticity of demand because elasticity of demand is related to only one good while cross-elasticity of demand is about the relation of 2 goods. We should first compare the elasticity of demand with the cross-elasticity of demand.
Introduction of Elasticity of Demand
Elasticity of demand is often referred to as the own-price elasticity of demand for a certain good, such as the elasticity of demand with respect to the price of a good. Elastic demand reflects that consumers are very price sensitive.
This concept is understandable because we all know price is one of important determinant of quantity, and the quantity demanded of a good is negatively related to its price. We can suppose: for a seller, lower price promotes sales; for a buyer, higher price constraints their desire of purchase.
Take the example from the textbook, suppose that a 10% increase in the price of an ice-cream cone causes the amount of ice cream you buy to fall by 20%. According to the formula
We calculate your elasticity of demand as 20%/10%= 2. This result can be explained as the elasticity 2 reflects the change in the quantity demanded is twice as large as the change in the price in proportion. This result owes to reasons as follows: First, market for ice cream is very competitive instead of monopolistic. Second, consumers have choices of other substitutes such as other desserts. Third, when the price of ice cream rises, consumers can buy cakes, milk-shake or other desserts.
The above formula usually yields a negative value, because of the inverse nature of the relationship between price and quantity demanded. They are described by the “law of demand” (Gillespie, Andrew (2007). p.43.) but economists tend to refer to price elasticity of demand as a positive value (i.e., in absolute value terms).
Definition of Cross-elasticity of Demand
Based on the theory mentioned above about price elasticity of demand, we can go further to find out the relation of two goods. In order to distinguish it from the elasticity of demand for that good with respect to the change in the price of some other good, i.e., a complementary or substitute good. (Png, Ivan (1999). p.57.) The latter type of elasticity measure is called a cross-price elasticity of demand.
In microeconomics, cross-elasticity of demand is also called cross-price elasticity of demand, which measures the responsiveness of the demand for a good when there is a change in the price of another good. According to its definition, it is measured as the change in demand in percentage for the good A that occurs in response to a change in price in percentage of the good B. The formula to calculate cross-elasticity of demand is as follows:
Major Determinant
The cross-price elasticity of demand is often used to see how sensitive the demand for a good is to a price change of another good. The major determinant of cross-elasticity of demand is the closeness of the substitute or complement. A high positive cross-price elasticity indicates that if the price of a certain good goes up, the demand for the other good goes up as well. A negative one tells us the opposite – that an increase in the price of one good causes a decrease in the demand for the other good. A small value (either negative or positive) tells us that there is little or no relation between the two goods. They are listed in the table below:
Cross-price Elasticity
A positive cross-price elasticity
If the price of one good goes up, the demand for the other good goes up as well.
Pork and chicken, etc.
A negative cross-price elasticity
An increase in the price of one good causes a drop in the demand for the other good.
Bicycles and helmets; Petroleum and cars, etc.
A small value
There is little relation between the two goods.
Things have little or no relation at all
For example, if we suppose the price of chicken goes up by 20%, and as a result the quantity demanded of pork increases by 10%, at the premise that there is no change in the price of pork or anything else that would have influence on the demand for pork (such as quality, advertising, location, etc). Then the cross-elasticity of demand for pork, with respect to the price of chicken, is 10%/20% = 0.5.
This concept is also easy to understand. Firstly, as we know that for two goods that complement each other show a negative cross elasticity of demand, which means that an increase in the price of one good cuts the demand for the other. For instance, if the price of bicycles goes up, we will expect to see a decline in the demand for bike helmets; if the price of petroleum goes down, the demand for car will be expected to rise. In this sort of case, we can say the goods are complements and they have a close link in price and demand.
Secondly, on the contrary, two goods that are substitutes have a positive cross elasticity, it means that an increase in the price of one good will therefore increase the demand for the other good. When we observe a positive cross-elasticity, we can assume that the two goods are substitutes, as with chicken and pork, butter and margarine.
The Third circumstance is two independent goods. If two goods are independent, undoubtedly they have a zero cross elasticity of demand.
Practical Application
For firms and corporations, it is necessary for them to know the cross-elasticity of demand for their products when they consider the effect on the demand for their products of a change facing with the challenging price of a rival’s product or a complementary product. If the quality and appearance is almost the same (regardless of the factors of affection location, and loyalty, etc.) but the price of Firm A is higher than that of Firm B, most consumers will choose the products of Firms B. Among theories of marketing, “pricing” is not only difficult but technical. These are vital pieces of information for firms when making their production and strategic plans.
However, for goods those complement each other, a firm is supposed to promote the sales of both the products and their complements. Nowadays, the price of petroleum is constantly high and it will continuously get higher in the near future. This is definitely a disaster for automotive industry. Some of the automobile companies adopt the strategy of reduction but gets an unsatisfactory feedback. What affects the decision of a consumer is mainly the price of petroleum instead of the automobile, so some companies think out of a promotional tactic: buy car get petro discounted (though the price of a car may be very expensive), and this may be to some extent cater to the consumers’ psychology.
Another application of the concept of cross-elasticity of demand is in the field of international trade as well as the balance of payments around the world. What’s more, for different industries and fields, the concept of cross-elasticity of demand can be used to measure the closeness of relation of each other. For those monopoly enterprises, they are the unique suppliers in market and they are powerful enough to control the whole market, so they won’t suffer the pressure from others. However, for some industries, such as Ministry of Railway, if it decides to raise the price in a large scale, many passengers will prefer other transportation, which will make aviation industry or highroad industry prosperous. This will undoubtedly lay itself in an unadvantageous position.

Structure And Function Of The International Monetary Fund

History During the great depression times of 1930s the countries put a halt on the foreign trading. This act of putting barriers devalued the currency of the countries, and citizens were not allowed to keep foreign currency. This led the world to a sharp decline in the trade chart and lowered living standard of people. The establishment of International Monetary Fund was the result of economic breakdown. International Monetary Fund was formally established in December 1945 but representatives of 45 countries agreed for the framework of International Monetary Fund. Till 1975 the institution had a system called par value system, according to which the currencies of country was valuated against US dollar and US dollar was valuated against gold. This conversion of dollar into gold was stopped in 1975. From then International Monetary Fund solved the problem of balance of payments in many poor countries of the world. A loan facility program named as Structural Adjustment Facility was started in March 1986. The International Monetary Fund helped the oil exporting countries in paying their debts. These were some of the historical financial activities where the International Monetary Fund played a crucial role.
Overview The main function of International Monetary Fund is to push the cooperation in international monetary and stability of exchange rates assists the international trade to grow and provide resources for the member countries to help them in situation of difficult balance of payments and poverty conditions. Currently there are 187 countries which hold the membership of International Monetary Fund. The institution has its own organizational structure, governance, financial assets but is a specialized component of United Nations. The members of the International Monetary Fund have their own recognization in the global economy. The International Monetary Fund keeps record of its member countries and their economic condition, alerts them about the risks involved in any particular financial activity and gives advice on creating economic policies. International Monetary Fund help countries which are in difficulty by lending them, it also provide technical help and training to improve the economic condition of the country. All these works of International Monetary Fund are monitored and supported by the surveillance and research and development team of the International Monetary Fund. The International Monetary Fund also has collaboration and partnership with many international organizations which work for the growth and to reduce poverty. Institution also keeps active communication with civil societies, researchers and the media persons. (Eichengreen., 2002)
Operations of International Monetary Fund Surveillance The International Monetary Fund supervises the international monetary system and supervises the economic and fiscal policies of its member countries. National regional and global economic developments the member countries are tracked by the International Monetary Fund and macroeconomic and financial advice are also provided. International Monetary Fund’s act of monitoring of economic stability in the member countries is known as Surveillance. Surveillance is of three types: Country Surveillance, Regional Surveillance, and Global Surveillance. Country surveillance is the comprehensive consultation provided to the member countries of International Monetary Fund. An International Monetary Fund team is formed for the process which is used to visit the country and studies the financial and economical policies of the country. The report of the country is presented to the board of members of the International Monetary Fund to get the global views on the fiscal and economical policies. Regional surveillance is the monitoring of various currency unions like euro area, and Eastern Caribbean Currency Union. Global surveillance includes the process of reviewing global economic trends and covers the areas of economic developments, policies, and prospects of the global financial market.
Technical Assistance The International Monetary Fund provides its help in practical training of the countries which enables them to manage their financial policies more effectively. This training is beneficial for a country to upgrade the system and redesign the economic, financial and structural policies of the country. Providing technical assistance to its member countries is one of the core functions of the International Monetary Fund. International Monetary Fund supplies around 80% of the assistance to the countries which are highly indebted. The International Monetary Fund provides technical assistance in many different forms according to the need of the country. Partnership with many donors is extremely important for the functioning of International Monetary Fund as they used to finance around two third of the International Monetary Fund operations of technical assistance.
Lending Funds A country can face many severe financial crises like inability to pay foreign bills, negative balance of payments, and problem with the stability of international financial system. International Monetary Fund was established for the support of these countries in these financial crises. International Monetary Fund helps every member country in financing to pay off the balance of payments and international payments.
Organizational Structure of International Monetary Fund The board of governors is the top authority of the International Monetary fund. It has one governor and one alternate governor for each country which is member of the International Monetary Fund. The appointed governor of each country is either the finance minister or the governor of the central bank of the country. The power of authority in International Monetary Fund is concentrated to the board of governors. Certain powers of the Board of governors can be given to the board of executive. The meeting of board of governors of the International Monetary Fund happen only once in a year in normal circumstances. The executive board of IMF has 24 directors which are elected by the member countries of IMF and the managing director who is also the chairman of the board. Voting power of different member countries of IMF varies according to the matter related Departments. The managing director I selected by voting process and the member who gets the highest number of votes is appointed as the MD of the IMF. (International Monetary Fund Organization Chart)
International Monetary Fund Funds