 Hello, and welcome to the session in which we'll discuss cross elasticity. Now it's very important to understand what we did in the prior session, which we covered, the elasticity of supply and demand. So if you have not viewed the prior session, I strongly suggest you view the prior session because the cross elasticity is very similar, it's based on elasticity of supply and demand. Cross elasticity measures something different than elasticity of supply and demand, and it measures the responsiveness of quantity demanded of one product to the change in the price of another good. So what we're looking at is the change in quantity, the change of quantity, percentage of product A to the change in price of quantity of the change in price of product B, huh? So we're looking at two different products, one is the quantity and the other one is the price. So you're dealing with two different goods, and the answer is why? What's the purpose of cross elasticity? Well, it's going to help us determine whether these two goods A and B can be considered substitutes or compliments in the eyes of the consumer. So what is a substitute? What's a compliment? A substitute is when the consumer have two options, like Pepsi and Coke is the classic example. Well, if you don't want to drink Pepsi, you have Coke. Compliment, think of a burger and a bun. If you sell burgers, you need the bun to make a burger, to make a hamburger. You need the meat and the bun, they compliment, they compliment. So let's go ahead and get started. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation, as well as your accounting courses. My CPA material is aligned with your CPA review course, such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses, broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. Starting with the formula for elasticity, what's the formula? As I showed you earlier, it's the percentage change, the percentage change in quantity of product A divided by the percentage change of price in product B. Okay? So again, I'm not going to go over the details of the formula, but remember how to compute the percentage change if you're not familiar with this, and this is the third time I do so. I did the computation in the prior two sessions, subtract the initial value from the final value or the old value from the new value, take the difference, basically find the difference, take the difference, divide by the initial value, then multiply by 100. So if we're looking at a change from 50 to 60, the change is 10. That's the difference from the initial and the old. I'm going to take the 10 divided by the initial of 50, the change is 20%. Now this is not the same if we said the change was from 60 to 50. The change from 60 to 50 also $10, however, you're dividing by the initial value of 60, the change is 16.67%. Be careful about this. Let's use the formula and an example to illustrate this concept. Let's assume for the sake of illustration, we are dealing with two-brand smartphone, brand X and brand Y, and let's assume a brand X smartphone increases, so this is, I'm going to consider this is X and this is Y, and X increases because it has more features. The quantity demanded for Y smartphone also increases. Well, it indicated that these two brands are substituted. So if the price of iPhone X went up, what's going to happen is people is going to switch to brand phone Y. So let's just compute the elasticity to see how we can quantify this. We look at the percentage change in quantity demanded of product Y smartphone divided by the percentage of change in price in product X smartphone. So let's assume a product X smartphone increases by 10%. So the price increases by 10%, increases by 10%, and as a result, the demand for Y increase by 5%. So let's take a look at it, 5% divided by 10% is 0.5 or 50%. Since the cross elasticity is positive, positive means greater than zero, it suggests that brand X and Y smartphone are substituted. What happened is this, as the price of X went up, people switched to Y. As the increase in brand X smartphones leads to a proportionate increase in demand for brand Y smartphone. So people left, how did we measure this? We measure this in the change in the price of quantity demanded for brand Y as the price change in brand X. Brand X went up, what happened to the Y demand? So these products are substituted. I know it's a substitute because the coefficient is positive, greater than zero. Let's take a look at an example where they are considered complement. Let's assume coffee and creamer as complement because people that drink coffee, they need creamer to put with it, basically the milk. Now suppose the price of coffee increases by 15%. And as a result, the quantity demanded of creamer decreased by 10%. Now we can compute the cross elasticity, which is the change in quantity demanded for creamer relative because of the change in the price of the coffee. And let's assume the percentage change in the quantity demanded for creamer is negative 10, it went down 10%. The percentage change in the price of coffee is 15. So coffee went down by 15, creamer went down by 10. That's fine. We can use different numbers. So if we take negative 10 divided by 15, it's going to have a negative, negative 6.7. So this is less than zero, less than zero. Now the change could be higher, but nevertheless it's negative. The magnitude could be higher. What do we say? We say since the cross elasticity is negative, it suggests that coffee and creamer are complement because people are consuming less of the coffee, they are consuming less of creamers, but not as much. Okay? There's a negative, there's a negative coefficient. But coffee went down by 15%, creamer went down by 10. Okay? Now it could be, it could be much, the proportion could be much higher. For example, coffee could go down, the consumption could go down by 15, and the creamer could go down by 32%. And we can also perform this computation and let's do that if you choose. So if we say 0.32 divided by 0.15, we'll have a negative 2.13, which is 213, 213%. So the magnitude is much higher. It doesn't matter if it's, you know, 2.13, it's much higher, nevertheless, it's negative. They are, they are complements of each other. So in summary, cross elasticity of demand help analyze the relationship between two goods and determine whether they are substitutes or complements based on the direction and magnitude of the cross elasticity. So it could be positive, they could be negative. If it's negative, it means they complement each other. They complement. Positive, it means they substitute. So if the price of one went up, what's going to happen, people will switch to the other one and the quantity of the other one will go up because they are substituted. Compliment, if the price of one goes up, what's going to happen, the quantity demanded for the other one will go down. So now you have negative, remember, it's quantity divided by price. If one of them is negative, if one of them is negative, if quantity went down negative, you're going to have a negative coefficient. If you have a negative coefficient, it's a complement. The substitute, the price goes up, the quantity goes up as well. So both are positive. So you're going to have, if you divide two positives, you're going to have a positive. Therefore, they are considered substitutes. What should you do now? Go to Farhad Lectures and work MCQs, multiple choice questions about cross elasticity. This topic is covered on the CPA exam. Collect those easy econ points so you can improve your chances of passing the exam, and then your certification focus on your career. I'm here to teach you the material, your job is to learn it and perform well on the exam. Good luck, study hard, and of course, stay safe.