Cross Elasticity of Demand

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3.2 Price Elasticity of Demand (PED) and Cross Elasticity of Demand (CED) With predatory pricing and price wars being carried out, the drop in the prices of airline tickets has certainly affected other industries with different modes of transport. One example is the express buses. As the demand for express bus tickets is price elastic, the relative increase in the price of the tickets would result in a more than proportionate decrease in the quantity demanded for them. Such a prediction is highly possible as express buses and airplanes are close substitutes.

Figure 2(a) and Figure 2(b) show that the demand for express bus tickets is more price elastic as compared to that of air tickets. This is because services provided by express buses can be easily provided by airplanes, but the opposite may not hold true. In addition, in this modern world, people are becoming increasingly affluent. This means higher income levels and makes air tickets more affordable. In Figure 2(a), cheaper air tickets results in lower prices. As the price of air tickets drops from Pe to P1, the quantity of air tickets demanded increases from Qe to Q1. Such an increase in the quantity is due to a decrease in the quantity of express bus tickets demanded. This increase would not be as significant if the demand for express bus tickets was price inelastic. Since express buses and airplanes are substitutes, the CED is positive. This means that the change in the price of the air tickets and the change in the demand for its substitute are in the same direction. In order for the express bus firms to prevent the airline industry from affecting them, they would have to lower the substitutability between express buses and airplanes. In real life, this is done through active advertising where firms differentiate their products from airplanes.
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