Explain the relevance of XED to a producer
XED is a marketing policy.
XED refers to degree of responsiveness of demand of a good A in response to a change in price of a good B. It can be shown from the formula;
XED= %change in demand A/ %change in price B.
XED can be used by a producer for marketing purpose to maximize revenue.
Applying XED theory, for goods such as close substitutes, XED>1, if a competitor drops price, there is a more than proportionate drop in the demand of the producer’s good. For un-close substitutes, 0<XED<1, there is a less than proportionate drop in the demand for the producer’s goods. For example, a rise in the price of Coffee Bean leads to a more than proportionate drop in demand for Starbucks if they were close substitutes. With such knowledge, the producers could change their marketing strategy. They could drop their prices or try to use product differentiation to reduce the substitutability of his good to his competitors. In that case, the good will now be less cross elastic, ie it will not be affected significantly by competitors pricing. it can use product differentiation, such as offering new flavors/drinks, so that consumers see them as less close substitutes, as such will not be changing preference towards Coffee Bean should they drop prices.
For complementary goods, with XED < 0, if the price of a complement goes up, there is a subsequent drop in the demand of a producers good. Complements are goods that are used together with one another, for instance, smartphone and apps or printer and ink cartridge. If the price of printers go up, qty demand for printers drop, hence derived demand for ink drop as well. In this case, recognizing complementary relationship, producers should try to bundle complementary goods together to sell them, so that the demand of related items will not drop due to a price change in its complement, since consumers are buying both products at the same time.