Suppose Acme corporation sells a gadget and acquires a firm, producing another gadget. The cross-elasticity of demand between the 2 gadgets is +1.94. Should the firm increase or decrease the prices of its now two products? Why?

The XED coefficient can be interpreted using the following criteria.

• XED coefficient is positive - Goods are substitutes
• XED coefficient is negative - Goods are complements
• XED coefficient is zero - Goods are unrelated

In the example given above, the cross-elasticity of demand is +1.94. This means that gadgets are substitutes. Therefore, the increase in the price of one gadget will cause an increase in the quantity demanded for the second gadget. Assuming that there are not more close substitutes in the market, the best strategy is to increase the prices of these two products since that would increase the revenue and consumers would have as the only option to buy one of both products. However, note that to establish the most effective pricing strategy other factors should also be taken into account such as price elasticity of demand.