Cross elasticity of demand refers to the extent to which the demand for a given product will change in response to the price of another product. There are two major factors to be determined when considering the cross elasticity of demand: whether the products are competing or complementary and the degree of elasticity in the response of demand.
For example, we might want to measure the cross elasticity of the demand for chicken in relationship to the price of beef. Since chicken and beef are generally considered to be competing products, the demand for chicken will probably go up as the price of beef goes up, so the relationship is positive. If consumers will replace beef with chicken very readily, then the demand for chicken is highly elastic in relationship to the price of beef. If, on the other hand, only a small increase in the demand for chicken will occur even if the price of beef soars (perhaps because consumers have a wide variety of other competing products to replace beef with), then the demand for chicken is said to be relatively inelastic with regard to the price of beef.
On the other hand, we can also measure the cross elasticity of demand for complementary products. For example, peanut butter and jelly are often used together. The demand for jelly, therefore, is likely to respond to the price of peanut butter in an inversely proportional way (as the cost of peanut butter rises, the demand for jelly falls). If many consumers have no use for jelly if they don’t purchase peanut butter, then the demand for jelly will likely be very sensitive to the cost of peanut butter (that is to say, very elastic).