Cross Elasticity of Demand - Examples and multiple choice questions and answers

Cross Elasticity of Demand - Examples and multiple choice questions and answers

Cross Elasticity of Demand (XED) helps to find out how the quantity demanded of one good responds to a change in the price of another good. It is calculated as the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good. The formula is:

XED = %change in quantity demanded of Good A / %change in price of Good B​

Interpretation of XED:

1. Substitute Goods (XED > 0): If XED is found positive, it suggests that the two goods are substitutes. An increase in the price of one good leads to an increase in the quantity demanded for the other.

2. Complementary Goods (XED < 0): If XED is analysed negative, it indicates that the two goods are complements. An increase in the price of one good results in a decrease in the quantity demanded for the other.

3. Unrelated or Independent Goods (XED = 0): If XED is zero, it means the goods are unrelated or independent. Changes in the price of one good do not affect the quantity demanded of the other.

Examples:

1. Substitute Goods: If the price of milk increases by 10%, and the quantity demanded for coffee rises by 8%, the XED between milk and coffee is 8% / 10 % =0.8 indicating they are substitutes.

2. Complementary Goods: If the price of smartphones increases by 15%, and the quantity demanded for mobile phone covers decreases by 12%, the XED between smartphones and covers is −12% / 15% = −0.8 suggesting they are complements.

3. Unrelated Goods: If the price of apples changes by 20%, and the quantity demanded for pens remains unchanged, the XED between apples and pens is

0% / 20% = 0 implying they are unrelated.

Multiple Choice Questions:

1. What does the Cross Elasticity of Demand measure?

a) Change in quantity demanded due to income change

b) Change in quantity demanded of one good due to a price change in another good

c) Change in quantity demanded due to a change in the consumer's tastes

d) Change in quantity demanded due to changes in production costs

2. If the XED between two goods is 1.5, it suggests that they are:

a) Substitute goods

b) Complementary goods

c) Unrelated goods

d) Independent goods

3. If the XED between butter and margarine is -0.6, what does this imply?

a) They are substitute goods

b) They are complementary goods

c) They are unrelated goods

d) They are independent goods

4. If the XED between bicycles and helmets is -1.2, it indicates that they are:

a) Substitute goods

b) Complementary goods

c) Unrelated goods

d) Independent goods

5. A positive XED value suggests that the two goods are likely:

a) Complementary

b) Substitute

c) Unrelated

d) Independent

6. If the price of printers increases by 10%, and the quantity demanded for printer paper increases by 8%, the XED between printers and printer paper is:

a) 0.8

b) -0.8

c) 1.25

d) -1.25

7. What does a negative XED value imply?

a) The goods are substitutes

b) The goods are complements

c) The goods are unrelated

d) The goods are independent

8. If the XED between tennis rackets and tennis balls is -0.5, what does this suggest?

a) They are substitute goods

b) They are complementary goods

c) They are unrelated goods

d) They are independent goods

9. If the XED is zero between two goods, it indicates that they are:

a) Substitute goods

b) Complementary goods

c) Unrelated goods

d) Independent goods

10. If the XED between laptops and tablets is 0.2, what does this imply?

a) They are substitute goods

b) They are complementary goods

c) They are unrelated goods

d) They are independent goods

(Answers: 1-b, 2-a, 3-b, 4-b, 5-b, 6-a, 7-b, 8-b, 9-c, 10-a)