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CMA Foundation · Fundamentals of Business Economics and Management · The Fundamentals of Economics

The cross elasticity of demand between tea and coffee is measured as +1.5 for a given price change. Which statement correctly describes the relationship between the two goods?

Tea and coffee are substitutes because the cross elasticity is positive. A positive value means that when the price of one good rises, demand for the other rises as consumers switch. Complements have negative cross elasticity and unrelated goods have a value near zero.

  1. AThey are complements, because the value is greater than 1
  2. BThey are substitutes, because the value is positiveCorrect
  3. CThey are unrelated goods, because the value is not zero
  4. DThey are complements, because the value is positive

Explanation

Cross elasticity is the percentage change in quantity demanded of one good divided by the percentage change in price of another. A positive value means a rise in the price of one good increases demand for the other, which is the case for substitutes. Complements show a negative value, and unrelated goods show zero.

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