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CA Foundation · Business Economics · Theory of Demand and Supply

The price of good X rises from ₹50 to ₹60 per unit. As a result, the quantity demanded of good Y rises from 80 to 100 units. Using the percentage (simple) method with the original values as the base, the cross elasticity of demand of Y with respect to the price of X, and the relation between X and Y, are:

The cross elasticity is 1.25 and the goods are substitutes. Quantity of Y rises 25% when the price of X rises 20%, giving 25/20 = 1.25. A positive cross elasticity means that a rise in one good's price increases demand for the other, which marks substitutes.

  1. A1.25; substitutesCorrect
  2. B1.25; complements
  3. C−1.25; complements
  4. D−0.8; complements

Explanation

Percentage change in quantity of Y = 20/80 = 25%. Percentage change in price of X = 10/50 = 20%. Cross elasticity = 25/20 = 1.25. Being positive, the goods are substitutes. Complements would show a negative value, so options 2 to 4 are wrong.

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