CMA Foundation · Fundamentals of Business Economics and Management · Theory of Demand and Supply
The price of petrol rises by 8% and the quantity of two-wheeler tyres demanded falls by 2%. What is the cross elasticity of demand between petrol and tyres, and what does it indicate?
The cross elasticity is -0.25, showing the goods are complements. It equals the percentage change in tyre demand (-2) divided by the percentage change in petrol price (+8). The negative sign means that when one good becomes dearer, demand for the other falls.
- A+0.25, the goods are substitutes
- B-0.25, the goods are complementsCorrect
- C-4.0, the goods are complements
- D+4.0, the goods are substitutes
Explanation
Cross elasticity = % change in quantity of tyres / % change in price of petrol = (-2)/(8) = -0.25. A negative sign means a price rise of one good reduces demand for the other, so they are complements. Option with -4.0 inverts the ratio.
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