Association of Chartered Certified Accountants (ACCA) Certification Practice Test

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How is cross elasticity of demand typically calculated?

  1. By comparing the change in price of one product to the change in demand of another

  2. By calculating the percentage change in quantity demanded of one product divided by the percentage change in the amount of another good

  3. By finding the ratio of quantity supplied to quantity demanded

  4. By measuring consumer preference changes

The correct answer is: By calculating the percentage change in quantity demanded of one product divided by the percentage change in the amount of another good

Cross elasticity of demand is calculated by determining how the quantity demanded of one good responds to a change in the price of another good. Specifically, it involves taking the percentage change in the quantity demanded of the first good and dividing it by the percentage change in the price of the second good. This method allows economists and analysts to understand the relationship between two products—whether they are substitutes or complements. For instance, if the price of product A rises and leads to an increase in the quantity demanded of product B, then product B is considered a substitute for product A. Conversely, if the price of product A rises and the quantity demanded of product B decreases, then the two products are complements. The resulting cross elasticity coefficient helps indicate the strength and nature of the relationship between the two goods. Other approaches mentioned, such as comparing price changes to changes in demand or measuring consumer preference changes, do not accurately capture the specific relationship that cross elasticity is intended to measure. Calculating the ratio of quantity supplied to quantity demanded instead pertains to concepts of market equilibrium and supply and demand analysis, which is not relevant to cross elasticity of demand. Thus, the focus on percentage changes in quantity demanded and price is key to correctly calculating and interpreting cross elasticity.

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