Association of Chartered Certified Accountants (ACCA) Certification Practice Test

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If two goods are substitutes, what is the expected cross elasticity of demand?

Negative
Zero
Positive
Undefined

The correct answer is: Positive

When two goods are substitutes, an increase in the price of one good typically leads to an increase in the demand for the other good. This relationship indicates a positive correlation between the price of one good and the quantity demanded of the other. Therefore, the cross elasticity of demand is defined as the percentage change in the quantity demanded of one good in response to a percentage change in the price of a substitute good. In the context of substitute goods, since the demand for one good rises when the price of the other increases, this results in a positive value for the cross elasticity of demand. Hence, the correct association in this scenario is a positive cross elasticity, reflecting the competitive nature of substitutes in the market.