Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What is the formula for calculating cross elasticity of demand?

1. (% change in price of good 'A') ÷ (% change in quantity demanded for good 'B')

2. (% change in quantity demanded for good 'A') ÷ (% change in price of good 'B')

3. (% change in quantity supplied for good 'B') ÷ (% change in price of good 'A')

4. (% change in supply of good 'A') ÷ (% change in quantity demanded for good 'B')

The correct answer is: (% change in quantity demanded for good 'A') ÷ (% change in price of good 'B')

The formula for calculating cross elasticity of demand focuses on the relationship between the quantity demanded of one good and the price of another good. In this case, the correct formula is defined as the percentage change in the quantity demanded for good 'A' divided by the percentage change in the price of good 'B'. This concept is particularly useful for understanding how the demand for one product is affected by changes in the price of another related product. For instance, if the price of good 'B' increases, you can determine how much the quantity demanded for good 'A' changes in response. A positive value indicates that the goods are substitutes; as the price of one rises, demand for the other also rises. A negative value suggests that the goods are complements, meaning that an increase in the price of one leads to a decrease in demand for the other. By focusing on this relationship, the formula provides valuable insights for businesses in pricing strategies, product development, and marketing tactics. The other choices misapply the concepts or mix different economic principles such as supply or other types of elasticity, which are not relevant for cross elasticity of demand specifically.