A 3 percent increase in the price of tea causes a 6 percent increase in the demand for coffee. The cross elasticity of demand for coffee with respect to the price of tea is
A) −0.5.
B) +0.5.
C) −2.0.
D) +2.0.

Question

Quizplus · Accepted Answer

The cross elasticity of demand is calculated as the percentage change in quantity demanded of one good divided by the percentage change in the price of another good.

In this case, we know that a 3% increase in the price of tea leads to a 6% increase in the demand for coffee.

So, the cross elasticity of demand for coffee with respect to the price of tea is:

(6%/3%) = 2

Since the cross elasticity is positive, we can conclude that tea and coffee are substitute goods. This means that as the price of tea increases, people will shift towards consuming more coffee instead. A cross elasticity of 2 indicates a strong degree of substitution between the two goods.

A 3 Percent Increase in the Price of Tea Causes