If 20% rise in the price of Whisky leads to a 30% increase in quantity demanded of Schnapps, the cross elasticity of demand is

Answer Details

Cross elasticity of demand (XED) measures how the quantity demanded of one good responds to a change in the price of another good. The formula is:

\[\text{XED} = \frac{\% \text{ change in quantity demanded of Good B}}{\% \text{ change in price of Good A}}\]

In this question, a 20% rise in the price of Whisky leads to a 30% increase in quantity demanded of Schnapps. Substituting:

\[\text{XED} = \frac{30\%}{20\%} = \frac{30}{20} = 1.5\]

The cross elasticity of demand is 1.5.

The positive sign indicates that Whisky and Schnapps are substitute goods. When the price of one substitute rises, consumers switch to the other, increasing its quantity demanded. A value greater than 1 means the demand for Schnapps is relatively responsive to changes in the price of Whisky, confirming they are close substitutes.