Cross Elasticity Formula Application

Steps:

• Recall cross elasticity of demand (XED) formula: XED = (% change in rail demand) / (% change in bus price).
• Given XED = -2 (indicating substitutes, absolute value 2) and % change in rail demand = +10%.
• Solve for % change in bus price: 10% / 2 = 5% increase (using absolute value for substitute goods).
• Calculate % price changes: A = (1/20)×100=5%; B=10%; C=12.5%; D=20%.

Why A is correct:

• Matches the 5% bus price increase required by |XED| × %ΔP_bus = %ΔQ_rail.

Why the others are wrong:

• B: 10% exceeds the 5% needed, overestimating rail demand rise.
• C: 12.5% too high, implying larger rail demand change than 10%.
• D: 20% far exceeds 5%, inconsistent with given elasticity.

Final answer: A