Computing short circuit current of transformer
If the primary voltage is 120 V, your calculation is correct.


  This means if the secondary side of the 500VA transformer is short circuited. Then there will be 208.3A short circuit current produced?


Yes that is correct.


  How does this relate to whatever is the step down voltage?


The equivalent circuit of a transformer is shown below. The impedance of the transformer as viewed from the transformer is the primary impedance (Rp + jXp) plus the parallel combination of the magnetizing branch and the secondary impedance (Rs + jXs) referred to the primary. To refer the secondary impedance to the primary, it is multiplied by the square of the turns ratio. That is how the step-down voltage is related to the percentage impedance. Stating the impedance as a single impedance percentage with the secondary impedance referred to the primary accounts for the secondary voltage, so that the actual secondary voltage does not need to be known. The transformer manufacturer has taken care of that by providing the impedance as a single impedance percentage value.

Transformer manufacturers usually state both the percentage impedance and the X/R ratio, so that other impedances in the distribution circuit can be properly added when calculating the prospective short circuit current at a given point in a distribution system.

This type of transformer specification is generally given for power transmission and distribution transformers, not for a small transformer like 500 VA. A transformer of that size would have a much higher impedance. Only a large distribution transformer would have an impedance in the 2% range,



Image from Wikimedia Commons Cblambert