Question

Judy has decided to allocate exactly $500 to college textbooks every year, even though she knows that the prices are likely to increase by 5 to 10 percent per year and that she will be getting a substantial monetary gift from her grandparents next year. What is Judy’s price elasticity of demand for textbooks? Income elasticity?

Short answer

Judy’s demand elasticity for the textbook will be unitary elastic since expenditure remains the same even if the price rises.

The income elasticity of Judy will be perfectly inelastic or zero since her allocation remain constant even if she receives a monetary gift.

Step-by-step solution

Demand elasticity

The demand elasticity measures the degree of responsiveness in quantity demanded due to change in the price. One sees that Judy has a set expenditure of $500 for her textbook even if the price rises. It is the case of unit elastic demand only; since the expenditure is the same, Judy will keep altering her demand the same as the change in price. Therefore, her price elasticity of demand elasticity would be equal to -1.

Income elasticity

The income elasticities measure the change in the quantity demanded of the commodity due to a change in the income. Judy plans to keep the expenditure constant even if she receives a monetary gift from her grandparents. Even if her income increases, her income elasticity would be perfectly inelastic or equal to zero.