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?


Answer:Judy will spend the same amount ($500) on textbooks even when prices increase. We
know that total revenue (i.e., total spending on a good) remains constant when price
changes only if demand is unit elastic. Therefore Judy’s price elasticity of demand
for textbooks is –1. Her income elasticity must be zero because she does not plan to
purchase more books even though she expects a large monetary gift (i.e., an increase
in income).