Question

You are a monopolist that sells textbooks to undergraduate students. Currently you sell 100 books at a price of $100 each, for revenue of $10,000. Each book is essentially costless to print, so you ignore costs and focus on maximizing revenue. Based on research by your marketing team, you learn that some students will not buy the book if the price goes up. Also, if you cut the price more students will buy the book.

1. If the elasticity of demand is 0.5, what will be your new revenue if you raise the price by 10%?

2. If the elasticity of demand is 2, should you raise the price or lower the price? Briefly explain without performing any calculations.

Answer 1

Answer:

Consider the following calculations

Explanation:

(1)  Elasticity of demand = % Decrease in quantity demanded / % Increase in price

0.5 = % Decrease in quantity demanded / 10%

% Decrease in quantity demanded = 10% x 0.5 = 5%

New price = $100 x 1.1 = $110

New quantity = 100 x 0.95 = 95

New revenue = $110 x 95 = $10,450

(2)  If elasticity of demand is 2, which is higher than 1, it signifies that demand is elastic. With elastic demand, total revenue will increase if price is decreased, so I should lower price.