Elasticity - Application

The R. S. Smith corporation is a publisher of

romance novels- just stories of common people.
The corporation hires an economist to determine
the demand for its product. After months of hard
work, the analyst informed the company that the
demand for the firm`s novels Qx is given by the
following equation:
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 𝑄𝑥 = 12,000 − 5,000𝑃𝑥 + 5𝐼 + 500𝑃𝑐
Where,
𝑃𝑥 𝑖𝑠 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑐ℎ𝑎𝑟𝑔𝑒𝑑 𝑓𝑜𝑟 𝑡ℎ𝑒
𝑅. 𝐽 𝑆𝑚𝑖𝑡ℎ 𝑛𝑜𝑣𝑒𝑙𝑠;
𝐼 𝑖𝑠 𝑖𝑛𝑐𝑜𝑚𝑒 𝑝𝑒𝑟 𝑐𝑎𝑝𝑖𝑡𝑎;
𝑃𝑐 𝑖𝑠 𝑡ℎ𝑒 𝑝𝑟𝑖𝑐𝑒 𝑜𝑓 𝑡ℎ𝑒 𝐵𝑜𝑜𝑘𝑠 𝑓𝑟𝑜𝑚
𝑐𝑜𝑚𝑝𝑒𝑡𝑖𝑛𝑔 𝑝𝑢𝑏𝑙𝑖𝑠ℎ𝑒𝑟𝑠.
Assume that the initial values of 𝑃𝑥 , 𝐼 and 𝑃𝑐 are $
5, $10,000 and $6 respectively.

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Using the above information , the company’s manager
want to :
1. Determine what effect a price increased would have
on total revenues.
2. Evaluate how sale of the novels would changed
during a period of rising incomes.
3. Assumes the probable impact if competing
publishers would raised their prices.

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Solution :
1. Substituting the initial values of
𝐼 𝑎𝑛𝑑 𝑃𝑐 yields
𝑄𝑥 = 12,000 − 5000𝑃𝑥 + 5 ∗ 10,000
+ 500 ∗ 6
Which is equivalent to
𝑄𝑥 = 65,000 − 5,000𝑃𝑥 … … … … (1)

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The effects of a price increase can be assumed
by computing the point elasticity of demand.
𝑑𝑄𝑥
= −5,000;
𝑑𝑃𝑥
𝑎𝑡 𝑃𝑥 = $5 𝑎𝑛𝑑
𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑 𝑖𝑠 𝑄𝑥 = 40,000 𝐵𝑜𝑜𝑘𝑠

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Using these data, the point elasticity is
𝑑𝑄𝑥 𝑃𝑥 5
𝐸𝑝 = × = −5,000 × = −0.625
𝑑𝑃𝑥 𝑄𝑥 40,000
𝐼𝑓, 𝐸𝑝 < 1, the price elasticity of demand is
inelastic. We know, in the case of inelastic
demand Price and Total Revenue move in the
same direction, so rising the price of novels would
increase total revenue.
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The income elasticity determines whether a
product is necessity or a luxury. It has already
been determined that the initial 𝑄𝑥 at the given
values of price and income variables is 40,000.
From the problem,
𝑑𝑄𝑥 𝑖 𝑑𝑄𝑥
𝐸𝑖 = × , 𝐻𝑒𝑟𝑒, =5
𝑑𝑖 𝑄𝑥 𝑑𝑖
10,000
So, 𝐸𝑖 = 5 × = 1.25
40,000

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If 𝐸𝑖 > 1, the novels are luxury goods. Thus
income increases, sales should increase more
than proportionately.
𝑑 𝑄𝑥
3. From the demand equation, = 500;
𝑑 𝑃𝑖
𝑑 𝑄𝑥 𝑃𝑐 6
So, 𝐸𝑖 = × = 500 × = 0.075
𝑑 𝑃𝑐 𝑄𝑥 40,000

Thus, 𝐸𝑖 is positive, it means that Smith’s

romance novels and Books from competing
publishers are viewed by consumers as
substitutes.

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 Hence, 1 percent increase in the price of other Books
results in a 0.075 percent increase in demand for R. J.
Smith’s romance novels.

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