Exercise 4.1:
Why is the University bookstore more likely to put tee shirts "on sale" than textbooks?

The benefit of putting an item "on sale" (reducing its price) is that at lower prices, the quantity demanded will increase. Of course, the drawback is that each one sold will be sold for less. A store would want to lower price, and sell more if the merchandise will not sell at the current price (there is a surplus) or if the resulting increase in quantity sold is large enough to offset the lower sales price. In the latter case, the store is concerned with its total revenue (price times quantity sold). When a given percentage decrease in price (think of the lower price as the "bad news") results in an even larger percentage increase in quantity sold (think of this as the "good news"), the firm will receive higher total revenue (i.e. the good news outweighs the bad news). When a given percentage decrease in price (the bad news) results in a smaller percentage increase in quantity sold (the good news), the firm's total revenue will fall (i.e. the bad news outweighs the good news). Price elasticity of demand tells us how large the resulting percentage change in quantity demanded will be for a given percentage change in price.

It is possible that the store can lower the price of tee shirts and have the price decrease result in an even larger increase (in percentage terms) in quantity sold, therefore increasing the store's total revenue. This would happen if the demand for tee shirts is elastic. With an elastic demand, the percentage increase in quantity demanded is larger than the percentage decrease in price (i.e. the quantity demanded is very responsive to a price change).

In the case of textbooks, it is not likely that there will be a surplus of textbooks, since the store knows the books selected for each class and the number of students enrolled. The store also has the option of returning unsold books to the supplier or keeping extra copies for a future semester if the book will be used again. In addition, decreasing the price of textbooks is not likely to increase the quantity demanded by very much. The demand for a textbook is largely due to the fact that it is selected for use in a course. A lower price is not likely to cause very many more students than are enrolled in a course to buy the book. Would you be tempted to buy a chemistry book that you didn't need for class if the price were reduced to only $45?

The demand for textbooks will be close to vertical at the quantity representing the number of students in the course. Since the demand for textbooks is very inelastic (i.e. not very responsive to price changes), the bookstore will reduce its total revenue if it puts textbooks on sale (i.e. the bad news will outweigh the good news by far).

Exercise 4.2:
Why are People Willing to Pay a Higher Price for Christmas Presents on December 24?

The law of demand tells us that at higher prices, quantity demanded will be lower. We know that people respond to higher prices by reducing their quantity demanded. The amount by which quantity demanded will fall depends on the relative responsiveness of quantity demanded to changes in price – price elasticity of demand.

Someone shopping for a Christmas present well before Christmas will have a more elastic demand than if they were shopping the day before Christmas (ceteris paribus). With lots of time to shop, the gift-giver can respond to higher prices by shopping around for a lower price or waiting for a sale. They are very responsive to changes in price.

However, the day-before-Christmas shopper does not have the time to wait or shop around, if the gift is to be ready for Christmas the next day. The day-before-Christmas shopper is not very responsive to changes in price and will pay a higher price to have the gift in time for Christmas. The demand for the gift on December 24th is very inelastic.