Effect of price changes on sales
The Allocation of Resources – Price Changes
Objective: Effect of price changes on sales
📈 When the price of a good changes, the quantity sold usually changes too. Understanding this relationship helps businesses decide how to price their products and helps the economy allocate resources efficiently. In this lesson we will explore the key concepts, use real‑world analogies, and give you exam‑ready tips.
Key Concepts
- Demand Curve – shows the relationship between price and quantity demanded.
- Law of Demand – as price falls, quantity demanded rises, and vice versa.
- Price Elasticity of Demand (PED) – measures how responsive quantity demanded is to a price change.
- Revenue Effect – how total revenue (price × quantity) changes when price changes.
Price Elasticity of Demand (PED)
The formula for PED is:
$E_d = \frac{\%\Delta Q_d}{\%\Delta P}$
Where $\%\Delta Q_d$ is the percentage change in quantity demanded and $\%\Delta P$ is the percentage change in price.
| Elasticity Type | PED Value | Revenue Effect |
|---|---|---|
| Elastic | $|E_d| > 1$ | Price ↓ → Revenue ↑; Price ↑ → Revenue ↓ |
| Inelastic | $|E_d| < 1$ | Price ↓ → Revenue ↓; Price ↑ → Revenue ↑ |
| Unit Elastic | $|E_d| = 1$ | Revenue unchanged by price change |
Real‑World Analogy: The Pizza Parlor
Imagine a pizza shop that sells a slice for £2. If the shop raises the price to £3, customers might buy fewer slices.
Elastic demand example: If the shop raises the price to £4 and sales drop by 50%, the demand is elastic.
Inelastic demand example: If the price rises to £5 and sales only drop by 10%, the demand is inelastic.
📌 Why this matters: The shop can increase revenue by lowering the price if demand is elastic, or increase revenue by raising the price if demand is inelastic.
Exam Tips
1️⃣ Identify the type of good: Is it a necessity, luxury, or a substitute?
2️⃣ Use the PED formula: Show the calculation step‑by‑step.
3️⃣ Explain the revenue effect: State whether revenue increases or decreases and why.
4️⃣ Include real‑world examples: This demonstrates understanding and makes your answer memorable.
5️⃣ Check your units: Remember that PED is dimensionless.
Practice Question (for you to try)
- Suppose the price of a popular video game drops from £60 to £45, and sales increase from 10,000 to 15,000 units. Calculate the price elasticity of demand.
- Based on your calculation, would you advise the company to lower the price further or raise it? Justify your answer.
Revision
Log in to practice.