The Allocation of Resources - Price Changes: Effect on Sales

This section explores how changes in price affect the quantity of goods and services consumers are willing to buy. Understanding this relationship is fundamental to analyzing market dynamics and resource allocation.

Demand and Price Elasticity

Demand refers to the quantity of a good or service that consumers are willing and able to purchase at various prices during a specific period. The relationship between price and quantity demanded is often represented by a demand curve, which typically slopes downwards.

Price elasticity of demand (PED) measures the responsiveness of quantity demanded to a change in price. It is calculated as:

$$PED = \frac{\text{Percentage change in quantity demanded}}{\text{Percentage change in price}}$$

The value of PED indicates the sensitivity of consumers to price changes:

• Elastic Demand ($|PED| > 1$): A significant change in quantity demanded occurs with a small change in price. Consumers are very responsive to price changes.
• Inelastic Demand ($|PED| < 1$): A small change in quantity demanded occurs with a large change in price. Consumers are not very responsive to price changes.
• Unit Elastic Demand ($|PED| = 1$): The percentage change in quantity demanded is equal to the percentage change in price.

Effect of Price Increases on Sales

When the price of a good or service increases, generally the quantity demanded decreases. The extent of this decrease depends on the price elasticity of demand.

In the case of inelastic demand:

If the price increases, the quantity demanded will decrease by a smaller proportion. This means total revenue (price x quantity) may still increase or remain relatively stable.

In the case of elastic demand:

If the price increases, the quantity demanded will decrease by a larger proportion. This will likely lead to a decrease in total revenue.

Effect of Price Decreases on Sales

When the price of a good or service decreases, generally the quantity demanded increases. Again, the extent of this increase depends on the price elasticity of demand.

In the case of elastic demand:

If the price decreases, the quantity demanded will increase by a larger proportion. This will likely lead to an increase in total revenue.

In the case of inelastic demand:

If the price decreases, the quantity demanded will increase by a smaller proportion. This will likely lead to an increase in total revenue.

Table Summarizing the Effects of Price Changes

Price Change	Demand Elasticity	Effect on Quantity Demanded	Effect on Total Revenue
Price Increases	Inelastic	Quantity Demanded Decreases (less proportionally)	Total Revenue may increase or remain stable
Price Increases	Elastic	Quantity Demanded Decreases (more proportionally)	Total Revenue likely decreases
Price Decreases	Elastic	Quantity Demanded Increases (more proportionally)	Total Revenue likely increases
Price Decreases	Inelastic	Quantity Demanded Increases (less proportionally)	Total Revenue likely increases

Understanding price elasticity of demand is crucial for businesses when making pricing decisions. They need to consider how consumers will react to changes in price to maximize their revenue and profits.