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Performance Management · Pricing decisions

Factors Influencing Pricing and Price Elasticity of Demand

Updated 11 October 2026 · Fact-checked

Price is shaped by demand, costs, competition and market conditions. Price elasticity of demand (PED) measures how much quantity demanded changes when price changes: PED = % change in demand ÷ % change in price. For the demand line P = a − bQ, set marginal revenue equal to marginal cost to find the best price.

Understand Factors Influencing Pricing and Price Elasticity of Demand

A price must do two jobs. It must cover costs and it must be one customers will pay. So pricing is a balance of several factors. Cost sets the floor: in the long run the price must cover total cost. Demand sets the ceiling: customers' willingness to pay, their income, tastes, and the price of substitutes and complements.

Competition matters too. With many close rivals, you are a price taker and have little freedom. With few rivals or a unique product, you have more control. Other factors include the stage of the product life cycle, your strategy (for example skimming or penetration), brand strength, legal limits, and whether the product is part of a range.

Price elasticity of demand (PED) measures how sensitive demand is to price. It is the % change in quantity demanded divided by the % change in price. Ignore the minus sign in the exam unless asked. If PED is above 1, demand is elastic: a price rise cuts demand by a larger percentage, so revenue falls. If PED is below 1, demand is inelastic: a price rise cuts demand by a smaller percentage, so revenue rises. If PED equals 1, revenue is unchanged.

Inelastic demand is likely when there are few substitutes, the product is a necessity, it is a small part of spending, or customers are loyal. Elastic demand is likely with many substitutes, luxuries and high-cost items.

The demand curve turns this into a decision. ACCA PM uses a straight line: P = a − bQ. Here a is the price at which demand falls to zero, and b is the price fall needed to sell one extra unit. Marginal revenue is then MR = a − 2bQ. Profit is highest where MR = MC, and you read the price off the demand line.

Key rules to remember

Price elasticity of demand
PED = % change in quantity demanded ÷ % change in price
Use the absolute value. Above 1 is elastic, below 1 is inelastic, equal to 1 is unitary.
Demand line
P = a − bQ
a is the price where demand is zero. It is the intercept on the price axis.
Gradient b
b = change in price ÷ change in quantity
If price falls $1 for every 50 extra units, b = 1 ÷ 50 = 0.02.
Finding a
a = P + bQ
Use any known price and quantity point on the line.
Marginal revenue
MR = a − 2bQ
The slope is twice that of the demand line. It holds for a straight-line demand curve.
Profit-maximising output
MR = MC, so Q = (a − MC) ÷ 2b
Substitute Q back into P = a − bQ to get the price. This assumes MC is constant.
Point elasticity on a straight line
PED = (1 ÷ b) × (P ÷ Q)
Elasticity changes along the line. It is higher at higher prices.
Revenue effect
Elastic: raise price, revenue falls. Inelastic: raise price, revenue rises.
Reverse the effect for a price cut.

How to solve Factors Influencing Pricing and Price Elasticity of Demand questions

Use this method for any pricing question that involves demand, whether it is written or numerical.

  1. 1Read what is asked: a factor discussion, a PED calculation, a demand equation or an optimal price.
  2. 2For PED, work out the % change in quantity and the % change in price, both against the starting figures. Divide the % change in quantity demanded by the % change in price. State whether demand is elastic or inelastic.
  3. 3For a demand equation, find b first from the price change per unit change in quantity. Then find a using a = P + bQ with a known point.
  4. 4Write the demand line P = a − bQ. Derive MR = a − 2bQ.
  5. 5Identify marginal cost. Use only the variable cost per unit that is relevant. Ignore fixed costs for the optimal price.
  6. 6Set MR = MC and solve for Q. Substitute Q into P = a − bQ to find the price.
  7. 7Check by confirming the price and quantity sit on the demand line. Calculate contribution or profit if asked.
  8. 8In written parts, link the answer to the business: costs, competitors, substitutes, product life cycle and strategy.

Quickest way: Optimal price in four lines

When to use it: Use when you are given a price and quantity point plus the effect of a price change, and you need the profit-maximising price.

  1. b = price change ÷ quantity change. a = P + bQ.
  2. Q = (a − MC) ÷ 2b.
  3. P = a − bQ.
  4. Quick check: (a + MC) ÷ 2 also gives P when MC is constant.

Common mistakes in Factors Influencing Pricing and Price Elasticity of Demand

  • Working out the % change using the new figure as the base.

    Students divide by the final price or quantity because it is the number they just calculated.

    Fix: Always divide the change by the original (starting) figure.

  • Using b as the quantity change per $1 price change, instead of price change per unit.

    The wording 'demand falls by 50 units per $1' reads the wrong way round.

    Fix: Invert it. b = $1 ÷ 50 units = 0.02. Check by seeing that P falls as Q rises.

  • Writing MR = a − bQ.

    Students copy the demand line instead of doubling the slope.

    Fix: MR = a − 2bQ. The MR line has twice the gradient and the same intercept.

  • Including fixed costs in MC when setting MR = MC.

    Students confuse total unit cost with marginal cost.

    Fix: Use only the extra cost of one more unit. Fixed costs do not change the optimal price or quantity.

  • Saying a high-priced product always has inelastic demand.

    Students link 'premium' with 'loyal customers'.

    Fix: Elasticity depends on substitutes, necessity and share of income. Argue from the facts in the scenario.

  • Mixing up the revenue effect of a price change under elastic and inelastic demand.

    Students memorise 'elastic' without thinking about quantity response.

    Fix: Elastic means quantity reacts strongly, so a price cut raises revenue. Inelastic means a price rise raises revenue.

Worked examples

Example 1

A product sells 1,000 units at $20. Market research shows that for every $1 increase in price, demand falls by 50 units. Variable cost is $8 per unit. Find the profit-maximising price and quantity, and the contribution at that price.

Show the solution
  1. b = $1 ÷ 50 units = 0.02.
  2. a = P + bQ = 20 + (0.02 × 1,000) = 40. Demand line: P = 40 − 0.02Q.
  3. MR = 40 − 0.04Q.
  4. MC = 8. Set MR = MC: 40 − 0.04Q = 8, so 0.04Q = 32 and Q = 800.
  5. P = 40 − (0.02 × 800) = 40 − 16 = $24.
  6. Check: price rises $4 from $20, so demand falls 4 × 50 = 200 units, giving 800. This matches.
  7. Contribution = (24 − 8) × 800 = $12,800.
  8. Elasticity at this point: (1 ÷ 0.02) × (24 ÷ 800) = 50 × 0.03 = 1.5. Demand is elastic at the optimum.

Answer: Optimal price $24, quantity 800 units, contribution $12,800.

Example 2

A firm raises its price from $50 to $55. Monthly demand falls from 2,000 units to 1,700 units. Calculate PED, say whether demand is elastic or inelastic, and state the effect on revenue.

Show the solution
  1. % change in quantity = (1,700 − 2,000) ÷ 2,000 = −300 ÷ 2,000 = −15%.
  2. % change in price = (55 − 50) ÷ 50 = +10%.
  3. PED = 15% ÷ 10% = 1.5 (ignoring the sign).
  4. 1.5 is greater than 1, so demand is elastic.
  5. Revenue before = 50 × 2,000 = $100,000.
  6. Revenue after = 55 × 1,700 = $93,500.
  7. Revenue falls by $6,500, as expected with elastic demand.

Answer: PED = 1.5, demand is elastic, and revenue falls from $100,000 to $93,500.

Exam tips

  • Show the demand line, the MR line and the MR = MC step on separate lines. Marks are given for method even if the final number is wrong.
  • In objective test questions, you only get marks for the right answer. Do a quick check: substitute your optimal Q back into the demand line.
  • For written Section C parts, always tie the factor to the scenario (for example, many substitutes means elastic). Generic lists score poorly.
  • Do not forget to state the elastic or inelastic conclusion and what it means for the pricing decision.
  • When fixed costs appear in a question, say they are irrelevant to the optimal price, then ignore them.

Practice questions from Pricing decisions

Factors Influencing Pricing and Price Elasticity of Demand in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Factors Influencing Pricing and Price Elasticity of Demand: frequently asked questions

What is the difference between elastic and inelastic demand?

With elastic demand, PED is above 1, so quantity changes by a bigger percentage than price. A price rise cuts revenue. With inelastic demand, PED is below 1, so quantity changes by a smaller percentage and a price rise increases revenue.

How do I find a and b in P = a − bQ?

Find b as the price change divided by the quantity change. Then use a = P + bQ with any known price and quantity. For example, if price is $20 at 1,000 units and b is 0.02, a is 20 + 20 = 40.

Why is marginal revenue a − 2bQ?

With a straight-line demand curve, to sell one more unit you must cut the price on all units. So revenue gained on the extra unit is less than its price. Total revenue is aQ − bQ², and differentiating gives a − 2bQ.

Which factors influence pricing decisions in PM?

The main ones are demand and customers' willingness to pay, costs, competition, and market conditions. Also consider product life cycle stage, pricing strategy, brand, and legal or ethical limits. Always link them to the scenario.