A letter from Valley Grain: In December a letter arrives at the Mill Lane bakehouse. After a poor harvest, Valley Grain will charge more for its flour from January.
The bakery's other ingredients are going up too. Altogether, the bakery's ingredients will cost 10% more. Lena and Marco want to know one thing: what does that do to the profit?
Start from what 2025 looked like. Lena's Bakery Ltd sold $1,600,000 of bread, cakes and lunches. Its costs came in two kinds, as in 3.3.1.
Some costs rise and fall with how much the bakery bakes and sells (variable costs): flour, butter, eggs and paper bags. They came to $480,000.
Others stay the same however much it sells (fixed costs): wages and salaries, the shops' rent and the power bills, and everything else. They came to $1,035,000.
So total cost was $1,515,000, and the profit, before the interest on its bank loan and its tax, was $1,600,000 − $1,515,000 = $85,000 (3.3.3).
| 2025 | Ingredients up 10% | |
|---|---|---|
| Revenue | $1,600,000 | $1,600,000: same loaves, same prices |
| Variable costs (ingredients) | $480,000 | $480,000 + $48,000 = $528,000 |
| Fixed costs | $1,035,000 | $1,035,000: nothing here has changed |
| Total cost | $1,515,000 | $1,563,000 |
| Profit | $85,000 | $1,600,000 − $1,563,000 = $37,000 |
A small rise in cost, a big fall in profit: Costs went up by 10%. Profit fell by $48,000, from $85,000 to $37,000: more than half of it gone.
Profit is the small gap between two big numbers. Every dollar added to cost comes straight out of that gap.
In the same week the landlord of the Park Road shop, where Jonas is the manager, raises the rent by $12,000 a year. Rent is a fixed cost, so total cost rises by exactly $12,000 and profit falls from $85,000 to $73,000.
The two rises behave differently. The rent goes up by $12,000 whether the bakery sells more or less. The ingredient rise adds 10% to every loaf and every cake, so the more the bakery bakes, the more it costs.
Costs can fall too, and the same sums work in reverse: a cheaper power deal that saved $6,000 a year would add $6,000 to profit.
When a variable cost changes
- Example: Valley Grain's flour costs 10% more
- Total cost moves with every item made: the more baked, the bigger the change
- Profit moves by the same amount as total cost, the other way
When a fixed cost changes
- Example: the Park Road rent rises by $12,000 a year
- Total cost moves by the same sum, however much is sold
- Profit moves by that sum, the other way
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Five per cent on every price: Marco has an idea: raise every price by 5%. A loaf would go from $3.00 to $3.15, and every cake and lunch would go up by the same share.
Lena is worried. Goldcrust plc has a bakery two streets from the Market Square shop, and its loaves are cheaper already.
A price change moves two things at once. Each item sold brings in more money. But some customers may buy less, or buy at Goldcrust instead, so the number sold (the quantity) may fall.
Revenue is price × quantity (3.3.2), so what happens to revenue depends on which of the two moves more. And there is a second effect: if fewer items are sold, fewer are baked, so the bakery spends less on ingredients. The fixed costs do not move at all.
| Every price up 5% | Customers buy the same | They buy 5% less | They buy 10% less |
|---|---|---|---|
| Revenue | $1,600,000 × 1.05 = $1,680,000 | $1,680,000 × 0.95 = $1,596,000 | $1,680,000 × 0.90 = $1,512,000 |
| Variable costs | $480,000 | $480,000 × 0.95 = $456,000 | $480,000 × 0.90 = $432,000 |
| Fixed costs | $1,035,000 | $1,035,000 | $1,035,000 |
| Total cost | $1,515,000 | $1,491,000 | $1,467,000 |
| Profit (2025: $85,000) | $165,000 | $105,000 | $45,000 |
Revenue can fall while profit rises: Look at the middle column. Revenue falls by $4,000, yet profit rises by $20,000.
Fewer items sold means fewer baked, so $24,000 less is spent on ingredients. That is why you must work out total cost again, not just revenue.
Working out a price change, step by step
New revenue
New price × new quantity. Prices up 5%, 5% fewer sold: $1,600,000 × 1.05 × 0.95 = $1,596,000.
New variable costs
They follow the quantity, not the price. 5% fewer made: $480,000 × 0.95 = $456,000.
Fixed costs stay put
The rent, the wages and the power bills do not change with the price: $1,035,000.
New profit, then compare
$1,596,000 − ($1,035,000 + $456,000) = $105,000. That is $20,000 more than the $85,000 of 2025.
A price cut is the same sum the other way round. Each item brings in less, so revenue rises only if enough extra items are sold. And every extra item needs its own ingredients, so profit rises only if the extra revenue is bigger than the extra variable costs.
Two questions for any price change: How many will customers buy at the new price?
And what will it cost to make that many? Answer both, and profit follows.
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Back to the flour letter: The flour rise will cost the bakery $48,000 a year. Lena and Marco have three choices.
The three choices
- Keep prices as they are and take the lower profit.
- Raise prices to cover the rise, which is called passing the cost on to customers.
- Find savings in other costs.
Passing the whole rise on needs $48,000 more revenue. That is 3% of $1,600,000, so the bakery would raise every price by 3%.
If every customer keeps buying, revenue becomes $1,648,000, total cost is $1,563,000, and profit is back at $85,000. The whole question is how many customers keep buying.
| What happens | Revenue | Total cost | Profit |
|---|---|---|---|
| Prices stay the same | $1,600,000 | $528,000 + $1,035,000 = $1,563,000 | $37,000 |
| Prices up 3%, customers buy the same | $1,648,000 | $528,000 + $1,035,000 = $1,563,000 | $85,000 |
| Prices up 3%, 3% less sold | $1,598,560 | $512,160 + $1,035,000 = $1,547,160 | $51,400 |
| Prices up 3%, 10% less sold | $1,483,200 | $475,200 + $1,035,000 = $1,510,200 | a loss of $27,000 |
Passing the cost on works only if customers stay: If one customer in ten went to Goldcrust instead, the price rise would turn a profit of $37,000 into a loss of $27,000.
A price rise is safest when customers value what they buy and have nowhere cheaper to go.
Easier to pass the cost on when
- Customers are loyal, like the regulars who queue at High Street every morning
- Rivals face the same rise: Goldcrust buys flour too
- The rise is small, a few cents on a loaf
- The product is hard to find elsewhere, like a birthday cake made to order
Harder to pass the cost on when
- A cheaper rival is close by, like Goldcrust near Market Square
- Customers buy often and notice every cent, as with a daily loaf
- The same product is easy to buy elsewhere
- The cost rise may not last, so a higher price could lose customers for nothing
The third choice is to save money elsewhere. Priti's bakers could cut the loaves left unsold at the end of the day, or the vans could share one delivery round in quiet weeks. Every dollar saved on another cost is a dollar of the $48,000 that does not have to come from customers.
Most businesses mix the three: a small price rise where customers will accept it, some savings, and a slightly lower profit for a while.
How this comes up: A case gives you figures from before and after a change in price or cost, often in a table over two or three years.
The usual questions
- Comment on what happened to revenue or profit, for two marks.
- Calculate the new profit, showing your working, for two.
- Explain one advantage and one disadvantage for the business of raising its prices, for four marks. This asks about a decision on prices head-on.
The two-mark comment pattern
- Say what happened. Revenue went up, or profit fell: one plain sentence.
- Show it with the data. Give the size of the change from the table, in dollars or as a percentage.
- Link it to the price or cost change. Say why: a higher price outweighed fewer sales, or a cost rise came out of profit.
The trap: a comment with no numbers: 'Revenue increased' earns one mark. The second mark needs the data: how much it rose, and that it rose even though fewer items were sold.
In a calculation, write the method as well as the answer: profit = total revenue − total cost, with the figures put in, and the $ sign on the answer.
Goldcrust plc raised the price of its large white loaf in 2025. Comment on Goldcrust's revenue from the loaf in 2024 and 2025.
Model answer plan
See the answer broken into clear points, with guidance on how each point earns marks.