The price elasticity of demand (PED) is a measure of how much the quantity demanded

changes with a change in price. The PED for a given good is determined by one or a
combination of the following factors:
1. Availability of substitute goods: The more possible substitutes there are for a given
good or service, the greater the elasticity. When several close substitutes are available,
consumers can easily switch from one good to another even if there is only a small change in
price. Conversely, if no substitutes are available, demand for a good is more likely to
be inelastic.
2. Proportion of the purchaser's budget consumed by the item: Products that consume
a large portion of the purchaser's budget tend to have greater elasticity. The relative
high cost of such goods will cause consumers to pay attention to the purchase and seek
substitutes. In contrast, demand will tend to be inelastic when a good represents only a
negligible portion of the budget.
3. Degree of necessity: The greater the necessity for a good, the lower the elasticity.
Consumers will attempt to buy necessary products (e.g. critical medications like insulin)
regardless of the price. Luxury products, on the other hand, tend to have greater elasticity.
However, some goods that initially have a low degree of necessity are habit-forming and can
become "necessities" to consumers (e.g. coffee or cigarettes).
4. Duration of price change: For non-durable goods, elasticity tends to be greater over
the long-run than the short-run. In the short-term it may be difficult for consumers to find
substitutes in response to a price change, but, over a longer time period, consumers can adjust
their behavior. For example, if there is a sudden increase in gasoline prices, consumers may
continue to fuel their cars with gas in the short-run, but may lower their demand for gas by
switching to public transportation, carpooling, or buying more fuel-efficient vehicles over a
longer period of time. However, this tendency does not hold for consumer durables. The
demand for durables (cars, for example) tends to be less elastic, as it becomes necessary for
consumers to replace them with time.
5. Breadth of definition of a good: The broader the definition of a good, the lower the
elasticity. For example, potato chips have a relatively high elasticity of demand because many
substitutes are available. Food in general would have an extremely low PED because no
substitutes exist.
6. Brand loyalty: An attachment to a certain brand (either out of tradition or because of
proprietary barriers) can override sensitivity to price changes, resulting in more inelastic
demand.
Determinants/Factors of Price Elasticity of Supply:

The main determinants/factors which determine the degree of price elasticity of supply are as
under:
(i) Time period. Time is the most significant factor which affects the elasticity of supply. If the
price of a commodity rises and the producers have enough time to make adjustment in the
level of output, the elasticity of supply will be more elastic. If the time period is short and the
supply cannot be expanded after a price increase, the supply is relatively inelastic.
(ii) Ability to store output. The goods which can be safely stored have relatively elastic
supply over the goods which are perishable and do not have storage facilities.
(iii) Factor mobility. If the factors of production can be easily moved from one use to
another, it will affect elasticity of supply. The higher the mobility of factors, the greater is the
elasticity of supply of the good and vice versa.
(iv) Changes in marginal cost of production. If with the expansion of output, marginal cost
increases and marginal return declines, the price elasticity of supply will be less elastic to that
extent.
(v) Excess supply. When there is excess capacity and the producer can increase output easily
to take advantage of the rising prices, the supply is more elastic. In case the production is

already up to the maximum from the existing resources, the rising prices will not affect supply
in the short period. The supply will be more inelastic.
(vi) Availability of infrastructure facilities. If infrastructure facilities are available for
expanding output of a particular good in response to the rise in prices, the elasticity of supply
will be relatively more elastic.
(vii) Agricultural or industrial products. In agriculture, time is required to increase output
in response to rise in prices of goods. The supply of agricultural goods is fairly inelastic. As
regards the supply of manufactured consumer goods, it is comparatively easy to increase
production in a short period.
Therefore, the supply of consumer goods is fairly more elastic; In case of supply of aero planes
or any other heavy machinery, the supply is relatively inelastic as it takes time to manufacture
heavy machinery.
Explain the characteristics of public goods. Cite an example of public goods and
explain how it meets the characteristics.
A public good is a good that is both non-excludable and non-rivalrous in that individuals cannot
be effectively excluded from use and where use by one individual does not reduce availability
to others. The defining characteristic of a public good is that consumption of it by one
individual does not actually or potentially reduce the amount available to be consumed by
another individual.
Characteristics
1. They have positive externalities- A positive externality is an economic activity that
imposes a positive effect on an unrelated third party.
2. Non-rivalrous in consumption- the consumption of one individual does not reduce the
availability of goods to others
3. Non-excludability in consumption-it is impossible to exclude individuals from
consumption.
4. Generally marginal cost in zero.
Examples of pure public goods include flood control systems, street lighting and national
defense. A flood control system, cannot be confined to those who have paid for the service.
Also, the consumption of the service by one household will not reduce its availability to others.
If left to the free market mechanism, no public goods would be provided and, as a result, there
would be a clear market failure. No individual consumer would pay for a product that could be
consumed for free if another household decided to purchase it.

Explain the characteristics of positive externality. Cite an example of positive

externality and explain how it meets the characteristics.
A positive externality is a benefit that is enjoyed by a third-party as a result of an economic
transaction. Third-parties include any individual, organization, property owner, or resource that
is indirectly affected. While individuals who benefit from positive externalities without paying
are considered to be free-riders, it may be in the interests of society to encourage free-riders to
consume goods which generate substantial external benefits.
Most merit goods generate positive consumption externalities, which beneficiaries do not pay
for. For example, with healthcare, private treatment for contagious diseases provides a
considerable benefit to others, for which they do not pay. Similarly, with education, the skills
acquired and knowledge learnt at university can benefit the wider community in many ways.
People who get vaccinations against a communicable disease reduce other peoples chances of
getting the disease. People who improve their property may create benefits for their neighbors
by creating a more pleasing neighborhood and increasing property values.
Explain the characteristics of negative externality. Cite an example of negative
externality and explain how it meets the characteristics.

A negative externality occurs if an activity creates costs (harm or discomfort) for uninvolved
people. Again, it is an economic activity that imposes a negative effect on an unrelated third
party. It can arise either during the production or the consumption of a goods and services.
Examples of negative externalities:
Cars and factories generate air pollution that affects peoples health. Cars entering congested
freeways impose time costs on other drivers, as all cars slow down as a result.
Water pollution by industries that adds effluent, which harms plants, animals and humans.
Noise pollution during the production process which may be mentally and psychologically
disruptive.

How Government can remedy the shortcomings of market?