Give examples of how to use the concept of elasticity:

1) including an explanation of why or how businesses might use the concept of elasticity.

2) Give examples of negative/positive externalities, defend your position on why you be believe they are externalities. What can governments do to correct for these market failures?

Elasticity

1. Elasticity is the percentage change in quantity demanded of the good due to percentage change in other variables like price of the good, price of the related goods, and income of the consumers. Elasticity of the good helps in determining the responsiveness of the quantity demanded with respect to other variables. Businesses can use the concept of elasticity to determine the level of advertising costs to be incurred, the pricing strategy to be kept for the good, the type of customer segment to cater and the amount of inputs to be used in production. Since elasticity helps in understanding the responsiveness of the consumers, it helps in various aspects of decision making for the firms in positioning themselves in the market.

Externalities

2. Externalities are the benefits or costs incurred by the third party without them having to pay for it. The externalities arise due to consumption and production decisions in the market. During the production or consumption of goods, there can arise some external benefits and costs, which affects other individuals and members of society who do not pay for it. Externalities can be both positive or negative. In case of positive externality, the marginal social benefit from the consumption decision is greater than the marginal private benefits of production and consumption. On the other hand, in case of negative externality, the marginal social cost to the society will exceed the marginal private cost.

Example of positive externality:

Suppose a farmer grows apples in the orchard and nearby the orchard is a bee farm. In that case, the bees from the orchard will help in the process of fertilisation in the apple farms. On the other hand, it will enrich the quality of honey produced by the bees. So here, the benefits from the farming of apple and bee is not just restricted to the farmers undertaking it, but it is also creating external benefits for each other. This is the case of positive externality.

Example of a negative externality:

When a person who is an active smoker, smokes in public place, he not only harms himself but also effect the health of those who are in his close vicinity. In this case all the passive smokers are incurring an increased cost due even when they are actually involved in the consumption process themselves. This is the case of negative externality.

Government can undertake variety of steps in this direction to internalise the external costs or benefits associated with the consumption and production decisions in the market which do not incorporate the externalities in it. Government can impose taxes in case of negative externalities and give subsidies in case of positive externalities. This will make the pricing and output to shift to a level where the output produced and consumed equals the social optimum level. The government can also introduce market permits, and emission standards in the market.