Introduction
Price elasticity of demand (PED) measures the responsiveness of quantity demanded to changes in price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. PED can be elastic (greater than 1), inelastic (less than 1), or unitary (equal to 1). The determinants of PED influence its value and have significant implications for firms and governments in their decision-making.

Determinants of Price Elasticity of Demand
1. Availability of Substitutes
Goods with many close substitutes tend to have elastic demand. When the price of a product rises, consumers can easily switch to alternative options, leading to a large decrease in quantity demanded. For instance, if the price of Coca-Cola increases significantly, consumers may opt for Pepsi or other soft drinks. Conversely, goods with few or no substitutes have inelastic demand. For example, essential medicines often face limited substitutes, making their demand less sensitive to price changes.

2. Necessity vs. Luxury
Necessities, like basic food and healthcare, are less affected by price fluctuations and have inelastic demand. Consumers tend to purchase these goods regardless of price, as they are considered essential. On the other hand, luxuries, such as designer clothes or expensive vacations, are more sensitive to price changes and have elastic demand. When prices rise, consumers may forgo these non-essential goods, leading to a significant decrease in quantity demanded.

3. Proportion of Income Spent
Goods that constitute a large proportion of an individual's income tend to have elastic demand. A price increase for these goods would have a noticeable impact on consumers' budgets, leading to a significant decrease in quantity demanded. For example, a significant price increase in housing, a major expense for many households, could lead to a substantial decrease in demand. Conversely, goods that represent a small portion of income have inelastic demand. For instance, a small price increase in a pack of chewing gum is unlikely to significantly impact consumer purchases.

4. Time Period
The short-run is characterized by limited consumer options, often resulting in inelastic demand. Consumers may not have enough time to adjust their consumption patterns or find alternatives. For example, a sudden increase in gasoline prices might not significantly reduce driving in the short term. However, in the long-run, consumers have more time to adapt and find substitutes, resulting in more elastic demand. Over time, consumers may switch to more fuel-efficient vehicles, use alternative modes of transportation, or adjust their commute patterns.

Significance of PED to Firms
Firms leverage PED to make informed pricing decisions. Firms with products facing elastic demand can use price discrimination to charge different prices to different customer segments. For instance, airlines often offer discounts to passengers who book flights in advance, while charging higher prices to last-minute travelers. Firms with products facing inelastic demand might employ price skimming, setting high initial prices and gradually reducing them over time. For example, pharmaceutical companies often charge high prices for newly developed drugs with no close substitutes. <br/> PED also influences a firm's total revenue. For goods with elastic demand, a price increase leads to a decrease in total revenue, while a price decrease leads to an increase in total revenue. The opposite holds true for goods with inelastic demand. For example, a gasoline retailer might find that a price increase actually generates higher revenue in the short term because consumers are less sensitive to price changes.

Significance of PED to Governments
Governments use PED to design effective taxation policies. Indirect taxes, levied on goods and services, are often imposed on goods with inelastic demand, as they generate significant government revenue. For example, tobacco and alcohol are heavily taxed, as consumers are less likely to dramatically reduce their consumption due to price increases. Governments also consider PED in social welfare policies. Taxes on goods with elastic demand can disproportionately impact low-income households, as these goods represent a larger portion of their budget.

Conclusion
The determinants of price elasticity of demand, including the availability of substitutes, necessity vs. luxury, proportion of income spent, and time period, significantly impact the responsiveness of quantity demanded to price changes. These factors influence the pricing strategies of firms and the tax policies of governments. Understanding PED allows firms to make informed pricing decisions that maximize revenue and governments to design policies that balance revenue generation with social welfare concerns.

Sources:

Mankiw, N. Gregory. Principles of Microeconomics. Cengage Learning, 2014.
Sloman, John, et al. Economics. Pearson Education Limited, 2019.