Suppose researchers at the University of Wisconsin discover a new vitamin that increases the milk production of dairy cows. If the demand for milk is relatively inelastic, the discovery will
a. raise both price and total revenues.
b. lower both price and total revenues.
c. raise price and lower total revenues.
d. lower price and raise total revenues.
The correct answer and explanation is :
Correct Answer: b. lower both price and total revenues.
Explanation:
To understand why the correct answer is (b), we need to break down two key concepts: inelastic demand and changes in supply.
1. What is Inelastic Demand?
Demand is said to be inelastic when consumers are not very responsive to changes in price. That means if the price drops or rises, the quantity demanded changes only slightly. In other words, the percentage change in quantity demanded is less than the percentage change in price. Milk often has inelastic demand because it is a basic necessity for many consumers—people will buy nearly the same amount regardless of price.
2. What Happens When Supply Increases?
In this case, a new vitamin increases the productivity of dairy cows, which increases the supply of milk. When supply increases (shifts to the right), prices drop because more milk is available in the market.
3. Applying the Concepts:
With an increase in supply, the price of milk decreases. Because demand is relatively inelastic, the quantity demanded does not increase much in response to the lower price. That means although more milk is sold, it is sold at a much lower price, and the small increase in quantity sold does not offset the price drop.
So, total revenue, which is Price × Quantity, will fall.
Summary:
- Supply increases → Price falls
- Inelastic demand → Quantity demanded rises slightly
- Total revenue falls because the price drop outweighs the small gain in quantity
Thus, the discovery of the new vitamin will lower both the price and total revenues, making (b) the correct answer.