The total supply of milk might remain the same, because the remaining high-efficiency producers are likely to be able to earn profits at this level of output. In the long-run, however, lower prices are going to sustain the quantity of milk demanded at higher than equilibrium levels, and the profits available to producers at lower than equilibrium levels. Producers, in their efforts to control costs, are going to reach a point of diminishing returns on those efforts. The result of this is that the market for milk will eventually become so distorted by the price ceiling that the government is forced to raise the price ceiling in order to ensure that there are producers remaining in the market. The government will have created a situation where to simply maintain the milk market requires active management. 2. There are several factors that contribute to the price elasticity of demand. One factor is the availability of substitutes. For milk, there are many substitutes available. Another factor, directly related, is the propensity to substitute. For most consumers, there is a relatively low propensity to substitute milk for other products. However, as milk alternatives become more mainstream, the propensity to substitute is likely going to increase over time.

Another factor that affects elasticity is how important the product is. For many people, milk is an essential part of their diet, if not directly than in the form of other dairy products like cheese, butter, yoghurt or ice cream. As such, milk is likely to have a low level of elasticity because people will be hesitant to reduce consumption of these staple products. A fourth factor is the cost of the product relative to the consumer's total budget. In general, products that represent a minor portion of the budget are less likely to experience high level of elasticity. If the price of milk increases by 10%, that might only be an increase of 30 cents...

The demand for milk is price inelastic. Milk is a staple product that for most consumers represents a small portion of their total budget. While substitutes are readily available, the propensity to substitute is low, so that consumers are likely to absorb increases in the price of milk without adjusting their consumption. If the demand for milk changes at a lower rate than the price for milk, that implies that the demand for milk is price inelastic.
4. For inelastic goods, an increase in the price of the good is likely to increase the profit. The reason for this is that the demand does not decrease as quickly as the price increases. If elasticity is 0.5, then a 10% increase in the price of a gallon of milk would reflect on demand as follows, then if P. goes from $3 to $3.3, D would go from 100 to 95. If the cost of producing a gallon of milk is $1, the profits would be as follows:

($3-$1)(100) = 200 under the base scenario and ($3.3-$1)(95) = 218.5 with the price increase. This shows that the total revenue and the total profits increase when the price of milk increases and the demand for milk is inelastic. This creates an incentive for producers to keep milk prices high.

Works Cited:

Rittenberg, L. And Tregarthen, T. (2009). Chapter 3: Demand and Supply. Section 1 and 3. Principles of Microeconomics. FlatworldKnowledge.com. Retrieved December 2, 2011 from: click here

Rittenberg, L. And Tregarthen, T. (2009). Chapter 4: Applications of Demand and Supply. Section 1 and 3. Principles of Microeconomics. FlatworldKnowledge.com. Retrieved December 2, 2011 from: click here

Rittenberg, L. And Tregarthen, T. (2009). Chapter 5: Elasticity…