Question

We are analyzing the market for hybrid cars after innovations in the production of batteries (an input in the production of hybrid cars). Which of the following must be true?

(I) In the market for hybrid cars, supply increases while demand stays the same.

(II) The equilibrium price and the equilibrium quantity of hybrid cars increase.

(a) Only I is true.

(b) Only II is true.

(c) Both are true.

(d) Neither is true.

Answer 1

ANSWER-

option ( a) only I is true

An innovation in the production of batteries would reduce the cost of producing batteries. As the cost of producing batteries will decrease, the cost of producing hybrid cars will also decrease. At a particular price, a decrease in the cost of Production will increase the profit margin of supplier and hence the supplier will be willing to supply more and hence SUPPLY OF HYBRID CARS WILL INCREASE. As supply will increase the Supply curve will shift to right, with Demand remaining the same, a surplus will occur at the original Equilibrium price. Buyers seeing the unsold stock of cars will begin to ask for lower price. Suppliers also may start offering lower price in an attempt to sell the cars. In both the cases, a downward pressure is exerted on the price and PRICE WILL FALL. As supply of cars has increased due to innovation in batteries , the Equilibrium quantity of batteries will INCREASE.

As such, only ( I) is correct because only supply will increase due to innovation in batteries.

Option b is incorrect because ( II) is incorrect because Equilibrium price will FALL and not increase.