Question

In a number of countries, consumers regularly make a choice between wireless phone service or traditional phone lines. Estimated supply and demand in each of these markets is

Wireless:

Q^W_D=20-8P_W+4P_T

Q^W_S=1+4P_W

Traditional:

Q^T_D=10-10P_T+2P_W

Q^T_S=2+6P_T

Using the above information concerning wireless and traditional phone service, a new regulation restricts the supply of traditional service. As a result, the wireless market now has (relative to a position where both markets are in equilibrium):

a. Higher Q_W and Lower P_W

b. Higher Q_W and Higher P_W

c. Lower Q_W and Lower P_W

d. Lower Q_W and Higher P_W

Answer 1

Correct opition is b: higher Qw and higher Pw

The explanation can be discussed in the following two parts.

1. Effect of quantity restriction on the Price of Traditional service.

As informed in the question the market for traditional service was already in equilibrium which means demand and supply were equal to each other. Therefore the new regualation restricting supply of it would cause a shortage of supply and as a result of shortage of supply in relation to demand, price of traditional service would increase.

2. Effect on quantity and price of wireless phone service.

Wireless service and traditional service are substitutes goods. In case of substitute goods, demand of one good is positively related to price of the substitute good and it can be seen in demand equation for wireless service that demand for wireless service (QwD) is positively related to price of traditional service (PT). From part 1, we know that price of traditional service has increased due to new regulation. Now increased prices of traditional service would cause increase in demand for wireless service due to positive relationship between these two variables. Further, since the market for wireless service was also in equilibrium before this new regulation, increase in  demand would result in excess demand in relation to supply of wireless service. This will increase price of wireless service and hence new equilibrium will be established at a higher price and higher quantity levels.

Graphically, in the market for wireless service demand curve for wireless service would shift forward. This will result in a new equilibrium point at a higher price and higher quantity.