All answers must be typed no hand written work will be graded.

Diagrams and equations might be drawn or written by hand. You must submit a hard copy of the work in class. Q1: The demand function for VCRs has been estimated to be Qv = 134 1.07 Pt + 46 Pm 2.1Pv 5M , where Qv is the quantity of VCRs, P is the t P is the price of a movie, P is the price of a VCR, and M price of a videocassette, m v is income. Based on this information, answer the following questions. a. Are VCRs normal or inferior goods? An inferior good is a good that decreases in demand when consumer income rises, unlike normal goods, for which the opposite is observed. In our demand function, the coefficient associated with income is negative (-5), implying that an increase in income leads to a decrease in demand for VCRs. Therefore, VCRs are inferior goods. b. Are movies substitutes or complements for VCRs? A substitute good, in contrast to a complementary good, is a good with a positive cross elasticity of demand. This means a good's demand is increased when the price of another good is increased. In the above demand function for VCRs, the coefficient associated with the price of a movie is positive. This means that an increase in the price of a movie will increase the demand for VCRs. Therefore, movies are substitutes for VCRs. c. What additional information is needed to calculate the price elasticity of demand for VCRs? In order to calculate the price elasticity of demand for VCRs we would need the actual values of prices and income. Once we have these values we can determine the price elasticity of demand for VCRs. Q2: When the price of butter was low, consumers spent $5 billion annually on its consumption. When the price doubled consumer expenditures increased to $7 billion. Recently you read that this means that the demand curve for butter is upward sloping. Do you agree? Explain.

Disagree. The demand for butter is negatively sloped. The rise in expenditures is due to the fact that demand is inelastic (meaning that an increase in price increases total revenue despite a fall in the quantity demanded). To justify the above statement please refer to the example below.

Let x = initial price 2x = the new (doubled) price Q(x) = demand for butter when the price is x (original demand) Q(2x) = demand for butter when price is 2x (new demand) Then Q(x)*x = $5B Q(2x)*2x=$7B
Q ( x) * x 5 10 x * Q (2 x ) 10 = Q( x) = Q ( x) = * Q( 2 x ) Q ( x ) > Q ( 2 x) Q(2 x) * 2 X 7 7x 7

As we can see, an increase in price leads to a decrease in quantity demanded. Thus, the demand curve for butter is negatively sloped. Q4: The Kalamazoo Brewing Co (KBC) currently sells its microbrews in three-state area: Illinois, Indianan, and Michigan. The companys marketing department has collected data from its distributors in each state. These data consist of quantity and price (per case) of microbrews sold in each state, as well as the average income (in thousands of dollars) of consumers living in various regions of each state. The data for each state are available under the file name: Data_IL.xls, Data_IN.xls, and Data_MI.xls. Assuming the underlying demand relation is a linear function of price and income, obtain the leastsquare estimates of the states demand for KBC microbrews. Print the regression output and provide an economic interpretation of the regression results. You must comment on the significance of the slope-coefficients based on t-table assuming 95% significance level.

1. Illinois: The estimated regression is: Q = -42.65 + 2.62 P + 14.32 I t-stat (-0.086) (0.187) (2.098) Where: Q = quantity, P= price, I= income The slope coefficients have signs that are NOT predicted by economic theory. The coefficient associated with price is positive, meaning that an increase in price triggers an increase in demand, which is not consistent with the basic economic relationship between price and demand. The law of demand says that as price goes up, demand falls. The slope coefficient associated with income has a positive sign, which is consistent with the economic theory predictions. As income goes up, the demand for a good goes up. Coefficient of price = 2.62; which means that $1 increase in price per case will result in a 2.62 increase in cases of beer sold. Coefficient of income = 14.32; which means that $1,000 increase in average income will result in a 14.32 increase in cases of beer sold. At 95% confidence level and (n-k=50-3=47) degree of freedom, the critical-t value from the Table is For price (P): critical-t = 2.0117 calculated-t =0.187 calculated-t < critical-t fail to reject H0 there is no relationship between Q and P For income (I): critical-t = 2.0117 calculated-t =2.098 calculated-t > critical-t reject H0 there is a relationship between Q and I R2= 0.085612213, implies that 8.56% of the variation in quantity (Q) is explained by the variations in Price (P) and Income (I). F-statistics = 2.20 At 95% confidence interval the critical F-value (F(3-1),(50-3)0.05 = F 2,470.05) = 3.195 critical-F = 3.195 calculated-F =2.20 calculated-F < critical-F fail to reject H0 which means that Quantity(Q) is unrelated to price (P) and income (I).

2. Michigan The estimated regression is: Q = 182.43 t-stat (11.227) 1.022 P + 1.411 I (-3.281) (4.089)

Where: Q = quantity, P= price, I= income In this case, the slope coefficients have signs that are predicted by economic theory. The coefficient associated with price is negative, meaning that an increase in price triggers a decrease in demand, which is consistent with the basic economic relationship between price and demand. The law of demand says that as price goes up, demand falls. The slope coefficient associated with income has a positive sign, which is consistent with the economic theory predictions. As income goes up, the demand for a good goes up. Coefficient of price = - 1.022; which means that $1 increase in price per case will result in a 1.022 decrease in cases of beer sold. Coefficient of income = 1.411; which means that $1,000 increase in average income will result in a 1.411 increase in cases of beer sold. At 95% confidence level and (n-k=50-3=47) degree of freedom, the critical-t value from the Table is For price (P): critical-t = 2.0117 calculated-t = -3.281 calculated-t < critical-t fail to reject H0 there is no relationship between Q and P critical-t = 2.0117 calculated-t = 4.089 calculated-t > critical-t reject H0 there is a relationship between Q and I R2= 0.3975, implies that 39.75% of the variation in quantity (Q) is explained by the variations in Price (P) and Income (I). F-statistics = 15.50 At 95% confidence interval the critical F-value (F(3-1),(50-3)0.05 = F 2,470.05) = 3.195 critical-F = 3.195 calculated-F =15.50 calculated-F > critical-F reject H0 which means that at a 5% level of significance there is a strong relationship between Quantity(Q) and price (P) and income (I). Or we can conclude with 95% confidence that in 95% of cases variations in Quantity (Q) will be explained by variations in price (P) and income (I).

3. Indiana The estimated regression is: Q = 97.53 - 2.517 P + 2.108 I t-stat (8.963) (-10.242) (8.1205) Where: Q = quantity, P= price, I= income The slope coefficients have signs predicted by economic theory. The coefficient associated with price is negative, meaning that an increase in price triggers a decrease in demand, which is consistent with the basic economic relationship between price and demand. The law of demand says that as price goes up, demand falls. The slope coefficient associated with income has a positive sign, which is consistent with the economic theory predictions. As income goes up, the demand for a good goes up. Coefficient of price = - 2.517; which means that $1 increase in price per case will result in a 2.517 decrease in cases of beer sold. Coefficient of income = 2.108; which means that $1,000 increase in average income will result in a 2.108 increase in cases of beer sold. At 95% confidence level and (n-k=50-3=47) degree of freedom, the critical-t value from the Table is For price (P): critical-t = 2.0117 calculated-t = -10.242 calculated-t < critical-t fail to reject H0 there is no relationship between Q and P For Income (I): critical-t = 2.0117 calculated-t = 8.1205 calculated-t > critical-t reject H0 there is a relationship between Q and I R2= 0.7588, implies that 75.88% of the variation in quantity (Q) is explained by the variations in Price (P) and Income (I). F-statistics = 73.96 At 95% confidence interval the critical F-value (F(3-1),(50-3)0.05 = F 2,470.05) = 3.195 critical-F = 3.195 calculated-F =73.96 calculated-F > critical-F reject H0 which means that at a 5% level of significance there is a strong relationship between Quantity(Q) and price (P) and income (I). Or we can conclude with 95% confidence that in 95% of cases variations in Quantity (Q) will be explained by variations in price (P) and income (I).