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Economic Case study

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Demand can be estimated with experimental data, time-series data, or cross-section data. Sara

Lee Corporation generates experimental data in test stores where the effect of an NFL-licensed

Carolina Panthers logo on Champion sweatshirt sales can be carefully examined. Demand

forecasts usually rely on time-series data. In contrast, cross-section data is appear in Table 1. Soft

drink consumption in cans per capita per year is related to six-pack price, income per capita, and

mean temperature across the 48 contiguous in the United States.

Table 1

Alabama

Arizona

Arkansas

California

Colorado

Connecticut

Delaware

Florida

Georgia

Idaho

Illinois

Indiana

Iowa

Kansas

Kentucky

Louisiana

Maine

Maryland

Massachusetts

Michigan

Minnesota

Mississippi

Missouri

Montan

Nebraska

Nevada

New Hampshire

New Jersey

Cans/Capita/ 6-Pack $

Income

Yr

Price

$/Capita

200

2.19

150

1.99

237

1.93

135

2.59

121

2.29

118

2.49

217

1.99

242

2.29

295

1.89

85

2.39

114

2.35

184

2.19

104

2.21

143

2.17

230

2.05

269

1.97

111

2.19

217

2.11

114

2.29

108

2.25

108

2.31

248

1.98

203

1.94

77

2.31

97

2.28

166

2.19

177

2.27

143

2.31

Mean

Temp. F

13

17

11

25

19

27

28

18

14

16

24

20

16

17

13

15

16

21

22

21

18

10

19

19

16

24

18

24

66

62

63

56

52

50

52

72

64

46

52

52

50

56

56

69

41

54

47

47

41

65

57

44

49

48

35

54

New Mexico

New York

North Carolina

North Dakota

Ohio

Oklahoma

Oregon

Pennsylvania

Rohde Island

South Carolina

South Dakota

Tennessee

Texas

Utah

Vermont

Virginia

Washington

West Virginia

Wisconsin

Wyoming

Total

Mean

157

111

330

63

165

184

68

121

138

237

95

236

222

100

64

270

77

144

97

102

7594

2.17

2.43

1.89

2.33

2.21

2.19

2.25

2.31

2.23

1.93

2.34

2.19

2.08

2.37

2.36

2.04

2.19

2.11

2.38

2.31

105.72

15

25

13

14

22

16

19

20

20

12

13

13

17

16

16

16

20

15

19

19

861

158.2083333

2.2025

17.9375

56

48

59

39

51

82

51

50

50

65

45

60

69

50

44

58

49

55

46

46

2573

53.6041666

7

QUESTION 1

Estimate the demand for soft drinks using a multiple regression program available on your

computer.

Estimated Demand for soft drink:

QD = 514.267 242.971 Price + 1.224 Income 2.931 Temp

(4.120)

r2 =0.698

(0.804)

SSE=38.261

(-5.582)

Multiple Regression :

Demand of soft drink : constant + 6 - pack price + income per capita + mean temp +error

: 514.27 242.97 6 pack price + 1.22 income per capita + 2.93 mean.Temp

Method: Least Squares

Sample: 1 48

Included observations: 48

Variable

C

PRICE

INCOME

TEMP

R-squared

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Coefficient

514.2669

-242.9708

1.224164

2.931228

0.698024

0.677435

38.26108

64412.06

-240.9536

33.90231

Std. Error

113.3315

43.52628

1.522613

0.711458

t-Statistic

4.537722

-5.582162

0.803989

4.120027

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

QUESTION 2

Interpret the coefficients and calculate the price elasticity of soft drink demand.

Prob.

0.0000

0.0000

0.4257

0.0002

158.2083

67.36719

10.20640

10.36233

10.26533

1.980543

Both temperature and price are statistically significant with expected signs while income is

insignificant in its effect on soft drink demand.

for the log-linear model 3.12.

Mean P

=105.72 / 48

= 2.2025

Mean Q

= 7594 / 48

= 158.2083

Q/P

= -242.97

ED = (-242.97) / ( 2.2025 / 158.2083 )

ED = ( - 3.38 ) elastic

Interpretation on Price Elasticity: Based on the calculated price elasticity, the consumption on

soft drink is price elastic in nature. This means that for a 1% increase in price will result in more

than 1% decrease in quantity demanded for soft drinks.

This point elasticity at the mean price and quantity across the states is in the elastic range, as

expected. These are market-level price elasticities, so no firm behaviour is directly implied by

this estimate. An elastic demand at the market level does imply elastic firm-level demand at

comparable prices, comparable price sensitivity, and the smaller quantities facing each firm.

1)

The coefficient for demand for soft drink and price of soft drink is inverse relationship.

2) The quantity demand for soft drink per capita will change in opposite direction as the price of

soft drink change.

3) Demand for soft drink will reduce by 242.97 when price of soft drink change in the opposite

direction or inverse direction.

4)

The coefficient for demand for soft drink and income and demand for soft drink and

5)

The quantity demand of soft drink will change in same direction as the income and mean

temperature change. So that, demand for soft drink will increase by 1.22 when income per

capita increase, and demand for soft drink also will increase by 2.93 when mean temperature

increase.

QUESTION 3

Omit price from the regression equation and observe the bias introduced into the parameter

estimate for income.

Income elasticity

Q = 514.89 - 242.88P + 1.22Y + 2.92T

Income elasticity, Ey = Q/Y x Y/Q

= 1.22*(17.89/160.76)

= 0.14

LogQ = 1.06 - 3.19LogP + 0.22LogY + 1.11LogT

Income elasticity, Ey = 0.22

Interpretation on Income Elasticity: Based on the calculated income elasticity, a positive

income elasticity indicates that soft drink is a normal goods.

R2 = 0.49

(5.96)

( 0.73)

SSE = 0.137

When the independent variable of Price is removed from the equation, the R-Squared value

drops from 0.66 to 0.47. Thus the strength of correlation falls under moderate range (0.4 to 0.6).

The variables have a low association with the dependent variable as only 47% in quantity

demanded are explained by the independent variables.

QUESTION 4

Now omit both price and temperature from the regression equation. Should a marketing plan for

soft drinks be designed that relocates most canned drink machines into low income

neighborhoods? Why or why not?

Method: Least Squares

Sample: 1 48

Included observations: 48

Variable

C

INC

Coefficient

254.5629

-5.371683

R-squared

Adjusted R-squared

S.E. of regression

Sum squared resid

Log likelihood

F-statistic

Prob(F-statistic)

0.111849

0.092542

64.17440

189444.3

-266.8446

5.793010

0.020162

Std. Error

41.09082

2.231815

t-Statistic

6.195129

-2.406867

S.D. dependent var

Akaike info criterion

Schwarz criterion

Hannan-Quinn criter.

Durbin-Watson stat

Prob.

0.0000

0.0202

158.2083

67.36719

11.20186

11.27983

11.23132

2.313418

QD = 254.563 5.372Y

QD = 254.6 5.37 INCOME R2 = 0.11

( 2.11) SSE = 64.2

For the log-linear model, one obtains

QD = 4.47 0.552 INCOME R2 = 0.09

( 2.13) SSE = 0.18

No, a marketing plan should not be designed specifically to introduce canned soft drink

machines into low-income neighborhoods. And students should not offer the negative and

significant income parameter estimate above as their reason. The above regression does NOT

call for relocating canned soft drink machines away from low-income neighborhoods. The

regression coefficient on income has been biased downward by the omission of price and

temperature enough to make an insignificant factor appear negative and significant in its effect

on demand. This illustrates the critical importance of using analytical reasoning and demand

theory to correctly specify a regression model.

INCOME

350

300

250

Q

200

Linear (Q)

R = 0.11

150

100

50

0

5

10

15

20

25

30

The graph above shows the weak relationship between Income and Quantity Demanded. Thus,

the marketing plan should not be designed based on the income per capita factor as it does not

strongly correlated with the demand of soft drink cans.

Whether they market the product at low income groups or otherwise, it will not affect the

quantity demanded that much. We strongly believe that the company should not design their

marketing plan to relocate most canned drink machines into low-income neighbourhood.

In addition, as some variables i.e. price and temperature were removed from the equation, it is

unwise to rely solely on income factor to design on marketing plan as there exists a bias.

Instead of wasting resources in trying to influence a variable that is weakly related to the

dependant variable, the company should focus on other variables such as pricing as the critical

component of their marketing plan. Since price is strongly related to Quantity Demanded, the

company can stimulate the demand for their soft drink by giving discounts and "buy one, free

one" (BOGO) promotions.

The best demand specification

PRICE

350

300

250

R = 0.57

200

Q

Linear (Q)

150

100

50

0

1.8

1.9

2.1

2.2

2.3

2.4

2.5

2.6

2.7

For Price, the R-squared is 0.5683 which is within the 0.4 to 0.6 range. Hence it has moderately

strong correlation.

INCOME

350

300

250

Q

200

Linear (Q)

R = 0.11

150

100

50

0

5

10

15

20

25

30

For Income, the R-squared is 0.1094 which is within the range of 0 to 0.2. This indicates a very

weak correlation.

TEMPERATURE

350

300

R = 0.46

250

200

Linear (Q)

150

100

50

0

30

40

50

60

70

80

90

For Temperature, the R-squared is 0.4555 which is within the range of 0.4 to 0.6. Hence it has

moderate strong correlation.

Conclusion: The best demand specification is to remove income per capita from the regression

equation as the variable has a low correlation to the equation.

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