128 PART TWO Demand Analysis CASE STUDY 4-2 ee la Teresi. nea a Using the technique of regression analysis presented in Chapter 5. “Mathia estimated the following demand function for sweet potatoes in the United States for the period of 1949 0 1972: 0, 7609 ~ 1,606P,, + 597 49471 + 479P,.~271t [4 juantty of sweet potatoes sold per year inthe United States pe 1,000 hundred weight ew) real-dollar price of sweet potatoes per hhundredweight received by farmers N= two-year moving average of total U.S. ‘population, in millions Teal per capita personal disposable ‘income, in thousands of dollars P= real-dollar price of white potatoes per hhundredweight received by farmers time trend (f= 1 for 1949, = 2for 1950, upto r= 24 for 1972) 1 ‘This estimated demand function indicates that the quantity demanded of sweet potatoes per year in 1,000-owt (ie. in 100,000-pound) units in the United States (QD,) declines by 1,606 for each $1 increase in its price (P,), increases by 59 for each 1 million increase in population (N), increases by 947 for each $1,000 increase in real income (2), increases by 479 for each $1 increase in the real price of white potatoes (P,), but falls by 271 with each passing year the coefficient oft, the time trend variable). Thus, the demand curve for sweet potatoes is negatively sloped, and it shifts o the right with an increase in population, in income, and in the price of white potatoes, but shifts tothe left with each passing year Since the demand for sweet potatoes increases (i shifts to the right) with an increase in income, sweet potatoes are a normal good (even though we usually think of potatoes as being an inferior good). Since QD, increases with an increase in P, and declines ‘with a reduction in P,, white potatoes are a substitute for sweet potatoes Finally, the negative coefficient of tean be taken to reflet the declining tastes for sweet potatoes overtime. Tf we now substitute into Equation 4-4 the actual values of N= 150.73,1= 176, Py =2.94, and ¢= 1 for the United States for the year 1949, we get the fol- Jowing equation forthe U'S. demand curve for sweet potatoes in 1948: 609 ~ 1,606P, + $9(15073) 49471176) + 4792.94) ~ 27101) 71609 ~ 1,606P, + 8.893 $1,667 + 1,408 — 271 9.306 ~ 1,606, us) By then substituting the value of $7 for Py into Equation 4-5, we get QD, = 8.064. If P, = $5.60 (the actual real price of sweet potatoes in the United States in 1949), QD, = 10,312. Finally if P, = $4, (QD, = 12,882, This demand schedule is ploted as Dyin Figure 4-3. (On the other band, if we substitute into Equation 4-4the values of N= 208.78, [= 3.19, Py = 241, and 1= 24 for the year 1972, we get Equation 4-6 for the US. demand curve for sweet potatoes in 1972: oD’ By then substituting the same values as above for , into Equation 4-6, we get market demand curve ‘Diy in Figure 4-3. Note that the redaction in tastes for sweet potatoes between 1949 and 1972 and in Py tends t9 shift D, to the left, while the increase in Nv and [tends to shift D, tothe right. Since the first set of forces overwhelms the second, D's tothe left of Da, In general, itis the average value of the indepen- dent or explanatory variables over the entire period that is substituted into the estimated demand equa tion to get the equation of the average demand curve for the period (see Problem 2, with the answer at the end ofthe text) 17,598 ~ 1,606, (4-6) continueder s & FIGURE 4-3 The Market Demand Cun sweet potato: left of by. Finally, it must be pointed out that each producer ‘of sweet potatoes shares in the total market demand for sweet potatoes. Therefor, for a given change in the market price of potatoes or other variable, the quantity response by a firm will be some fraction of the total market response. Furthermore, in ode t0 estimate demand correctly, a producer would have to include explanatory variables in addition to those Source: Ronald A Shimer snd Gane A. Mathis, “Reservation an Mast Demands fr Sweet Potatoes at the Farm eve” American ‘Foard of Agiudarl Economics, wl, 5 (abrary1973) for Sweet Potatoes in the United States By Substituting into Equation 4-5 the values for P, of $7, $5.60, and $4 and plotting, we get market demand curve D, for sweet potatoes in the United States for 1949. On the ather hand, by substituting the same values for & into Equation 4-6, we get 0: as the US. in 1972, Since the constant term is smaller for 1972 than for 1849, CHAPTER Demand theory 128 CH o 3 12 treeamdeat mand curve for tothe used to estimate the market demand—as indicated in the previous section, Practically all the available esti- mutes of demand, however, efer to market demand ‘because firms do not want to disclose their knowledge (of the market and their strategies and plans to com- ptitors, An example of the demand faced by a firm is given in Problem 2 (withthe answer atthe end of the text, Point Price Elasticity of Demand ‘The responsiveness in the quantity demanded of a commodity to a change in its price could be measured by the inverse of the slope of the demand curve (ie., by AQ/AP)* The disadvantage is that the inverse of the slope (AQ/AP) is expressed in terms of the units of ‘measurement. Thus, simply changing prices from dollars to cents would change the value of AQ/AP one hundredfold. Furthermore, a comparison of changes in quantity to changes ‘Since price i plotted on the vertical axis nd quantity onthe horizontal ans, the quantity response toa changin pice could be measured by AQIAP, which isthe inverse of the pe ofthe demand curve.