about regression in Econimics

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about regression in Econimics

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By

Mr. Tahir Islam

Demand Estimation by regression

analysis

What is regression

The term regression was first introduced by Francis

Galton

In a famous paper Galton found that there was a

strong tendency for all tall parents to have tall children

and for short parents to have short children

Meaning that average height of children born tends

to move towards the average height of the parents

This is universal law of Galton and is confirmed by

his friend Karl Pearson

Regression means to move towards the center to

average

Regression analysis

Concerned with the study of the dependence of one

variable (dependent variable) on one or more other

variables (explanatory variables) with a view to estimate

or predict the average value of the dependent variable

Regression analysis used for observation of relationship

between two or more than two variables

Regression analysis

In order to introduce regression analysis,

suppose that a manager wants to determine the

relationship between the firms advertisement

expenditures and its sale revenue

The manager wants to test the hypotheses that higher

the advertising expenditures leads to higher sale for a

firm

Manager wants to estimate the strength of the

relationship (i.e. how much sales increase for each dollar

increase in advertising expenditures)

The manager collects data on advertising expenditure

and on sales revenue in specific period of time

Introduction to Regression analysis in

Managerial Economics

Suppose that advertising and sale data are given below

for 10 years

Year (t) 1 2 3 4 5 6 7 8 9 10

Advertising Exp (X) 10 9 11 12 11 12 13 13 14 15

Sales Revenue (Y) 44 40 42 46 48 52 54 58 56 60

If we now plot each pair of advertising-sales value on a

graph, with advertising expenditures measured along the

horizontal axis and sales revenue measured along

horizontal axis

Introduction to Regression analysis in

Managerial Economics ( cont)

Introduction to Regression analysis in

Managerial Economics ( cont)

9 10 11 13

12 14 15

40

45

50

55

60

Advertising

expenditure

Sales

Introduction to Regression analysis in

Managerial Economics ( cont)

9 10 11 13

12 14 15

40

45

50

55

60

Advertising

expenditure

Sales

^

Y

Introduction to Regression analysis in

Managerial Economics ( cont)

We gets points or dots in figure

This is known as a scatter diagram

It shows the spread of the points in the X-Y plane

There is a positive relationship between the level of

firms advertising expenditure and its sales revenue

Relationship between them is linear

One way to estimate the relationship is visual inspection

Draw a straight line among these points in such away

that these points are cluster around the straight line

By extending a line to the vertical axis, we can estimate

the firm sale revenue with zero advertisement

Introduction to Regression analysis in

Managerial Economics ( cont)

Where as the slop of line presents the linear relationship

between sale revenue and advertisement i.e. how much

sale revenue would increase for one dollar increase in

advertisement

This will give us a rough estimate of relationship

between these two variables

The manager could use this information to estimate how

much sale revenue of the firm would be if its

advertisement expenditure were anywhere between $9

million and $15 million

Regression analysis is a best statistical technique for

obtaining the line that best fits the data points

Regression line is obtain to minimize the

difference/deviations between each points and

regression line

This method is called method of least square

Introduction to Regression analysis in

Managerial Economics ( cont)

Y refers to actual or observed sale revenue of $44

million associated with advertising expenditure of $10

million in first year

Y is estimated sale for a firm for advertising

expenditures of $10 million in first year

The term e in the figure is the corresponding vertical

deviation or error and is equal to the difference between

the actual value and estimated value of the firm

The formula for error is e =Y-Y

Since there are 10 observation points in figure, we have

10 such vertical deviations or errors

Introduction to Regression analysis in

Managerial Economics ( cont)

^

^

Demand Estimation by regression analysis

As we know that demand plays a vital role in

managerial making decision, so correct

estimation about demand is important as well as

a problem

Although many techniques are used for

estimating demand but the most common

method for estimating demand in managerial

economic is regression analysis

This method is more objective , provide more

complete information and is generally less

expensive

Demand Estimation by regression analysis

In this section we summarize and review

the method of estimating demand by

regression analysis

We discuss

1. Model specification

2. Data requirements

3. Functional form

4. Evaluation of econometric results obtain

Demand Estimation by regression analysis

1. Model specification

Model specification is first step in estimating demand

function

This involves identifying most important variables that

affect the demand for a commodity

Usually we include explanatory variables

a. price of commodity

b. consumer income

c. numbers of members in a family

d. price of related goods

e. level of advertisement expenditure

f. availability of credit incentives and consumers price

expectation are

Demand Estimation by regression analysis

But specification of demand function for different

goods are different

Demand function for expensive durable goods, such

as automobiles and houses

Explanatory variables are

a. Credit terms

b. rate of interest

c. Income level

Demand Estimation by regression analysis

(cont)

Demand function for seasonal equipment, such as air

conditioner , swimming suits and cold beverages

Explanatory variables are

a. weather conditions

b. Income level of consumer

Demand Estimation by regression analysis

(cont)

Demand function for capital goods such as machinery

and factory buildings

Explanatory variables are

a. rate of profits

b. capital utilization

c. wage rate

d. Income level of investor

The researcher must avoid omitting important variables

Other wise he or she will obtain biased results

Demand Estimation by regression analysis

(cont)

2. Collecting data on variables

Collecting of data is another step to estimate the

demand function

Data can be collected for each variable over the time

(yearly, quarterly and monthly) is called time series

data

Data for different economic units (individuals,

households) at particular point of time i.e. for a

particular year, month or and year is called cross-

sectional data

Demand Estimation by regression analysis

(cont)

If data about variables are incorrect then researcher can

not make a best estimation

Specifying the form of the demand function

The third step in estimating demand by regression

analysis is to determine the functional form of the model

Linear model is the simplest and realist form of demand

function

Qx =ao +a1px + a2I +a3N +a4PY +)

In above equation as are parameters to be estimated

Demand Estimation by regression analysis

(cont)

Testing the Econometrics results

The fourth and final step in the estimation of demand by

regression analysis is to evaluate the regression results

First, the sign of each estimated coefficient must be

checked to confirm whether it matched economic theory

Tests are used to find the value of parameters , usually

we use t-statistic

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