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Chap 007
Chap 007
McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
Direct Methods of Demand Estimation
• Consumer interviews
• Range from stopping shoppers to speak with
them to administering detailed questionnaires
7-2
Direct Methods of Demand Estimation
• Potential problems with consumer
interviews
• Selection of a representative sample, which is a
sample (usually random) having characteristics that
accurately reflect the population as a whole
• Response bias, which is the difference between
responses given by an individual to a hypothetical
question and the action the individual takes when
the situation actually occurs
• Inability of the respondent to answer accurately
7-3
Direct Methods of Demand Estimation
7-4
Empirical Demand Functions
• Demand equations derived from actual
market data
• Useful in making pricing & production
decisions
7-5
Simple regression analysis
• Simple linear regression assumes one-
way causation
• Inappropriate for competitive markets
• Price and output are simultaneously
determined in competitive markets
• Advanced regression techniques are
available for estimating demand in
competitive markets
7-6
7-6
Empirical Demand Functions
• In linear form, an empirical demand function
can be specified as
Q a bP cM dPR
where Q is quantity demanded, P is the price of the good or
service, M is consumer income, & PR is the price of some
related good R
7-7
Empirical Demand Functions
Q a bP cM dPR
• In linear form
• b = Q/P
• c = Q/M
• d = Q/PR
• Expected signs of coefficients
• b is expected to be negative
• c is positive for normal goods; negative for inferior goods
• d is positive for substitutes; negative for complements
7-8
Empirical Demand Functions
Q a bP cM dPR
• Estimated elasticities of demand are
computed as
ˆ ˆ P
Eb
Q
M
EM c
ˆ ˆ
Q
ˆ ˆ PR
E XR d
Q
7-9
Nonlinear Empirical Demand
Specification
• When demand is specified in log-linear
form, the demand function can be written as
Q aP M P
b c d
R
7-11
Checkers Pizza
7-12
7-
Linear Regression
7-13
7-
Time-Series Forecasts
• A time-series model shows how a time-
ordered sequence of observations on a
variable is generated
• Simplest form is linear trend forecasting
• Sales in each time period (Qt ) are assumed to
be linearly related to time (t)
Qt a bt
7-14
Linear Trend Forecasting
• Use regression analysis to estimate
values of a and b
ˆ aˆ bt
Q ˆ
t
• If b > 0, sales are increasing over time
• If b < 0, sales are decreasing over time
• If b = 0, sales are constant over time
t
2006
2005
2004
2007
1997
1999
2000
1998
2001
2002
2003
2012
7-16
Linear Trend Estimation
7-17
7-
Forecasting Sales for Terminator
Pest Control (Figure 7.2)
7-18
Seasonal (or Cyclical) Variation
• Can bias the estimation of parameters in
linear trend forecasting
• To account for such variation, dummy
variables are added to the trend equation
• Shift trend line up or down depending on the
particular seasonal pattern
• Significance of seasonal behavior determined by
using t-test or p-value for the estimated
coefficient on the dummy variable
7-19
Sales with Seasonal Variation
(Figure 7.3)
7-21
Effect of Seasonal Variation
(Figure 7.4)
Qt
Qt = a′ + bt
Qt = a + bt
Sales
c
a′
a
t
Time
7-22
Quarterly Sales Data
7-23
7-
Dummy Variable Estimates
7-24
7-
Dummy Variable Specification
7-25
7-
Some Final Warnings
• The further into the future a forecast is made,
the wider is the confidence interval or region
of uncertainty
• Model misspecification, either by excluding
an important variable or by using an
inappropriate functional form, reduces
reliability of the forecast
7-26
Some Final Warnings
• Forecasts are incapable of predicting sharp
changes that occur because of structural
changes in the market
7-27
Confidence Intervals
7-28
7-