LU 4:

DEMAND ESTIMATION
 • A chief uncertainty for managers is the future.
They fear what will happen to their product?
• Managers use forecasting, prediction &
Estimating Demand

estimation to reduce their uncertainty.

• The methods that they use vary from consumer
surveys or experiments at test stores to statistical
procedures on past data such as regression
analysis.

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 • Consumer Surveys
• ask a sample of consumers their attitudes
Marketing Research

• Consumer Focus Groups

• experimental groups try to emulate a market (Hawthorne
effect = behave differently in when observed)
• Market Experiments in Test Stores
• get demand information by trying different prices
Techniques

• Historical Data
• what happened in the past is guide to the future

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 • Look at the Price
relationship of price Is this curve demand
and quantity over or supply?
Plot Historical Data

time
Statistical Estimation of

2000
• Plot it 2004

• Is it a demand
Demand Functions:

curve or a supply 2001

2003
curve? 2002
2001
1999
• The problem is this
does not hold other
things equal or
constant. quantity
 • Steps to take:
Statistical Estimation of

• Specification of the model -- formulate the

demand model, select a Functional Form
Demand Functions

• linear Q = a + b•P + c•Y

• double log log Q = a + b•log P + c•log Y
• quadratic Q = a + b•P + c•Y+ d•P2
• Estimate the parameters --
• determine which are statistically significant
• try other variables & other functional forms
• Develop forecasts from the model
 • Regression is a statistical measure used in finance,
investing and other disciplines that attempts to
determine the strength of the relationship between
Regression Analysis

one dependent variable (usually denoted by Y) and

a series of other changing variables (known as
independent variables).
• Example: Factors affecting demand of local car

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 • Dependent Variable -- quantity in units, quantity
in dollar value (as in sales revenues)
Specifying the Variables

• Independent Variables -- variables thought to

influence the quantity demanded
 • Imagine your company wants to look into the
Regression in Business
effect of its new advertising plan on sales numbers.
• You can use correlation analysis to determine the
link between the two variables.
• Alternatively, if you would like to determine
whether increasing the number of advertisements
leads to increased sales, you will have to use
regression to find causation. 

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 • Used in various business applications:
• Measuring the impact on a corporation’s profits of an
increase in profits
• Understanding how sensitive a corporation’s sales are
to changes in advertising expenditures
• Seeing how a stock price is affected by changes in
interest rates
…Continue

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 1. Simple regression
• The relationship between two variables
Types of Regression

• Y – dependent variable (sales)

• X – independent variable (price)

2. Multiple regression
• The relationship between more than two variables
• Y – dependent variable (sales)
Analysis

• X1, X2, X3 – independent variables (price, promotion,

income),
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 • Used to estimate the relationship between a
dependent variable and a single independent
variable; for example, the relationship between
Simple Regression

crop yields and rainfall.

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 Simple Linear Regression:
Assumptions & Solution Methods
1. The dependent variable • Spreadsheets - such as
is random • Excel, Lotus 1-2-3, Quatro
Pro, or Joe Spreadsheet
2. A straight line
relationship exists • Statistical calculators
3. error term has a mean • Statistical programs such as
of zero and a finite • Minitab
variance • SAS
4. the independent • SPSS
variables are indeed • ForeProfit
independent
• Mystat
 • Used to estimate the relationship between a
dependent variable and two or more independent
variables; for example, the relationship between
Multiple Regression

the salaries of employees and their experience and

education.

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 • Example: Q = a + b•P + c•Y
• The effect of each variable is constant, as in
• Q/  P = b and  Q/  Y = c, where P is price and Y is
income.
Linear Regression

• The effect of each variable is independent of other variables

• Price elasticity is: ED = ( Q/  P)(P/Q) = b•P/Q

• Income elasticity is: EY = ( Q/  Y)(Y/Q)= c•Y/Q

• The linear form is often a good approximation of the
relationship in empirical work.
FIGURE 1 Regression Line
 • We have a set of data on the relationship between
X and Y
Example 1

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 • For the fitted regression line, there is some
discrepancy (random error) between the actual and
the fitted line
Regression Line

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 • Sherwin-Williams Company attempts to develop a
demand model for its line of exterior house paints.
The company’s economist feels that the most
important variables affecting paint sales (Y) are:
1. Promotional expenditure (A)
2. Selling price (P)
Example 2:

3. Disposable income per household (M)

• The economist decides to collect data on the
variables in a sample of 10 sales regions.

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 Sales Promotion $1000 Price $ Income
Region (Y) (A) (P) (M)
1 160 150 15 19
Data for 10 Regions

2 220 160 13.5 17.5

3 140 50 16.5 14
4 190 190 14.5 21
5 130 90 17 15.5
6 160 60 16 14.5
7 200 140 13 21.5
8 150 110 18 18
9 210 200 12 18.5
10 190 100 15.5 20
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 Sales Promotion $1000
Region (Y) (A)
1 160 150
2 220 160
Simple Regression

3 140 50
4 190 190
5 130 90
6 160 60
7 200 140
8 150 110
9 210 200
10 190 100
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SUMMARY OUTPUT

Regression Statistics
Multiple R 0.72059
R Square 0.51925
Adjusted R Square 0.459156
Standard Error 22.79937
Observations 10

ANOVA
Significanc
  df SS MS F eF
Regression 1 4491.509 4491.509 8.640653 0.018724
Residual 8 4158.491 519.8113
Total 9 8650      

Standard Lower Upper

  Coefficients Error t Stat P-value Lower 95% Upper 95% 95.0% 95.0%
Intercept 120.7547 19.81233 6.094928 0.000291 75.0674 166.442 75.0674 166.442
PROMOTION (A) 0.433962 0.147631 2.939499 0.018724 0.093524 0.774401 0.093524 0.774401
 1. Specify the equation of sales for Sherwin-
Williams
2. Based on the results, what advice you can offer to
the top management of Sherwin-Williams?
3. If Sherwin-Williams increases the spending on
promotion to RM185, what is the predicted sales
for the 10 regions?
Exercise

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 • Ten regions with data on promotional expenditures (A)
and sales (Y)
• Result: Y = 120.755 + 0.434 A
• One use of a regression is to make predictions.
• If a region had promotional expenditures of 185, the
prediction is Y = 201.045, by substituting 185 for A
Regression
1. Simple

Analysis
 • RULE: If absolute value of the
T-tests estimated p > p-value, then
• Different REJECT Ho.
samples would • We say that it’s significant!
yield different • Therefore, |0.018| < 0.05, so we reject the
coefficients null hypothesis.
• Test the • We informally say, that promotional
hypothesis that expenses (A) is “significant” at 5%
coefficient significance level.
equals zero
• Ho : b = 0
• Ha: b 0
 • We would expect more promotional expenditures to be associated
Correlation Coefficient
with more sales at Sherwin-Williams.
• A measure of that association is the correlation coefficient, r.
• If r = 0, there is no correlation. If r = 1, the correlation is perfect
and positive. The other extreme is r = -1, which is negative.

Y Y Y

r = -1 r = +1 r=0

X X X
 • R-square is the Y
percentage of the
variation in dependent Yt
variable that is explained
2

^
R

Yt predicted
_
• As more variables are Y
included, R-square rises
Determination:
Coefficient of

• Adjusted R-square,
however, can decline

_
X
 • Regressions indicate association, but beware of jumping to
Association and
Causation
the conclusion of causation
• Suppose you collect data on the number of swimmers at a
beach and the temperature and find:
• Temperature = 61 + .04 Swimmers, and R2 = .88.
• Surely the temperature and the number of swimmers is positively
related, but we do not believe that more swimmers CAUSED the
temperature to rise.
• Furthermore, there may be other factors that determine the
relationship, for example the presence of rain or whether or not it is
a weekend or weekday.
• Education may lead to more income, and also more income
may lead to more education. The direction of causation is
often unclear. But the association is very strong.
Figure 2
Regression Line KFC Case
 • To do this, we must have more observations (N) than
the number of independent variables, and no exact
linear relationships among the independent variables.
• At Sherwin-Williams, besides promotional expenses,
different regions charge different selling prices (P)
Multiple Linear

and have different levels of disposable income (M)

Regression
2. Multiple Regression

Region Sales (Y) Promotion $1000 Price $ Income

1 160 150 15 19
2 220 160 13.5 17.5
3 140 50 16.5 14
4 190 190 14.5 21
5 130 90 17 15.5
6 160 60 16 14.5
Analysis

7 200 140 13 21.5

8 150 110 18 18
9 210 200 12 18.5
10 190 100 15.5 20
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 1. Using Excel, perform regression analysis
2. Specify the demand function for KFC
What should we do?

3. Test whether the coefficients are statistically

significant?
4. Determine the percentage of variation of output.
5. Based on the findings, what advice should the
Manager propose to the top management?

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 Regression Statistics

Multiple R 0.88858

R Square 0.78957
Adjusted R
Square 0.68436

Standard Error 17.41710

Observations 10

ANOVA
  Df SS MS F Significance F
Regression 3 6829.866 2276.622 7.504796 0.018697722
Residual 6 1820.134 303.3556
Total 9 8650     

Coefficient
  s Standard Error t Stat P-value Lower 95% Upper 95%

Intercept 310.2447 95.07486 3.263163 0.017181 77.60497482 542.8846

Promotion 0.007716 0.204064 0.037816 0.971061 -0.491610423 0.507044

Price -12.2024 4.58207 -2.6631 0.037369 -23.41441609 -0.99057

Income 2.676784 3.160072 0.847064 0.429446 -5.05563355 10.4092

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 Dep var: Sales (Y) N=10 R-squared = .790
Adjusted R2 = .684 Standard Error of Estimate = 17.417

Variable Coefficient Std error T P

Constant 310.245 95.075 3.263 .017
Promotion .008 0.204 0.038 .971
Price -12.202 4.582 -2.663 .037
Summary

Income 2.677 3.160 0.847 .429

 • Write the result as an equation:
Sales = 310.245 + .008 A -12.202 P + 2.677 M

• Does the result make economic sense?

Interpreting Multiple

• As promotion expense rises, so does sales. That makes sense.

Regression Output

• As the selling price rises, so does sales. Yes, that’s reasonable.

• As disposable income rises in a region, so does sales. Yup. That’s reasonable.
• Is the coefficient on the selling price statistically significant?
Step 3: Test whether
the variables are
significant

3. t-test
2. F-test

4. P-value
1. R-square

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2. F-statistic (F-ratio)

F-statistic is used to test the hypothesis that all the independence

variables (X1, X2, ….. Xm ) explain the variation in the dependence
variable (Y).
Null hypothesis = HO : All βi = 0 (rejected)
Alternative hypothesis = Ha : At least one βI ≠ 0 (cannot be
rejected)
In other words, we are testing whether at least one of the explanatory
variables contributes information for the prediction of Y
The greater the F-value the better the overall fit of the regression line.

Slide 36
 • t-statistic is also used to test the hypothesis that all the independence
3. t-statistic (or t-test)

variables (X1, X2, ….. Xm ) explain the variation in the dependence

variable (Y).
Null hypothesis = HO : All βi = 0
Alternative hypothesis = Ha : At least one βI ≠ 0

• In other words, we are testing whether at least one of the explanatory

variables contributes to the explanation for the prediction of Y.
• The rule of thumb: if the absolute value of t-statistic is greater or equal
to 2, than the parameter estimate is statistically different from zero.

Slide 37
 P value is associated with a test statistic, i.e. to test the hypothesis of
relationship between dependent and independent variables.

The smaller the P value, the more strongly the test rejects the null
hypothesis, and thus, to accept the alternative hypothesis.

A p-value of .05 or 5% confidence level implies that 95% of the observed

variables are strongly correlated.
4. P-value

Slide 38
 •The Marketing Manager of SHELL
was asked by the top management to
find ways to increase the sales for
petrol kiosks in Kuala Lumpur. For
this purpose, the Manager is
attempting to develop a demand
model to determine important factors
affecting the sale in a sample of 10
kiosks in Kuala Lumpur.
•Important variables selected are
sale (Y), Shell Card (C),
Advertising (A) and disposable
income of consumers (M).
•The information gathered is
Example 3

represented in Table 1
• The Model is written:
• Y = α + b1C + b2A + b3M
+ɛ
Based on the above instruction in the case study,
what are the tasks the Marketing Manager
TASK 1: Using computer software, perform regression analysis from the data in
the Table.

TASK 2: Write the function in linear form of demand model for the SHELL sale.

TASK 3: Test whether the coefficients of the variables used are statistically
significant.

TASK 4: Determine the percentage of the variation of output that is ‘explained’

by the regression equation.

TASK 5: Based on the findings, what advise should the Manager propose to the
top management?
should do?

Slide
40

Credit to Dr Muzahet Masruri

Thank You.