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Estimating Demand Functions: Managerial Economics

Business Economics

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88 views38 pages

Estimating Demand Functions: Managerial Economics

Business Economics

Uploaded by

alauoni
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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MANAGERIAL ECONOMICS:

THEORY, APPLICATIONS, AND CASES


W. Bruce Allen | Neil A. Doherty | Keith Weigelt | Edwin Mansfield

Chapter 4

ESTIMATING DEMAND
FUNCTIONS
THE IDENTIFICATION PROBLEM

• Task of estimating the demand curve


• Difficult, since both demand and supply
curves are shifting over time
• Shifts occur because nonprice variables are
influencing demand and supply
THE IDENTIFICATION PROBLEM (CONT’D)

• Econometrics techniques such as


regression attempt to estimate demand
curves when both supply and demand are
shifting
• Consumer Interviews and Market
Experiments are also widely used
PRICE PLOTTED AGAINST QUANTITY,
2010–2012

Managerial Economics, 8e
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ESTIMATED DEMAND CURVE CONTRASTED WITH
ACTUAL DEMAND CURVES

Managerial Economics, 8e
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FIXED DEMAND CURVE AND SHIFTING
SUPPLY CURVE

Managerial Economics, 8e
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CONSUMER INTERVIEWS

• Managers interview consumers and


administer questionnaires concerning
their buying habits, motives, and
intentions.
• Managers might also use focus groups.
• Consumer surveys have limitations.
MARKET EXPERIMENTS

• Direct market experiments


• Vary the price of the product while
attempting to keep other market
conditions fairly stable
• Generally expensive or risky and might
result in lost customers
• Experiments cannot produce all the
information that is needed.
© 2013 W. W. Norton Co., Inc.
SIMPLE REGRESSION MODEL

• Model: a simplified or idealized


representation of reality
• Population Regression Line or True
Regression Line
• Yi = A + B(Xi) + ei
• Line resulting from regressing the dependent
variable on the independent variable where
the entire population of values of the
variables is used
SIMPLE REGRESSION MODEL (CONT’D)

• Error term: a random amount that is


added or subtracted from the population
regression line
• Assumptions about the error term are
necessary in order to conduct regression
analyses.
SIMPLE REGRESSION MODEL

Managerial Economics, 8e
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SAMPLE REGRESSION LINE

• Estimated Regression Line or sample


regression line is the line resulting from
regressing the dependent variable on the
independent variable where only a
sample of the variables is used.
• General Expression is:
• Y(hat) = a + b(X)
SAMPLE REGRESSION LINE (CONT’D)

• Y(hat) is the value of the dependent


variable predicted by the regression line.
• a and b are estimators of A and B,
respectively, of the population regression
line.
• a measures the intercept of the regression
line.
• b measures its slope.
SAMPLE REGRESSION LINE (CONT’D)

• a measures the value of the dependent


variable when the independent variables
have a value of zero.
• b measures the change in the predicted
value of Y, associated with a one-unit
change in the value of X.
• Method of Least Squares is often used to
determine the values of a and b.
SAMPLE REGRESSION LINE

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COEFFICIENT OF DETERMINATION

• A measure of how well the sample regression


line fits the data
• The coefficient of determination is denoted by
R2.
• Its value lies between 0 and 1. The closer it is to
1, the better the fit; the closer to zero, the worse
the fit.
• In a simple linear regression, R2 is the square of
the correlation coefficient, r.
COEFFICIENT OF DETERMINATION

Managerial Economics, 8e
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MULTIPLE REGRESSION

• A multiple regression includes two or more


independent variables, whereas a simple
regression includes only one independent
variable.
• In the case of the Miller Pharmaceutical
Company:
• Yi = A + B1Xi + B2Pi + ei
• As in the case of simple regression, least
squares estimates are obtained.
© 2013 W. W. Norton Co., Inc.
SOFTWARE PACKAGES AND COMPUTER
PRINTOUTS

• Regression analyses are carried out on


computers.
• Some widely used packages are Minitab,
SAS, SPSS, and in Microsoft Excel.
• Packages produce similar output.
SOFTWARE PACKAGES AND COMPUTER
PRINTOUTS

Managerial Economics, 8e
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INTERPRETING THE OUTPUT OF
STATISTICAL SOFTWARE

• The Standard Error of the Estimate is a


measure of the amount of scatter of
individual observations around the
regression line.
• It is useful in constructing prediction
intervals.
INTERPRETING THE OUTPUT OF
STATISTICAL SOFTWARE (CONT’D)

Managerial Economics, 8e
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INTERPRETING THE OUTPUT OF
STATISTICAL SOFTWARE (CONT’D)

Managerial Economics, 8e
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INTERPRETING THE OUTPUT OF
STATISTICAL SOFTWARE (CONT’D)

• The F Statistic
• Answers the question of whether any of
the independent variables really
influences the dependent variable
• Large values of F tend to imply that at
least one of the independent variables
has an effect on the dependent variables.
INTERPRETING THE OUTPUT OF
STATISTICAL SOFTWARE (CONT’D)

• Tables of the F distribution are used to


determine the probability of the observed
value of the F Statistic having arisen by
chance alone, given that none of the
independent variables has any effect on
the dependent variable.
• This probability is denoted by “p.”
INTERPRETING THE OUTPUT OF
STATISTICAL SOFTWARE (CONT’D)

• Tables of the F distribution are used to


determine the probability of the observed
value of the F Statistic could have arisen
by chance alone, given that none of the
independent variables has any effect on
the dependent variable.
• This probability is denoted by “p.”
INTERPRETING THE OUTPUT OF
STATISTICAL SOFTWARE (CONT’D)

• The t statistic.
• Used to determine which of the independent
variables influences the dependent variable.
• Assumes that the true value of the parameter
estimate is zero.
• Uses a probability also denoted by “p.”
• In general, large ‘t’ statistics (small p-values)
would lead to a rejection of the null hypothesis.
MULTICOLLINEARITY

• A condition where two or more


independent variables are very highly
correlated
• Impacts the accuracy of the coefficient
estimates
• Difficult to reduce the extent of
multicollinearity
SERIAL CORRELATION

• Violation of the assumption that the error


terms are independent
• Positive serial correlation occurs when the
error terms in regression analyses have the
same sign as in the previous time period.
• Negative serial correlation occurs when the
error terms have the opposite signs as in the
previous time period.
SERIAL CORRELATION (CONT’D)

• Presence of serial correlation is tested by use of the


Durbin-Watson statistic d.
• Reject hypothesis of no serial correlation against
alternative hypothesis of positive serial correlation
when d < dL and accept when d > dU .
• Values of dL and dU are shown in Appendix E, Table
E.7.
• Note that values of dL and dU depend on both sample
size and the number of independent variables.
SERIAL CORRELATION (CONT’D)

• One solution to deal with the problem of


serial correlation is to take first differences
of all the independent and dependent
variables in the regression.
• Note that the sample size is reduced.
SERIAL CORRELATION OF ERROR TERMS
(CONT’D)

Managerial Economics, 8e
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FURTHER ANALYSIS OF THE RESIDUALS

Managerial Economics, 8e
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FURTHER ANALYSIS OF THE RESIDUALS

Managerial Economics, 8e
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This concludes the Lecture
PowerPoint Presentation for
Chapter 4: ESTIMATING DEMAND FUNCTIONS

Visit the StudySpace at:


http://www.wwnorton.com/college/econ/mec8/

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