Estimating Demand

Functions
Chapter 3.1

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 1. Objectives of Demand Estimation
•determine the relative influence of
demand factors

•forecast future demand

•make production plans and effective

inventory controls

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 2. Major approaches to Demand
Estimation
a.Marketing Research
•Consumer survey
• telephone,
•questionnaire,
•interviews,
•online survey

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Advantage: provides useful data for the
introduction of new products

Disadvantages:
It could be biased due to
unrepresentative sampling size

Consumers may provide socially

acceptable response rather than true
preferences
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• Consumer Clinic
 a sample of consumers is chosen either randomly,
or based on socio-economic features of the market
 They are given some money to spend on goods
Their purchases are being observed by a researcher
.
Advantages:
• more realistic than consumer surveys
• avoids the shortcomings of market
experiments(costs).
Disadvantages:
• participants know that they are in an
artificial situation
•small sample because of high cost
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• Market Experiments
• Similar to consumer clinic, but are
conducted in an actual market place
• Select several markets with similar socio-
economic characteristics and change a
different factor in each
market
• Use census data for various markets and study the impacts of
differences in demographic characteristics on buying habits

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Advantages:
-can be done on a large scale
-consumers are not aware that they are
part of an experiment
Problems of Marketing Research
-the sample may not be representative
-the consumers may not be able to answer
the questions accurately- biased

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2b. Statistical Method
-Involves the use of regression analysis to
determine the relative quantitative effect of each
of the demand determinants.

QDVD  f (DVD , R , income, pop, Ad )

Regression Analysis is usually:
-more objective than marketing research
- provides more complete
information than market research
-less expensive

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 3. Steps in regression analysis
• Specify the model (theory)
• Obtain data (types and sources)
• Specifying the form of the demand equation
(linear, log linear)
• Specifying the form of the demand equation
(linear, log linear)
• Estimate the regression coefficients (Finding the
line of best fit by minimizing the error sum of
squares)
• ∑(Y t – ̂t ) 2
= ∑(Y t - a - bXt) =0
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Regression Parameters

â    b

 t  t
ˆb  (   )(   ) / (   ) 2
t

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 … Steps in regression analysis
• Test the significance of the regression
results (Overall tests and individual tests).
• Use the results of the regression analysis
as a supporting evidence in making
business policy decisions (change price, ad
strategy, customer service)

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4 a.Given Sales (Yt in ‘000 units) and
Advertising Expenditures (Xt) (in
mill. $) data as follow:

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Yt X t 
t   t   [( t   )(  t  )] (  t  ) 2

37 5 -7 -1 7 1
48 7 4 1 4 1
45 6 1 0 0 0
36 3 -8 -3 24 9
25 4 -19 -2 38 4
55 9 11 3 33 9
63 8 19 2 38 4
0 0 144 28
   309
t

  t  42  (   )(  )  144

t t

 (   )  28
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t
2
   t / n  309 / 7  44

X   X t / n  42 / 7  6

a.
 t  t
ˆb  (   )(  ) / (   ) 2  144 / 28
t
 5.14
aˆ    b  44  5.14(6)  13.14  13

b. ˆ  13  5.14 
t t
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4c. Interpretation of Regression
Coefficients
a-- is the intercept term which represents
the value of the dependent variable when
Xt=0.

-- has no economic meaning when its

value lies outside the range of observed
data for Yt. Note: Data Range=> 25-63

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 b- the slope of the regression line
- represents the change in the dependent
variable (Yt) related to a unit change in
the independent variable

b=5.14 means that a $ 1 million dollar

increase in ad expenses will result in an
increase in sales by 5140 units.
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 4d. Overall Measures of Model
Performance
(i) R2=coefficient of determination
= the ratio of the variation in sales explained
by the variation in ad expenses.
=Explained Variation/Total Variation

R   (t   ) /  (t   )  751 / 973  .761

2 ˆ 2 2

R  1  [(1  R )(n  1) /( n  K )]  .713

2 2

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Notice that R2 is adjusted for the degrees of
freedom- the number of observations beyond the
minimum needed to calculate a given regression
statistic.

For example, to calculate the intercept term, at

least one observation is needed;
to calculate an intercept term plus one slope
coefficient, at least two observations are required,
and so on.

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 Unexplained
variation
t . t - ̂t = u
̂t . Explained
variation

̂t - 


 X
Explained and Unexplained Variations of the Dependent Variable
in a Regression Model
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R2 is high when unexplained variation is low.
 
 
( t   ) ( t   )
2 2
t

39 25 49
49 44 0
44 0 1
28 256 64
34 100 361
59 81 121
54 100 361
 t
( ˆ
   ) 2
 731  t
(    ) 2
 973

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 t
( 
   ) 2
 731 =>Explained variation
 t
(    ) 2
 973 =>Total variation

R   ( t   ) / ( t   )  731 / 973 .751

2  2 2

2 =.761means that 76.1% of the variation of in

R
sales is explained by the variation in advertising
expenditures.

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Note: One would like R2 to be as high as possible.
R2, however, depends on the type of data used in
the estimation.
It is relatively higher for time series and smaller
for cross-sectional data.

For a cross-section data, R2 of .5 is acceptable.

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(ii)F-Statistic- a statistical test of
significance of the regression model.

F-test of Hypotheses

  :b1  0
  :b1  0
Decision Rule:
Accept  if F-calculated<F-table
Reject   if F-calculated >F-table
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F-table is defined for df1=k-1, df2=n-k)
at = .05 (conventional) or =.01, or any other level of
significance.

[k= # of parameters (2), n= # of observations (7)]

F(1, 5) at = .05 = 6.61,

F-cal= R2/k-1/[(1-R2)/(n-k)]
=.751/.249/5=15.1

Reject Ho since F-cal>F-table, i.e.

the regression model exhibits a statistically significant
relationship.
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4 e. The t-statistic test is a test of the
individual independent
variable.

t-test of Hypotheses
  :b1  0
  :b1  0

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 Decision Rule
Accept Ho
ift-lower<t-cal<t-upper critical
Value. Reject Ho if t-cal < t-lower o
t-cal> t-upper critical value.
t-table( d.f.=n-k= 5, = .05 or at .01)

t-table (5, =.05)=2.571,

t-cal = ˆb / S =5.14/1.45=3.54>2.51.
bˆ
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 Accept H0

Reject H0 Reject H0

t
-2.751 0 2.751

Decision: Reject Ho since t-cal> t-upper value

from the table or t-cal<t-lower value. There is
a statistically significant relationship between
sales and advertising
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Multiple Regression has more than one
independent variable.
Example: Earnings=f(Age, ED, JOB
Exp.)
•How do we estimate the regression
coefficients in this case?

-Use a variety of statistical software

(Minitab, Excel, SAS, SPSS, ET, ,Limdep,
Shazam, TSP)
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Incˆome= -7.06 -.21Age +2.25ED +1.02JEXP
(-2.1) (-1.93) (8.86) (4.07)
(The numbers in parenthesis are t-values).

R2 = .874
F-cal =37.05
Test the significance of each of the variables.
Interpret the meaning of the coefficients.

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5.The regression coefficients which
are obtained from a linear demand
equation represent slopes (the effect
of a one unit change in the independent
variable on the dependent variable

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6. ˆ t  114 .07  9.47 X 1t  .029 X 2t
(-5.21) (4.51)

2
R = .968; R =.964; F=258.942
2

*Linear form

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 7. ln ˆ t  .533  .38 ln X 1t  .769 ln X 2t
(-3.304) (4.042)

R2 = .95; F-cal=183.582
-The statistical significance is similar
-The coefficients in # 7 represent elasticities, not
slopes as in #6.
- Example: -.389 means that a 1% increase in X1t
results in a .389% decline in t

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