demand estimation & forecasting

15
DEMAND ESTIMATION & FORECASTING Dr Sayyid Salman Rizavi Hailey College of Commerce University of the Punjab Lahore

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Page 1: Demand Estimation & Forecasting

DEMAND ESTIMATION &

FORECASTING

Dr Sayyid Salman Rizavi

Hailey College of Commerce

University of the Punjab

Lahore

Page 2: Demand Estimation & Forecasting

PLAN OF LECTURES

� Lecture 1: Demand Analysis-I

� Lecture 2: Demand Analysis-II

� Lecture 3: Demand Estimation I� Lecture 3: Demand Estimation I

� Lecture 4: Demand Estimation II

� Lecture 5: Demand Forecasting

Page 3: Demand Estimation & Forecasting

LAW OF DEMAND

� Demand: A relationship of price and quantitydemanded shown by a ‘demand function’

� Quantity demanded: The amount of goodspurchased at a specific price

� Law of demand: Demand varies inversely withprice ceteris paribusLaw of demand: Demand varies inversely withprice ceteris paribus

� Extension and contraction in demand: changes inquantity demanded caused by price changes

� Shifts in demand (rise & fall): shifts in thedemand curve caused by changes in factors otherthan price

� Demand function: A function showing whatimpacts the quantity demanded

Page 4: Demand Estimation & Forecasting

DEMAND FUNCTION

� = ���, �, �� , � , �

� = �� ����� ��� ����

� = � ���� ����

� = ����� ����� �� �ℎ� �������

�� = � ���� ���� �� �� ����������

� = � ���� ���� �� ��������� �� ���

= �ℎ�� � ���� ���� � ���

!�!� < 0

!�!� > 0

!�!� < 0

Normal Good

� = � ���� ���� �� ��������� �� ��� = �ℎ�� � ���� ���� � ���

Substitute: A good that is alternatively demanded

%&%'(

> )

Complimentary good: A good that is jointly demanded

%&%'*

< )

Individual demand & market demand: Market demand curve is

the horizontal summation of individual demands

!�!� < 0

!�!� < 0

!�!� > 0

!�!� < 0

Giffen Good

Inferior Good

Page 5: Demand Estimation & Forecasting

SPECIFICATION OF DEMAND FUNCTION

� Linear:

� Qd= a – b P , where b > 0 for normal goods

� Qd= a – b P + c Y , where b > 0 & c > 0 for normal

goods Quantity

Quantity

Quantity

Linear Demand

� Non-linear (e.g. Power form)

� Qd = a Pb

� Qd = a PbYc

Quantity DemandedQuantity Demanded

Price

Price Non-linear Demand CurveNon-linear Demand Curve

Quantity Demanded

Price Non-linear Demand Curve

PricePrice

Quantity

Quantity

Price

Quantity

Page 6: Demand Estimation & Forecasting

Pri

ce

CHANGES IN DEMANDa

b

c

Fall

Rise in Demand (Normal good):

•Increase in income

•Increase in price of substitute

•Decrease in price of

complimentary good

Quantity demanded

Pri

ce

d

e

Rise

Movements: Extension & Contraction

Shifts: Rise & Fall

complimentary good

•Increase in Population

•Development of taste

Page 7: Demand Estimation & Forecasting

ELASTICITY OF DEMAND

� In order to increase TR Should

we increase the price or decrease

it?

� The answer depends on the

reaction of the consumer to pricesreaction of the consumer to prices

changes.

� Inelastic and elastic demand

� Price Elasticity measures the

response of the consumer to price

changes

���� +� ������ = Percentage change in quantity demandedPercentage change in price

Page 8: Demand Estimation & Forecasting

PRICE ELASTICITY OF DEMAND

���� +� ������ = Percentage change in quantity demandedPercentage change in price

+� = <∆�∆�> �

∆�∆� = slope of demand curve

OR

+ = ?!�@ �P

AB

∆�OR

+� = ?!�!�@ �

Ed < 1Ed > 1

P1

P2

Q1 Q2A Q2B

∆P

Page 9: Demand Estimation & Forecasting

OTHER ELASTICITIES

����� +� ������ = Percentage change in quantity demandedPercentage change in income

+� = <∆�∆�> �

� OR +� = <!�!�> �

0 < +� < 1 ��� ���� � ����������

+� < 0 ��� �������� ����

0 < + < 1 ��� ���� � ����������+� < 0 ��� �������� ����

C���� ���� +� ������ = Percentage change in quantity demanded of a commodityPercentage change in price of other related commodity ′y

+ = ?∆�G∆��

@ ���G

OR +� = ?!�G!��

@ ���G

+ > 0 ��� �����������

+ < 0 ��� ��������� �� ����

Page 10: Demand Estimation & Forecasting

SELECTED ELASTICITIES OF DEMAND

ProductProduct Short RunShort Run Long RunLong Run

Clothing 0.9 2.9

Tobacco products 0.46 2.1

10

Medical care and hospitalization 0.3 0.9

Jewelry & Watches 0.41 0.67

Gasoline/Petrol 0.2 0.6

Page 11: Demand Estimation & Forecasting

SELECTED INCOME ELASTICITIES OF DEMAND

ProductProduct Short RunShort Run

Household Electricity 1.94

Beef 1.06

11

Beef 1.06

Chicken 0.28

Flour -0.36

Page 12: Demand Estimation & Forecasting

SELECTED CROSS ELASTICITIES OF DEMAND

ProductProductCross elasticity Cross elasticity w.r.tw.r.t. price . price

of of

Cross Cross

price price

elasticityelasticity

Margarine Butter 1.53

12

Margarine Butter 1.53

Natural Gas Electricity 0.8

Entertainment Food -0.72

Clothing Food -1.8

Page 13: Demand Estimation & Forecasting

USING ELASTICITIES I

A coffee company markets coffee brand X and estimates the following demand function :

�G = 1.5 − 3.0 �G + 0.8 � + 2.0 �� − 0.6 �� + 1.2 P

Qℎ��� �G = R ��� �� ����� �� �� S �� �������� �� ���� � ��

�G = ���� �� ����� �� �� S �� T� ��� ���� � �

� = ������ � ���������� ����� �� �������� �� T������

�� = ���� �� ���������� �� �� �� ����� �� T� ��� � . �� = ���� �� �� � �� T� ��� � . P = P������������ +G��������� ��� ����� �� �� S �� ℎ������� �� �ℎ��� ��� �� T�. R������ �ℎ � �ℎ�� �� � �G = 2, � = 2.5, �� = 1.8, �� = 0.5, P = 1

� = ���� �� �� � �� T� ��� � .P = P������������ +G��������� ��� ����� �� �� S �� ℎ������� �� �ℎ��� ��� �� T�.R������ �ℎ � �ℎ�� �� � �G = 2, � = 2.5, �� = 1.8, �� = 0.5, P = 1

• Find quantity demanded of x and all possible elasticities and interpret them. Is this coffee a normal good? It is

elastic or inelastic?

• What will happen if the advertisement expenditure rises by 2 percent

• What will happen if the advertisement expenditure rises by 2 percent and incomes rise by 5 percent

• What will happen if the advertisement expenditure rises by 2 percent, incomes rise by 5 percent and price of

sugar falls by 8 percent?

• Solve the integrated problem 12 from your text book (Salvatore, given at page 130 in the fourth edition)

Hint:

�G′ = �G + �G �∆�G�G

�+� + �G �∆�� �+� + �G �∆��

���+G� + �G �∆��

���+G� + �G �∆�G

�G�+� + �G �∆P

P �+P

Page 14: Demand Estimation & Forecasting

USING ELASTICITIES IIProblem from Salvatore (problem 12 page 130, 4

th edition):

The research department of the corn Flakes Corporation estimated the following regression of the demand

of the cornflakes it sells:

�G = 1.0 − 2.0 �G + 1.5 � + 0.8 �� − 3.0 �� + 1.0 P

Qℎ��� �G = R ��� �� CUC C����� ���, �� �������� �� 10 ���� ��G�� ��� �� �

�G = ���� �� CUC C����� ���, �� ���� �� ��� 10 ���� ��G

� = ������ � ���������� ����� �� �������� �� ���� �� ��� �� �

�� = ���� �� ���������� �� �� �� C����� ���, �� ���� �� ��� 10 ���� ��G

�� = ���� �� ����, �� ���� �� ��� V� ��

P = P������������ +G���������� �� CUC ����� ���, �� ℎ������� �� �ℎ��� ��� �� ���� �� ��� �� �

� = $2, � = $4, � = $2.5, � = $1, �� P = $2

� = ���� �� ����, �� ���� �� ��� V� ��P = P������������ +G���������� �� CUC ����� ���, �� ℎ������� �� �ℎ��� ��� �� ���� �� ��� �� �

This year, �G = $2, � = $4, �� = $2.5, �� = $1, �� P = $2

(a) Calculate the sales of CFC cornflakes this year; (b) calculate the elasticity of sales with respect to

each variable in the demand function; (c) estimate the level of sales next year if CFC reduces �G by

10%; increases advertising by 20%, � rises by 5%, �� is reduced by 10% and �� remains unchanged; (d)

By how much should CFC change its advertising if it wants its sales to be 30% higher than this year?

Also interpret the marginal effects (slope coefficients) of the estimated demand function.

Page 15: Demand Estimation & Forecasting

USING ELASTICITIES IIIXYZ corporation estimated the following demand function in 2010:

� = 1500 − 5.4 � + 2.8 � − 1.2 �� + 0.8 P

Where Q = Quantity demanded in thousands per month

P = price of the product in Rs.

Y = per capita disposable income in thousands of rupees

Py = price of a product by ABC corporation

A = Advertisement expenditure in thousands of rupees

Answer the following: Answer the following:

(a) Interpret the marginal effects; (b) During next year per capita income may

increase by 2500 rupees; what effect will this have on the firm’s sales (c) If XYZ

wants to raise its price to offset the effects of increase in income, by how much

should she raise the price?

(d) if P = 20, Y = 5, Py = 18, A = 1 then compute the elasticity with respect to each

independent variable in the equation

(e) What will be the quantity demanded if P increases by 10% and Py decreases by

10%?

(f) Are the products by XYZ and ABC complimentary goods or substitutes?