DEMAND ESTIMATION & FORECASTING

Dr Sayyid Salman Rizavi

Hailey College of Commerce University of the Punjab Lahore

PLAN OF LECTURES

Lecture 1: Demand Analysis-I Lecture 2: Demand Analysis-II Lecture 3: Demand Estimation I Lecture 4: Demand Estimation II Lecture 5: Demand Forecasting

LAW OF DEMAND
Demand: A relationship of price and quantity demanded shown by a demand function Quantity demanded: The amount of goods purchased at a specific price Law of demand: Demand varies inversely with price ceteris paribus Extension and contraction in demand: changes in quantity demanded caused by price changes Shifts in demand (rise & fall): shifts in the demand curve caused by changes in factors other than price Demand function: A function showing what impacts the quantity demanded

DEMAND FUNCTION
= =

, , ,

<0 >0 <0

Normal Good

Inferior Good
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

Giffen Good

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 Quantity Quantity Quantity
Linear Demand

Non-linear (e.g. Power form)

Qd = a P b c Qd = a P Y
b

Price

Price Price Price

Non-linear Demand Curve

Quantity Demanded

CHANGES IN DEMAND
a
Fall

b Price c d
Rise

Rise in Demand (Normal good): Increase in income Increase in price of substitute Decrease in price of complimentary good Increase in Population Development of taste

e Quantity demanded
Movements: Extension & Contraction Shifts: Rise & Fall

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 prices changes. Inelastic and elastic demand Price Elasticity measures the response of the consumer to price changes
Percentage change in quantity demanded = Percentage change in price

PRICE ELASTICITY OF DEMAND

= =

Percentage change in quantity demanded Percentage change in price

= slope of demand curve

OR =

P1 P P2
Ed < 1

Ed > 1

Q1

Q2A

Q2B

OTHER ELASTICITIES
= = 0<

Percentage change in quantity demanded Percentage change in income =

OR

<0

<1

= =

Percentage change in quantity demanded of a commodity Percentage change in price of other related commodity y

OR

>0 <0

SELECTED ELASTICITIES OF DEMAND Product Clothing Tobacco products Medical care and hospitalization Jewelry & Watches Gasoline/Petrol Short Run 0.9 0.46 0.3 0.41 0.2 Long Run 2.9 2.1 0.9 0.67 0.6

10

SELECTED INCOME ELASTICITIES OF DEMAND Product Household Electricity Beef Chicken Flour Short Run 1.94 1.06 0.28 -0.36

11

SELECTED CROSS ELASTICITIES OF DEMAND Cross elasticity w.r.t. price w.r.t. of Butter Electricity Food Food Cross price elasticity 1.53 0.8 -0.72 -1.8

Product Margarine Natural Gas Entertainment Clothing

12

USING ELASTICITIES I
A coffee company markets coffee brand X and estimates the following demand function : = = = = =
Hint:

= 1.5 3.0 =

+ 0.8

+ 2.0

0.6

+ 1.2

. = 2, = 2.5, = 1.8, = 0.5, = 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)

USING ELASTICITIES II
Problem from Salvatore (problem 12 page 130, 4th edition): The research department of the corn Flakes Corporation estimated the following regression of the demand of the cornflakes it sells: = = = = =

= 1.0 2.0
=

+ 1.5

+ 0.8
,

3.0

+ 1.0

10 ,

10 10 ,

This year, = $2, = $4, = $2.5, = $1, = $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 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.

USING ELASTICITIES III

XYZ corporation estimated the following demand function in 2010: = 1500 5.4 + 2.8 1.2 + 0.8 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: (a) Interpret the marginal effects; (b) During next year per capita income may increase by 2500 rupees; what effect will this have on the firms 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?