ECO740: ECONOMIC ANALYSIS

INDIVIDUAL REGRESSION ASSIGNMENT

Data Ior 'Fantastic Frieda video game is given in the Iollowing table.

Year Q
F
P
F
($) P
C
($) Y
a
($) A ($)
1993 50000 18 20 24580 7500
1994 60000 16 20 26433 10500
1995 55000 16 18 27735 10500
1996 61000 17 20 29458 11500
1997 63000 17 21 30970 12000
1998 65000 18 22 32191 12400
1999 75000 16 21 34213 13000
2000 70000 20 24 35353 12500
2001 75000 20 24 35939 14000
490 Q
F
is the quantity demanded per year oI the games, P
F
is the price oI the game,
P
C
is the price oI competing games, Y
a
is the median annual Iamily income, and A is
the monthly advertising expenditures.

QUESTIONS

&sing any oI the standard multiple regression computer packages and the data:
1. stimate the demand Iunction Ior the video game.
2. Based on your regression estimates, would you be able to convince the video
game company to accept the model that you estimated? Why or why not?
3. Find the elasticity estimates.
4. Write a report on how the company may beneIit Irom your demand estimation
in its decision-making.

ANSWERS

Question 1:
Data transIormation:
Year logQ
F
logP
F
($) log P
C

($)
logY
a
($) log A ($)
1993 4.6990 1.2553 1.3010 4.3906 3.8751
1994 4.7782 1.2041 1.3010 4.4221 4.0212
1995 4.7404 1.2041 1.2553 4.4430 4.0212
1996 4.7853 1.2304 1.3010 4.4692 4.0607
1997 4.7993 1.2304 1.3222 4.4909 4.0792
1998 4.8129 1.2553 1.3424 4.5077 4.0934
1999 4.8751 1.2041 1.3222 4.5342 4.1139
2000 4.8451 1.3010 1.3802 4.5484 4.0969
2001 4.8751 1.3010 1.3802 4.5556 4.1461

For this data, the dependant variable is quantity demanded per year oI the games, Q
with 4 independent variables which are price oI the game, P
F
, price oI competing
games, P
C
, median annual Iamily income, Y
a
, and monthly advertising expenditures,
A. Thus, the data will be analyzed using a multiple linear regression model in a
multiplicative exponential Iorm. So, the demand Iunction Ior 'Fantastic Frieda video
game will be in the Iorm oI:
Q o
P
[
1

C
[
2

u
[
3

[
4
q. 1.1
Or, in the Iorm oI simple linear relationship, the equation will be:
log Q = log o +
1
log P
F
+
2
log P
C
+
3
log Y
a
+
4
log A +c q. 1.2
where, log o ,
1
,
2
,
3
is the coeIIicient (parameter) oI independent variable and c is
an error term.
Assumptions:
(i.)Assuming that the change oI quantity demanded oI the games per year, Q
depended on price oI the game, P
F
, price oI competing games, P
C
, median
annual Iamily income, Y
a
, and monthly advertising expenditures, A and/or
other Iactors.

(ii.)ultiplicative exponential model is chosen due to its easiness in estimating

elasticity as it gives constant elasticities over the range oI data.

From the regression output in Appendix 1, demand Iunction Ior the video
game with t-statistic in parentheses is:
log Q = . - .98 log P
F
+ .99 log P
C
+ . log Y
a
+ . log A
(2.356) (-2.504) (2.513) (1.689) (0.533)
Or
Q .9 P
F
0.798
P
C
0.949
Y
a
0.574
A
0.112



Question 2

Based on the regression output using SPSS 17.0 attached in Appendix 1:

(i.) Durbin-Watson
Since the data is in terms oI time, t, the value oI Durbin Watson should be
analyzed Iirst to determine whether autocorrelation existed. The value oI
Durbin-Watson is 1.824 which closes to 2. This value indicates possible
presence oI positive autocorrelation but since the value is close to 2, the data is
acceptable. So, the value oI t-statistics, r
2
and F is considered reliable.

(ii.) T-Test:
This test was done to test whether each oI the independent variables oI price oI
games, P
F
, price oI complementary games, P
C
, median annually Iamily income,
Y
a
, monthly advertising expenditures, A has a signiIicant relationship with
quantity oI games demanded per year ,Q by testing:
The null-hypotheses : H
0
:
i
0 (not signiIicant) against
alternative hypothesis: Ha: i 0 (signiIicant)
Decision rule: Reject H
0
iI , t , ~ critical t (t*), then it is signiIicant.
For 95 conIidence level or a 0.05 signiIicant level, t critical can assumed to
be:
t* 2

From the regression output, the independent variable(s) that is deemed

signiIicant by t-test is P
F
, P
C
and constant with value oI ,-2.504, ~ 2, 2.513 ~ 2,
and 2.356 ~ 2 respectively. We can say that the PF, PC and constant (other
Iactors) are important in estimating the demand Ior 'Fantastic Frieda video
games. However Ior annual Iamily income, Y
a
and monthly advertising
expenditures, A exhibits a t-statistics less than t-critical with each t-statistics
valued at 1.689 and 0.533 respectively, so they are not signiIicant to inIluence
quantity demanded per year oI games, Q.

(iii.) Correlation coeIIicient, r:
Based on the regression output, the correlation coeIIicient oI the model is 0.984
which is very close to 1 (almost perIect correlation) which shows a high
strength oI association between independent variable and dependent variable. In
other words, high value oI one variable is associated with a high value oI
another variable.

(iv.) Analysis oI variance:
CoeIIicient oI determinant, r
2
can be used to measure whether the regression
model Iit` to the samples oI observation oI the video game data.
The value oI r
2
oI 0.968 (96.8) is very close to 1(100) that shows the
regression model is almost perIectly Iit to the samples oI observation. This
value also explains that 96.8 oI the data variation can be explained by the
model while only 3.2 oI the data could not be explained by the regression
model.
F-statistics oI the regression model will show whether r
2
is signiIicant or
not.
(v.) F-statistics:
This model shows F-statistics oI 30.10. The value oI F-distribution Ior this
particular data is F
0.05, 4, 25
2.76. Since F-statistic ~ F-distribution table, 30.10
~ 2.76, thereIore, this shows that the r2 is signiIicant. Overall, the model is able
to explain a signiIicant proportion oI variation in Q caused by change oI all
independent variables.

(vi.) ames sales Iorecasting

The standard error oI estimate, J

can be used to predict the range or the

intervals oI sales oI games, Q. This value will show the interval at which the
actual value oI Q lies in. For a 95 conIidence level, the prediction Q range can
be calculated as:
Actual Q = Q _ J

In this case, Irom the regression model output, s
e
is 0.015, so the predicted range
oI Q will be: Actual Q = Q_ (.)

Question 3:
From the coeIIicient oI the independent variable, elasticity can be estimated as
Iollows:
(i.) ame price elasticity oI demand,
D

1
- 0.798
The market demand Ior game price was price inelastic where 0 ,-0.798, 1,
which explains that a percentage change in P
F
will result in a smaller
percentage oI change in Q. For example a 20 percent increase in P
F
will lead
to a 15.96 percent decrease in demand oI Q.
Calculation:
(0.2)(-0.798) 0.1596 15.96 (decrease)

(ii.) Cross price elasticity oI demand,

2
0.949
A competitors` price elasticity oI demand oI 0.949 shows P
C
is inelastic, as
20 percent increase in competitors` price, P
C
will lead to 18.98 percent
increase in quantity oI video games demanded, Q.
Calculation:
(0.2)(0.949) 0.1898 18.98 (increase)
Since the elasticity measured is highly positive, then both products are
substitute products. The high degree oI substitute relationship between
'Fantastic Frieda and other video game competitors shows a high
competition between them in a market.

(iii.) Income elasticity oI demand,

3
0. 574
The income elasticity oI 0.574 suggests that the income is inelastic which
means that iI there is 6 percent increase in the annual Iamily income then, the
quantity demanded Ior video games will increase 3.44 percent.
Calculation:
(0.06)(0.574) 0.0344 3.44 (increase)

(iv.) Advertising expenditure elasticity oI demand,
A

4
0.112
As advertising expenditure shows inelastic demand oI 0.112, Ior a 20 percent
increase in the ads expenditures, the demand will increase in 2.24 percent.
Calculation:
(0.2)(0.112) 0.0224 2.24 (increase)

(v.) Combined eIIect oI demand elasticity,

The demand oI 'Fantastic Frieda video games can also be estimated Ior
increasing change oI two Iactors (independent variable) simultaneously. For
this case, iI the price oI the video games and the Iamily income changes
simultaneously with other Iactors (competitor`s price and advertising
expenditures were assumed independent and additive respectively) remains
the same, the eIIect on the quantity demanded can be estimated using the
equation below:
Q
2
= Q
1
| +

(%AP
F
) +

(%AY
a
)] q. 1.3
Previously,
D
- 0.798;

0. 574; %AP
F
= %; %AY
a
= %;
For year 2001, Q
2001
75000;
So, substituting relevant data into eq. 1.3 yields the Iorecasting demand Ior
year 2002 which are as Iollows:

2002
= | + (- .98)(.) +. (.)] = units

Question 4:

Overall, this model shows a good Iit Ior the data as it explained 96.8 oI the
variations oI quantity demanded sales per year. Based on the regression model Ior
'Fantastic Frieda video games, it can be seen that Ior this particular product i.e.
'Fantastic Frieda video game, the price oI the video games and price oI competitors
is a signiIicant variable to be considered in estimating the demand oI the product.
(i). As the price oI the video game increases, the quantity demanded decreases.
(ii). As the price oI video game competitor increases, the quantity demanded also
increases.

It can be stipulated that the price oI the product is important in inIluencing the
demand oI the 'Fantastic Frieda. Based on these Iacts, the company should Iocus
more on coming up with a competitive price to compete with the other video games
competitor.
As the annual Iamily income and monthly advertising expenditures were less
inIluencing than the other two variables, the company may in order to reduce the total
cost oI product, adopt less cost advertising strategy such as through social networking
and through the internet.