Assignment 1 Farley 1

Assignment 1: Demand Estimation

Mark Farley

Dr. Bernadette West

ECO 550 Managerial Economics and Globalization

5/2/2023

Assignment 1 Farley 2

I will base this assignment on the scenario that I work for the maker of a leading brand of

low-calorie, frozen microwavable food. Using data from 26 supermarkets around the country for

the month of April, I will estimate the following demand equation for our product;

QD = -2,000 - 100P + 15A + 25PX + 10Y

(5,234) (2.29) (525) (1.75) (1.5)

R2 = 0.85 n = 26 F = 35.25

My supervisor has asked me to compute the elasticities for each independent variable. Assume

the following values for the independent variables:

QD = Quantity demanded of a unit (dependent variable)

P (in cents) = 200 cents per unit (price per unit)

PX (in cents) = 300 cents per unit (price of leading competitor’s product)

Y (in dollars) = $5,000 (per capita income in the Standard Metropolitan Statistical

Area (SMSA) where the 26 supermarkets are located)

A (in dollars) = $640 (monthly advertising expenditures)

I will compute the elasticities for each independent variable. Determine the implications for each

of the computed elasticities for the business in terms of short-term and long-term pricing

strategies by providing a rationale for my results. Based on my results, I will make a

recommendation whether firm should or should not cut its price to increase its market share. I

will work from the assumption that all the factors affecting demand in this model remain the

same, but that the price has changed. Further assume that the prices are 100, 200, 300, 400, 500,

Assignment 1 Farley 3

600 cents. I will plot the demand curve for the firm and plot the corresponding supply curve on

the same graph using the following MC / supply function (with the same prices 100, 200, 300,

400, 500, and 600 cents): QS = -7909.89 + 79.0989P. I will determine the equilibrium price

and quantity and outline the significant factors that could cause changes in supply and demand

for the product. I will determine the primary manner in which both the short-term and the long-

term changes in market conditions could impact the demand for, and the supply, of the product.

Finally, I will indicate the crucial factors that could cause rightward shifts and leftward shifts of

the demand and supply curves.

I will use regression analysis and standard error will test if the independent variables that

make up our demand function are statistically significant. Using the explanatory values above I

can therefore calculate elasticities for each variable. First, I have to calculate the quantity

demanded below using demand function provided.

QD = -2,000 – 100(200) + 15(640) + 25(300) + 10(5,000)

= 45,100

= 45,100

Since we have found the quantity demanded we can then calculate all the elasticities for our

independent variables.

• Price elasticity ED = (Q/P)*(P/Q)

= (-100)*(200/45100)

= -0.44 which is inelastic

• Advertising elasticity EA = (Q/A)*(A/Q)

= (15)*(640/45,100)

= 0.213 which is inelastic, but a necessity

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• Cross-price elasticity PX = (QPX/PX)*(PX /Q)

= (25)*(300/45,100)

= 0.166 which is a Substitute Good.

• Income elasticity EY = (Q/Y)*(Y/Q)

= (10)*(5,000/45,100)

= 1.11 which is a normal good, but a necessity

In looking at the implications from the computed elasticities with respect to short-term

and long-term pricing strategies I learn that the EP of demand measures the rate of response of

QD due to a price change. Regarding our low-calorie microwavable food, the calculated price

elasticity of demand is -0.44, which is 0.44 in absolute values. This tells me that our good is

inelastic and in order to increase our total revenue we need to increase price. The advertising

elasticity of demand can be used to measure advertising effectiveness. It measures the percentage

change in demand to the percentage change in the level of advertising expenditure. The EA of

demand for our product is 0.213 which is positive and inelastic which means that for every dollar

increase in our advertising there will be a 21 percent increase in QD. The EPX of demand helps

determine how competitive a substitute or complimentary good is and how it can impact the

quantity demanded of our low-calorie, frozen microwavable food. The elasticity is a positive

0.16 which signifies that this competitor product is a substitute good. The greater the elasticity

means the greater the product will have on our sale. (Cuddington 2015). The EY of demand is

used to interpret how responsive demand is for a good is to change in income. In this exercise, I

calculated the income elasticity to be positive 1.11 meaning that it is a normal luxury (elastic)

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good. (Andreyeva 2010). We see positive income elasticities in the live cycle of normal goods.

As income increases more products are consumed.

I can determine from the calculation that our product is inelastic and prices should be

raised until unit price elasticity is attained. Also the cross price elasticity is only 0.21 which

means that any price changes will result in only 21% loss in quantity demanded. It’s my opinion

that our substitute or competitor good has little influence on our product.

I will find the demand curve using the demand function;

QD = - 2,000 – 100P + 15A +25PX + 10Y

-2,000-100P + 15(640) + 25(300) + 10(5,000)

QD = 65,100-100P

I will use the supply equation QS = -7909.89 + 79.0989P

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Market equilibrium occurs when quantity demanded converges with the quantity

supplied. The equilibrium point can be calculated by either using the graph or mathematically.

QD = QS

65,100-100P = -7,909.89 + 79.0989P

65,100+7,909.89 = 79.0989P+100P

73,009.89 = 179.0989P

P = 407.65

Therefore equilibrium QD = 65,100-100(407.65)

= 24,335

A demand curve is a graphical representation of the demand schedule. It shows the

relationship between quantity demanded and the price that consumers are willing to pay. A shift

to the right shows that an item has become more commercially desirable and that a larger number

will be sold at a given price. Usually a price change results in a shift to the right or left along the

demand curve. In the short run, a price change can either create a surplus or a shortage of the

product on demand. As price increases consumers will tend to consume less, thereby creating a

shortfall in demand of the product. As prices decrease consumption increases creating excess

demand. However, in the long run, equilibrium will occur as consumers tend to shift

consumption to alternative products if the price raises thereby driving cost down. As price drops,

consumption increases creating excess demand and driving cost as too many dollars chase too

few goods. Eventually equilibrium occurs when the price of the quantity demanded equals what

the consumer is willing to pay.

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When consumers adjust their perceptions about a product, the demand curve shifts. If the

perception of the product becomes positive, consumers tend to consume more. This causes the

demand curve to move to the right. As the product becomes less desirable, a leftward shift to the

demand curve occurs in response to lowered consumption. Other factors that can contribute to a

shift either way includes changes to discretionary income, changes in consumer expectations for

substitute product, and changes in trends and what is fashionable.

Supply curves shift due to a change in one or more of the determinants of supply.

(Hoagland 2014). The supply curve shifts to the left when situations like increases in wage rate,

governmental taxes, and such cause cost increases for the business. The supply curve shifts to the

right if production costs decrease because of technological advances, system upgrades, or

government subsidy. Other factors include costs of inputs such as raw materials, competition,

and demand of the product.

References:

Andreyeva, Tatiana, Long, Michael W., Brownell, Kelly D. February 2010. American Journal of

Public Health. The Impact of Food Prices on Consumption: A Systematic Review of Research on

the Price Elasticity of Demand for Food. Retrieved January 23, 2014 from

http://eds.a.ebscohost.com/eds/pdfviewer/pdfviewer?sid=02196816-d840-4f61-81da-

0b4062b073d9%40sessionmgr4002&vid=0&hid=4210

Cuddington, John T. and Dagher, Leila. January 2015. Energy Journal. Estimating Short and

Long-Run Demand Elasticities: A Primer with Energy-Sector Applications. Retrieved January

23, 2015 from http://eds.a.ebscohost.com/eds/pdfviewer/pdfviewer?sid=f5e39fd3-a022-4f0e-

b28e-fea1830ebb21%40sessionmgr4001&vid=0&hid=4210

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Hoagland, Steven R. 2014. Price Analysis -- Research Starters Business. Retrieved January 23,

2015 from http://eds.a.ebscohost.com/eds/pdfviewer/pdfviewer?vid=13&sid=3ddb7e51-12e3-

4fab-82d5-bec307bd77d6%40sessionmgr4004&hid=4210