Question Details

(solution) Discussion Board Week 2 1. "Estimating Demand and Its

Discussion Board Week 2

1.   "Estimating Demand and Its Elasticities" and Statistical Estimation of the Demand Curve
ECO550 Week 2 Scenario Script: Models of Supply and Demand, and Non-Price


Determinants of Each


Slide # Topics Slide 1 Scene 1 Narration An older cottage style family run


business (Katrina?s Candies)


Slide 2 Scene 2


Herb and Maria are in Herb?s office


reviewing the demand model Herb and


Renee formulated and discussing the


data Maria compiled for estimating the


model. ECO550_2_2_Herb-1:Good day,


Maria. Thanks for responding so


quickly to my request for data.


ECO550_2_2_Maria-1:Hello, Herb.


No problem, I am assigned to the team


to help with the data so when I received


your email, I started looking for the data




ECO550_2_2_Herb-2:Fantastic. Let?s


get started by reviewing the data you


compiled. Then you can explain how I


can use Excel to estimate the model.


ECO550_2_2_Maria-2:First, would


you review the model with me? I need


to understand how the model is setup.


ECO550_2_2_Herb-3:Oh, okay.


Recall from our team meeting that the


team?s task is to provide Ken with


information he can use to respond to the


Board of Directors? request to expand


Katrina?s into international markets.


ECO550_2_2_Maria-3:Yes, I do recall




ECO550_2_2_Herb-4: Renee and I


met after the team meeting and decided


the best way to proceed is to build a


model of the demand for Katrina?s new


sugar-free-chocolate candy then use the


model to predict the demand. In the


model, the quantity of Katrina?s sugarfree-chocolate candy is the dependent variable and there are five


independent variables. Show the 5 variables on projector:


Price of Katrina?s Sugar Free




Price of the substitute good;


Complementary good;




Number of buyers in the market. ECO550_2_2_Maria-4: Very


interesting! Could you please go over


these five independent variables with




ECO550_2_2_Herb-5: Sure! The first


independent variable is theprice of


Katrina?s sugar-free chocolate. The


model must include the price of sugarfree-chocolate; otherwise, there is no


demand curve.


Next is the price of the substitute good.


In the case of chocolate, caffeinated


coffee is the substitute good. Then there


is the complementary good; for


Katrina?s model, we selected bottled


water; therefore the price of bottled


water is the next independent variable.


Income is another variable typically


included in a demand curve. For our


model, we selected median household




Last, since we are interested in the


market for Katrina?s sugar-freechocolate, the number of buyers in the


market is included as an independent




ECO550_2_2_Maria-5: Thanks for


going over that. You and Renee were


certainly busy!


ECO550_2_2_Herb-6: Yes, we were! I


am going to use the data you provided


to estimate the model to see if we


selected the right set of determinants.


Then, Renee and I can use the model to


develop other measures that tell us more


about the market for Katrina?s sugarfree-chocolate. Slide 3 Scene 3


In Herb?s office to explain concept of




Shows the model on the projector ECO550_2_3_Maria-1:You mentioned


a lot of terms that are sort of new to me.


In this case what does ?estimate? mean?


ECO550_2_3_Herb-1:Here this may


help with the concept of estimation,


here?s what the finalized model should


look like. We will talk about the actual


estimation process in a few moments.


ECO550_2_3_Maria-2: I?m not too


sure of what this model contains, could


you explain further? Show on the projector: The notation on


the left side of the equal sign,


Qsubscript-d-k-s-f-c represents the


dependent variable ECO550_2_3_Herb-2: Gladly! The


notation on the left side of the equal


sign, Q subscript-d-k-s-f-c represents


the dependent variable which is the


quantity of Katrina?s sugar-freechocolate candy. The terms on the


right-side of the equal sign are the


independent variables I just explained.


ECO550_2_3_Maria-3: That makes a


lot more sense now! Where does the


estimation process come into play?


ECO550_2_3_Herb-3: Estimating the


model means to find values for the


coefficients, which in our model are the


?b?s?. Coefficients are numeric values


that indicate how much the quantity of


the dependent variable will change as


independent variables change. The data


you compiled will be used to calculate


the coefficient values. This information


is important as it helps determine the


quantity demanded of sugar-freechocolate changes in response to


changes in the independent variables


included in the model.


ECO550_2_3_Maria-4:Okay, got it.


You?ve used the terms ?dependent


variable? and ?independent


variable?while explaining the model.Could you provide me with some


insight on these terms?


ECO550_2_3_Herb-4:Yes, of course.


A dependent variable is a variable that


changes value when changes occur in


some other variable. The term


?variable? is used to capture the fact


that the value can change. On the


flipside, an independent variable is a


variable that impacts or causes a change


in the dependent variable.


ECO550_2_3_Maria-5:Okay, Herb, I


think I understand now. Can you give


me examples of dependent and


independent variables that are different


from Katrina?s sugar-free-chocolate




ECO550_2_3_Herb-5:Yes I can,


Maria. I believe a good example is


umbrellas. Think about umbrella sales,


when the weather changes from clear to


rainy, people buy more umbrellas. This


is especially prevalent with people who


may have left their umbrellas at home.


In this example, the quantity of


umbrellaspurchased changes when the


weather changes, so it is quite easy to


identify the dependent and independent


variables in this example. The


quantity of umbrellas sold is the


dependent variable while rain is the


independent variable.




anexcellent example, Herb. I understand


exactly how the model functions now.


The independent variables you and


Renee selected will explain what caused


or is causing the demand for Katrina?s


sugar-free chocolate candy to change.


ECO550_2_3_Herb-6: Yes, Maria,


that?s right. Using the data you


provided, we are going to see how well the model we formulated explains the


demand for sugar-free-chocolate candy. Slide 4 Scene 4


Herb?s office to go over the data Maria


collected. ECO550_2_4_Herb-1: Maria, could


you update me on the data you collected


for this project?


ECO550_2_4_Maria-1:I located most


of the data you requested involving the


number of sugar-free-chocolates


Katrina?s sold since introducing the new


candy and the selling prices. You will


notice that this data is available in our


accounting database. However, I had to


search outside of the database for other




ECO550_2_4_Herb-2: What other data


did you need to acquire and how did


you go about doing this search?


ECO550_2_4_Maria-2:I needed to


find the prices of coffee and I simply


did a Google search and looked for


reliable sources of information


pertaining to concepts such as the price


of coffee. Insert the URL for the Census Bureau Show a pictures of the Strayer Resource


Center ECO550_2_4_Herb-3: Okay, that


leaves data on the price of water,


median income and the number of


buyers. Where did you retrieve data for


these independent variables?


ECO550_2_4_Maria-3: Well, I


retrieved median household income


data from the U.S. Census Bureau


website. Census data is easy to find,


reliable and easy to use. I just went to


the Census Bureau website, typed in the


key term, ?household income,? then


selected the median household income


for the appropriate years. ECO550_2_4_Herb-4:Did you know


you could have retrieved data on


income and other variables by going


through Strayer?s Global campus?


Resources Center?


ECO550_2_4_Maria-4: No, I didn?t


know that, Herb. Isn?t access to


Strayer?s Resources Center restricted?


ECO550_2_4_Herb-5:Yes, only


enrolled students, faculty and staff and


subscribers can use the Resource


Center. However, since there are so


many Strayer educated employees here


at Katrina?s, we have free access to the


Resource Center.


ECO550_2_4_Maria-5:That?s great


news, Herb!


ECO550_2_4_Herb-6: I agree! So in


the future when you need to search for


data, check out the Resource Center




Slide 5 Scene 5


Herb?s office to go over the data Maria


collected and investigate briefly the


Resource Center ECO550_2_5_Maria-1:The Resource


Center seems very easy to use. I?ll


definitely use it next time I need to find


data. Let?s see where we are with the


data I compiled. I told you about data


for the quantity and price of Katrina?s


sugar-free-chocolate candy, data on the


price of caffeinated coffee and median


household income. Now, I have to tell


you, I had a problem finding price data


for bottled water and finding the


number of consumers who purchase


chocolate candy.


ECO550_2_5_Herb-1:Oh, no. Does


this mean we have to change our




ECO550_2_5_Maria-2:That depends


upon whether you accept the proxy


variables I found and recommend using them to ?estimate? the model.


ECO550_2_5_Herb-2: I?m not quite


sure about these ?proxy variables.?


Could you elaborate on this concept?


ECO550_2_5_Maria-3: Sure thing!


When data is not available for a


variable, analysts often use data from


another variable to capture the same


relationship as the original variable. It is


this substitute variable that is referred to


as ?proxy variable.?


ECO550_2_5_Herb-3: Does data for


proxy variables work as well when the


model is estimated?


ECO550_2_5_Maria-4:That depends,


in some cases the answer is yes and in


others it is no. In order to determine the


answer, you are required to estimate the


model to find out. Keep in mind that if


the proxy data does not work, then the


variable is dropped from the model. Slide 6 Scene 6


Herb?s office to go over the data Maria


collected. Show data table of per capita


consumption of bottled water. ECO550_2_5_Herb-4: Thanks for the


clarification on this subject. We can


continue with our updates on the data


you collected.


ECO550_2_6_Maria-1:Again, since I


was unable to locate the price of bottled


water, I had to add a proxy variable.


The data I used dealt with the per capita


consumption of bottled water.


ECO550_2_6_Herb-1:The data I?m


looking at shows the per capita


consumption of bottled water, by gallon


over twelve years. I think this data


works well as a proxy. What data did


you find to proxy the number of




ECO550_2_6_Maria-2: I had to think


hard about a number of buyers proxy. In the end, I found a good proxy in a


Department of Commerce report, it is


called ?Current Industrial Reports.? The


proxy I used dealt with the


confectionery exports of domestic


merchandise measured in pounds per




ECO550_2_6_Herb-2:This data also


serves as a great proxy. Of course, I?ll


have to consult with Renee to get her


opinion because she?s the one


mentoring me on this project. But I?m


fairly certain Renee will agree with me.


ECO550_2_6_Maria-3:Okay! Here?s


the data I compiled from our accounting




ECO550_2_6_Herb-3: Great! Now,


can we create the data set in Excel and


then estimate the model?


ECO550_2_6_Maria-4:That?s correct!


I have some great resources that will


help you review how to create datasets


in Excel and how to use Excel functions


to estimate the model. Please look over


these resources and I will get back to


you once you are finished.


ECO550_2_6_Herb-4:Okay that


sounds great! Slide 7 Scene 7


Interaction Slide


Incorporate iPad to show Videos about


Excel and model creation Slide 8 Multiple Linear regression


analysis using Microsoft


Excel?s Data Analysis






Multiple Regression


Interpretation in Excel


v=tlbdkgYz7FM Scene 8


Herb?s office to go over the data Maria


collected Show regression output table ECO550_2_8_Maria-1: I hope those


videos helped you gain a better


understanding of using Excel to create


data sets. I want you to keep in mind


that the procedure we will be using to


estimate the model is regression. The


model Renee and you formulated is a


multiple regression model because there


is more than the price of chocolate


included as an independent variable.


Take a look at the regression output for


our estimated model.


ECO550_2_8_Herb-1: Wow! That was




ECO550_2_8_Maria-2:Yes, Herb,


Excel generates results almost


instantaneously. Herb shows formula ECO550_2_8_Herb-2: Okay, let?s see


what we have. I see the coefficients are


presented in a single column. Let me


rewrite the model to include the


coefficient values.


ECO550_2_8_Maria-3: What does all of this mean?


ECO550_2_8_Herb-3: Well, the first


number, three hundred and forty four


thousand and four hundred point five


refers to the number of boxes of sugarfree-chocolate demanded if none of the


independent variables changed their


value. If we assume one of the other


variables changes while all of the others


remain constant, then we calculate a


new number of boxes of chocolate.


ECO550_2_8_Maria-4: Could you


give me an example for this change? Herb shows Maria the updated formula One more formula for Herb to go over Display on projector: The new quantity


demanded is, three hundred seventyfour thousand, three hundred sixty-six


point two boxes of sugar-freechocolates. ECO550_2_8_Herb-4: Sure! For my


example, let?s assume that the price of


Katrina?s sugar-free-chocolates declines


by one dollar while none of the other


independent variables changes.


According to our model, the decrease in


price would cause quantity demanded to


increase by twenty nine thousand and


nine hundred and sixty five point seven


boxes. Each of the other coefficients is


then interpreted similarly. Here?s the


way we calculate the change in quantity


demanded, if price was to change.For


all of the variables that are constant,


that is, those unchanging variables, we


substitute a ?zero.?


ECO550_2_8_Maria-5: That is very


interesting! Is there anything else I


should know?


ECO550_2_8_Herb-5: There is one


more thing I?d like to add. For the price


of Katrina?s sugar-free-chocolate,


substitute one dollar, with a negative


sign in front of it to indicate price


declined. Here, I?ll show you how the


model determines quantity demanded.


After making the changes the new


quantity demanded is, three hundred seventy-four thousand, three hundred


sixty-six point two boxes of sugar-freechocolates.


ECO550_2_8_Maria-6:Thank you for


sharing that with me! Now that you


explained this all to me, things are


much clearer.


ECO550_2_8_Herb-6: Not a problem


at all. As you can see, regression


models are useful but only if the results


from the model are valid.


Slide 9 Scene 9


Herb?s office to conduct significance


test on the model and coefficients with


Maria Display on projector: The coefficient of


determination ranges from 0 to 1.


Display on projector: A higher adjusted Rsquare indicates a better model.


n ECO550_2_9_Herb-1: Now we need


to check the model and coefficients for




ECO550_2_9_Maria-1:How do we




ECO550_2_9_Herb-2: First, we


evaluate the adjusted R-square value to


see how much of the variation in the


quantity demanded of sugar-freechocolates is explained by the


independent variables we included in


the model. The closer R-square is to


one, the better is the explanatory power


of the independent variables.The


adjusted R-square for our model?s


results is point seven, nine, nine which


means the model explains seventy-nine


point nine percent of the variation in the


quantity of sugar-free-chocolates.


Maria, I found this video that helps to


explain the coefficient of determination


from another standpoint.


ECO550_2_9_Maria-2:Based upon the


explanation you gave about R-square


being close to one, seventy-nine-pointnine percent is very good.


ECO550_2_9_Herb-3:Yes, it looks as


if we included the right set of independent variables.


ECO550_2_9_Maria-3:What?s next,




ECO550_2_9_Herb-4:Now we


evaluate the overall significance of the


independent variable. We are looking


for the answer to the question: Can the


behavior of the dependent variable, our


quantity of sugar-free-chocolates, be


explained without relying on the


independent variables included in the


model? For this test we will evaluate


the F-statistic. We first need to state the


level of significance, called the


?critical-value,? which we will use to


test the F-statistic.


For our model we are going to use the


five-percent level of significance;


therefore,the table gives us a critical Fvalue of four-point-one-two.


ECO550_2_9_Maria-4:I think I


understand how you selected the critical


value. I think now we must compare the


F-statistic generated for the model to


the critical value.


ECO550_2_9_Herb-5:Yes, that?s


exactly what we will do. Since the Fcalculated value is eleven-point-ninefive-two and is greater than four-pointone-two, a significant relationship does


exist between the quantity of sugar-freechocolate and the four independent




ECO550_2_9_Maria-5:Great! So


we?re done then?


ECO550_2_9_Herb-6:No, not quite


yet. We still need to evaluate the


significance of each coefficient. We can


actually use the same method used to


find the critical value of F only this time we will conduct a t-test on each


coefficient value.


Slide 10 Scene 10


Herb?s office to conduct significance


test on the model and coefficients with


Maria ECO550_2_10_Maria-1:So based on


the t-test, tell me which independent


variables are significant.


ECO550_2_10_Herb-1: According to


the t-test, only the price per boxand


bottled water are significant. The


coefficient on median income is


marginally significant; however, we


cannot use the coefficient for anything.


Surprisingly, the caffeinated coffee


coefficient is insignificant.


ECO550_2_10_Maria-2:I see why you


are saying coefficients are insignificant.


ECO550_2_10_Herb-2: Yes, this


revelation about independent variable


significance means we need to drop the


caffeinated coffee variable and reestimate the model.


ECO550_2_10_Maria-3:Is it okay to


drop variables from a model after the


model is estimated?


ECO550_2_10_Herb-3: Yes, if an


independent variable is not significant,


one of the recommended solutions is to


drop the variable from the model. In


our model, this means sugar-freechocolate and caffeinated coffee are not


substitute goods so coffee does not


contribute anything to our


understanding about demand for


Katrina?s sugar-free-coffee.




dropping the insignificant variable


mean we still use the coefficients


generated when caffeinated coffee was


a variable in the model? ECO550_2_10_Herb-4: That is a good


question, Maria! The answer is, no.


When we drop a variable like


caffeinated coffee from the model, we


have to re-estimate the model and then


run the Excel regression procedure


again to generate new coefficient




ECO550_2_10_Maria-5:Let?s run the


regression without data on caffeinated


coffee?I?m anxious to see if there is


any difference in the results.


ECO550_2_10_Herb-5: Okay, but


before we re-estimate the model, I think


we should also drop the bottled water


variable. After some consideration, the


amount of water consumed is not a


good proxy for the price of water. Also,


the correlation coefficient between


bottles of water and income is nearly


one. Therefore, there seems to be a


problem with their correlation. Keep in


mind that we also need to add a Dummy


variable to measure the impact of sugarfree-chocolate which Katrina?s


introduced into the market last year.


Renee and I forgot to include a dummy


variable in the first model.


ECO550_2_10_Maria-6: Whatever


you say, Herb. You know this process


better than I do.


ECO550_2_10_Herb-6:Let me


compute this quick. (pause) Here are the


results now. Scene 11 Scene 11


Herb?s office to conduct significance


test on the model and coefficients with


Maria ECO550_2_11_Maria-1:Are these


results better, Herb?


ECO550_2_11_Herb-1:Yes, everything


is now significant. Now we can use the


regression equation to derive decisionmaking statistics like elasticity




ECO550_2_11_Maria-2:How do we


go about doing that?


ECO550_2_11_Herb-2: Make a note


that the point elasticity of demand is


calculated as the change in quantity


divided by the change in price times


price divided by quantity. Here?s how


the formula looks.


ECO550_2_11_Maria-3:Okay, so


where is the data to calculate elasticity?


ECO550_2_11_Herb-3:The regression


coefficients or the b?s in the model are


the change in quantity divided by a


change in price, so that part is simple.


ECO550_2_11_Maria-4:Do you mean


the negative forty-two thousand, one


hundred eighty-nine that is the


coefficient for the price variable?


ECO550_2_11_Herb-4:Yes, however,


we have to calculate the ?q? that?s in


the elasticity of demand formula.


ECO550_2_11_Maria-5:What does the


?q? stand for?


ECO550_2_11_Herb-5: In the


elasticity formula, q, is the quantity


demanded at a specific price. For this


step, we first find the demand curve.


ECO550_2_11_Maria-6:I thought we


already have the demand curve. ECO550_2_11_Herb-6: Not quite yet,


I was discussing the regression


equation which includes all of the


independent variables we included in


the model. The demand curve is


different, as only the price variable is


included in the demand curve.For our


example we will use some numbers


from 2004. We will then use these


numbers to showcase how to derive the


demand curve. First, go back to the


regression equation. Now substitute the


data as follows. For income, substitute


one-thousand dollars and for exports


substitute two-six-three-three-six-six


point seven.


Slide 12 Scene 12


Herb?s office to conduct significance


test on the model and coefficients with


Maria ECO550_2_12_Maria-1:Okay, I did


that. What about the price variable,


should I substitute for price?


ECO550_2_12_Herb-1:No, not yet.


Just solve what you have as this will


give the demand curve.


ECO550_2_12_Maria-2:Is that all


there is to finding the demand curve


from the regression model?


ECO550_2_12_Herb-2: Yes, that?s it!


We?re nearly finished as we have only


two more steps to calculate elasticity.


Again using the data from 2004


substitute twenty-four dollars for price


variable into thedemand curve and solve


to get a quantity equal to two-million,


ninety-six thousand, seven-hundred


eight-point eight-eight. The elasticity


coefficient is then negative zero point


four-eight-two-nine. We can then round


to negative zero point four-eight-three.


ECO550_2_12_Maria-3:Thank you for


going over this with me. Since you


showed me how to do this, things seem


clearer. Does this mean we are finished with this stage of the process to create


information for Ken to use when he


considers the decision to expand into


international markets?


ECO550_2_12_Herb-3: Yes, we have


completed this stage. We just need to


update Renee on our progress.


ECO550_2_12_Maria-4: I will update


Renee on our findings. While I


complete this task could you complete


this review activity based on what we


just discussed?


Slide 13 Scene 13


Check Your Understanding


Scenario-based and will use folder


structure to present scenario, then have


tabs to represent options for answers


Narrations will be provided for scenario


overview and choices (feedback


included as well) ECO550_2_13_Maria-1: Based upon


the result that the price elasticity of


demand coefficient is -0.483 for


Katrina?s sugar-free-chocolate, Herb


can advise Ken that Katrina?s should


never use price as a tool for increasing


total revenue?


ECO550_2_13_Maria, Agree,


Response 1-2:Agreed, that?s correct


since price elasticity of demand is less


than one it means demand is elastic. As


a result of this, the increasing price


would lower total revenue because


customers would react very strongly to


an increase in price by changing their


purchases by a greater percentage than


the percentage change in price.


Therefore, Herb is giving Ken the


appropriate advice.


ECO550_2_13_Maria Incorrect




We should expect the percentage


change in quantity demanded to


change by less than the percentage


change in price.


ECO550_2_13_Maria, Disagree,


Option 2-4: When the absolute value of the price elasticity of demand


coefficient is less than one it means


demand is inelastic, so if price is


increased by a certain percentage, say


ten percent, demand will change by a


lower percentage, such as eight percent.


Therefore, when demand is price


inelastic, increasing the price actually


results in higher total revenue. For


Katrina?s, this means demand for sugarfree-chocolate is price inelastic and the


company could increase total revenue


by increasing price.


Slide 14 Summary


Concluding scene taking place in


conference room ECO550_2_14_Herb-1: Maria, we


have discussed and analyzed a lot today.


ECO550_2_14_Maria-1: We sure


have. Let?s outline the tasks we


completed to make certain we


remember everything. First, you


explained the demand model that you


and Renee formulated. I then described


the data and its sources for the data that


I compiled. We later discussed proxy


data and agreed it was okay to use this


kind of data for two of the variables.


ECO550_2_14_Herb-2: Let?s not


forget about our creation of the data set


in Excel along with the creation of our


estimation model.


ECO550_2_14_Maria-2: I?m glad you


brought that up! Next, we discussed the


results of...


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