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4. Estimating Demand from Market Data
Reading:➝Boardman, Chapter 4
1. Introduction
➝Need to measure social surplus. These are found as areas under demand and supply curves. Triangles, trapezoids and so forth.
➝Curves are usually unknown, so we need to find ways to estimate them and, in then, calculate the triangles.
➝Here we look at some common ways of estimating demand.
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2. One Point Plus Slope or Elasticity
➝Usually know one point (current price & quantity).
➝ If you can get the slope from existing studies or using a plausible estimate and you are willing to assume linearity (impose structure), it is a simple to estimate demand
➝ Same is true if you get the elasticity. In this case you can estimate a linear or constant elasticity demand curve
➝ See next slide
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2. Extrapolating from a Few Points
➝You know a few points of p,q from historic data and you try to “fit ” a line through these points.
Known data points
➝Comments• Sensitivity to functional form• Controlling for other factors• Validity of measures from only 2 points• Extrapolating beyond ‘relevant range’
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3. Many Points Econometrics
➝Cross-Sectional or Time-Series data on p,q
price
quantity
( ; )Estimted demandq f p β=
➝Regress q on p, or fit a line to this scatter of points. You’d have something like the red linear regression or blue non-linear regression
price
quantity
( ; )Estimted demandq f p β=
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➝Use the estimated line in your analysis➝ Types of data
• individual vs. aggregate• time series (annual/monthly) vs. cross sectional• examples: electricity, farm crops, water, consumer goods galore,
automobiles, oil, minerals markets, traffic, computers, wine ……➝Major econometric issues
➥Omitted variable bias
➥Autocorrelation in time series data
( , , , )own substq f p p y d=
➥Identification Problem: Are you estmating a deamnd curve or a supply curve when you estimate the relationship between p and q?➥The ideal case. (Rain example. Cross sectional stories.) Shifting
supply is sketching out a demand curve.
Stable demand curve
Shifting supply curves
price
quantity
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» But it could have been supply that was sketched out
price
quantity
➥Trouble and likely outcome is that you observe price and quantity relationships that get both shifts.
➥Simultaneous equations/instrumental variables
price
quanity