C HAPTER 13 Valuing Impacts from Observed Behavior: Direct Estimation of Demand Curves.

CHAPTER 13

Valuing Impacts from Observed Behavior: Direct Estimation of Demand Curves

CHAPTER 13 ESTIMATING DEMAND

Think of the chapter title…

“Valuing behavior … by observing it…”

How does observation occur?


Chapter objectives…

Determine a demand function.

Learn how to estimate demand.

Understand statistical measures.


Interpret the results of statistical estimation of demand.

Depict a demand curve.

Determine social surplus.


“Measurement of changes in social surplus is relatively straightforward when we know the shapes (functional forms) and positions of supply and demand curves in the relevant market.”


Or, as Boardman, et al have stated, “to understand how a policy change will affect social surplus, we must know the shape and position of the supply and demand curves.”

“In practice… these curves are not usually known.”


Or, as Boardman, et al have stated, “to understand how a policy change will affect ___________, we must know the shape and position of the supply and demand curves.”



Or, as Boardman, et al have stated, “to understand how a policy change will affect _ social surplus_, we must know the shape and position of the supply and demand curves.”



To begin to understand the measurement of demand, economists use the tools of regression analysis.


“Regression analysis is a technique used to determine the mathematical relations between a dependent variable and one or more explanatory variables.”

Christopher Thomas and Charles Maurice, Managerial Economics, 10th Edition, McGraw-Hill, p. 121.


“Regression analysis is a technique used to determine the mathematical relations between a dependent variable and one or more ____________ variables.”



“Regression analysis is a technique used to determine the mathematical relations between a dependent variable and one or more __explanatory_ variables.”



“Explanatory variables are the economic variables that analysts believe affect the value of the dependent variable.”



Identify four or five explanatory variables:

1) “own price,” or “price”2)3)4)5)



1) “own price,” or “price,”2) income,3) 4)



1) “own price,” or “price,”2) income,3) population4)


Identify four or five explanatory variables in Problem 2, p. 338:

1) price,2) income,3) population

This problem has just three in all.


The analyst’s task…

Collect enough information to estimate demand – and consumer surplus – using econometric techniques.


Reminder…Boardman et al … “we

focus on estimating demand curves because, in practice, analysts are interested in estimating changes in social surplus …”

Boardman, Greenberg, Vining and Weimer, Cost- Benefit Analysis, Prentice-Hall, 4th edition,

p. 320.


Boardman, et al state that “the task in this chapter is to estimate changes in social surplus where there is limited information.”

Boardman, Greenberg, Vining and Weimer, Cost- Benefit Analysis, Prentice-Hall, 4th edition,

p. 320.


Think…

social surplus

demand

information


In beginning the process of measuring demand, the analyst often faces three common situations…

The analyst has only one observation … while some previous experience has led to an understanding of the demand curve’s slope or elasticity.


The analyst has several observations of price and quantity.


The analyst has many observations.


With many observations, the analyst may use econometric techniques to estimate the demand curve… and consumer surplus.

And once consumer surplus is known, the analyst can observe how changes in the independent variables may affect this surplus.


Assignment…

Prepare an econometric analysis of the demand for a publicly-funded swimming pool in Dryville, Texas.

Determine demand. Measure consumer surplus. Define NSB of the project.


Information…Dryville has a population of

70,200 people and a median household income of $31,500.

The analyst identified 24 towns in the region that already had public swimming pools.


Information… The analyst conducted a telephone interview with the recreation department in each town to find out what fee each charged per visit (FEE) and how many visits it had during the most recent summer season (VISITS).


In addition, the analyst was able to find each town’s population (POP) and median household income (INCOME) in the most recent census.


The assignment…

Observe how changes in the independent variables may affect this surplus.

This is an effort to observe demand.


The assignment…

Observe how changes in the independent variables may affect this surplus.

This is an effort to observe demand.

CHAPTER 13 … DATA …


Question…

How can the analyst use the foregoing data – information – to learn the dimensions of demand and the amount of well-being that constructing a pool will have for Dryville?


Response…

Follow a few basic steps to complete the analysis of this problem.

Then, present results…


As stated above, the analyst can use econometrics to estimate demand curves with many data observations.

The starting point is to determine the independent variables, or the “determinants of demand”.

The next step is to determine functional form.


Variable specification is used to isolate the independent effects of the variables of interest.

q= f (p, I, T)

Ordinary Least Squares regression is a useful estimation function for econometrics.


Cross-Sectional Data v. Time Series Data

Cross-Section Data involves observations on a number of comparable units at the same point in time…


Cross-Sectional Data v. Time Series Data

… Cross-sectional may be subject to heteroscedasticity problems.


Time Series Data…

… involves making repeated observations on the same unit at several points in time.

Time series data are prone to problems of autocorrelation.


Finally, the analyst subjects the data to statistical estimation…

Discussion…

STATISTICAL OUTPUT

VISITS | Coef. Std. Err. t P>|t| [95% Conf. Interval] -------------+------------------------------------------------------------------------------------------------------ FEE -14638.37 2634.376 -5.557 0.000 -20133.58 -9143.158 INCOME -.0011269 .2053551 -0.005 0.996 -.4294902 .4272364 POP .6030525 .0524211 11.504 0.000 .4937039 .7124011 _ con 140546.7 7135.002 19.698 0.000 125663.4 155430.1 ---------------------------------------------------------------------------------------------------------------------

DEMAND CURVE ESTIMATION

VISITSs= 140,547 – 14,638*FEE –

0.001127*INCOME + .6031 *POP (demand for any neighborhood)

Inserting Income = 31,500 and POP= 70,200, we get demand curve estimation for Dryville: VISITSdv

= 182,849 – 14,638*FEE

DEMAND CURVE FOR DRYVILLE

182,849

$12.49

0

FEE

Visits

DETERMINING DEMAND To estimate social benefits of Dryville pool based on the previous

demand curve, we must find the area under the demand curve from VISTISdv

= 0 to VISITSdv = 182,849.

Numerical Solution: .5*12.49*182,849 = $1,141,892

Graphical Solution:

Social Benefit

0

Fee12.49

Visits182,849

Fee

visits182849168211

$1

$12.49

VISITSdv = 182849 – 14638*FEE

VISITSdv = 182849 - 14638*(12.49) = 0

VISITSdv = 182849 - 14638*(0) = 182849

If Fee= 1

VISITSdv = 182849 - 14638*(1) = 168211

Government Revenue

Consumer Surplus

(.5)(168211)(12.49-1) = 966372

= (168211)(1)

The g

ross

ben

efi

t =

9663

72+

168

211

=

11

3458

3

Additional benefit in the form of reduced excess burden of taxation = (0.25 * 168211) = 42053

Total gross benefit = 1134583 + 42053 = 1176636

Consumer surplus

CONCLUSIONS

What are reasonable data sources?• Prior research

One must consider validity problems:

1. Internal Validity• How valid is the estimate?• How was it measured and computed?

2. External Validity• Can the data be used in this instance?• How similar is the case in question to the

research case?

CONCLUSIONSWhat factors are important in estimating a demand curve?

• Observations: more is better

• Which variables you put into the model

• Quality data sets

• Interpretation and understanding of data

Econometric analysis is very common and used to predict responses to changes in healthcare policy, infrastructure, and consumer prices.

CONCLUSIONSWhat factors are important in estimating a demand curve?

• Observations: more is better

• Which variables you put into the model

• Quality data sets

• Interpretation and understanding of data

Econometric analysis is very common and used to predict responses to changes in healthcare policy, infrastructure, and consumer prices.


Questions for Test 2 …….

1. What are several basic “starting points” (some knowledge of demand is known) in the estimation of

demand for a good or service? Describe these starting points and how you would proceed in the estimation of consumer surplus.2. Identify at least three determinants of demand.3. After these three, identify additional determinants in special circumstances (i.e. the demand function for residential electricity use most likely has a determinant that you would not have in the demand function for oranges).4. What is the difference between a movement along a demand curve and a shift in the curve?


Questions for the Final Exam …….

5. What is meant by specifying a demand relationship?6. Discuss how you would go about collecting data for an

estimation.7. Discuss how you would estimate demand once you have

collected the data that you believe that must be in the model.

a. Include a discussion of the signs on the coefficients of the independent variables.8. What is meant by the “standard error” on the coefficients of

the independent variables in the model?9. What is meant by price elasticity of demand, and how would you use the coefficient of price in an estimated model to identify the value of price elasticity?


Questions for the Final Exam …….

10. What is the expected sign on the coefficient of price elasticity in the model? 11. What is the expected sign on the coefficient of income (for a normal good)?12. What does the “R-square” tell the economist?

End of Questions

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C HAPTER 13 Valuing Impacts from Observed Behavior: Direct Estimation of Demand Curves.

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