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DEMAND ESTIMATION &
FORECASTING
Dr Sayyid Salman Rizavi
Hailey College of Commerce
University of the Punjab
Lahore
PLAN OF LECTURES
� Lecture 1: Demand Analysis-I
� Lecture 2: Demand Analysis-II
� Lecture 3: Demand Estimation I� Lecture 3: Demand Estimation I
� Lecture 4: Demand Estimation II
� Lecture 5: Demand Forecasting
LAW OF DEMAND
� Demand: A relationship of price and quantitydemanded shown by a ‘demand function’
� Quantity demanded: The amount of goodspurchased at a specific price
� Law of demand: Demand varies inversely withprice ceteris paribusLaw of demand: Demand varies inversely withprice ceteris paribus
� Extension and contraction in demand: changes inquantity demanded caused by price changes
� Shifts in demand (rise & fall): shifts in thedemand curve caused by changes in factors otherthan price
� Demand function: A function showing whatimpacts the quantity demanded
DEMAND FUNCTION
� = ���, �, �� , � , �
� = �� ����� ��� ����
� = � ���� ����
� = ����� ����� �� �ℎ� �������
�� = � ���� ���� �� �� ����������
� = � ���� ���� �� ��������� �� ���
= �ℎ�� � ���� ���� � ���
!�!� < 0
!�!� > 0
!�!� < 0
Normal Good
� = � ���� ���� �� ��������� �� ��� = �ℎ�� � ���� ���� � ���
Substitute: A good that is alternatively demanded
%&%'(
> )
Complimentary good: A good that is jointly demanded
%&%'*
< )
Individual demand & market demand: Market demand curve is
the horizontal summation of individual demands
!�!� < 0
!�!� < 0
!�!� > 0
!�!� < 0
Giffen Good
Inferior Good
SPECIFICATION OF DEMAND FUNCTION
� Linear:
� Qd= a – b P , where b > 0 for normal goods
� Qd= a – b P + c Y , where b > 0 & c > 0 for normal
goods Quantity
Quantity
Quantity
Linear Demand
� Non-linear (e.g. Power form)
� Qd = a Pb
� Qd = a PbYc
Quantity DemandedQuantity Demanded
Price
Price Non-linear Demand CurveNon-linear Demand Curve
Quantity Demanded
Price Non-linear Demand Curve
PricePrice
Quantity
Quantity
Price
Quantity
Pri
ce
CHANGES IN DEMANDa
b
c
Fall
Rise in Demand (Normal good):
•Increase in income
•Increase in price of substitute
•Decrease in price of
complimentary good
Quantity demanded
Pri
ce
d
e
Rise
Movements: Extension & Contraction
Shifts: Rise & Fall
complimentary good
•Increase in Population
•Development of taste
ELASTICITY OF DEMAND
� In order to increase TR Should
we increase the price or decrease
it?
� The answer depends on the
reaction of the consumer to pricesreaction of the consumer to prices
changes.
� Inelastic and elastic demand
� Price Elasticity measures the
response of the consumer to price
changes
���� +� ������ = Percentage change in quantity demandedPercentage change in price
PRICE ELASTICITY OF DEMAND
���� +� ������ = Percentage change in quantity demandedPercentage change in price
+� = <∆�∆�> �
�
∆�∆� = slope of demand curve
OR
+ = ?!�@ �P
AB
∆�OR
+� = ?!�!�@ �
�
Ed < 1Ed > 1
P1
P2
Q1 Q2A Q2B
∆P
OTHER ELASTICITIES
����� +� ������ = Percentage change in quantity demandedPercentage change in income
+� = <∆�∆�> �
� OR +� = <!�!�> �
�
0 < +� < 1 ��� ���� � ����������
+� < 0 ��� �������� ����
0 < + < 1 ��� ���� � ����������+� < 0 ��� �������� ����
C���� ���� +� ������ = Percentage change in quantity demanded of a commodityPercentage change in price of other related commodity ′y
+ = ?∆�G∆��
@ ���G
OR +� = ?!�G!��
@ ���G
+ > 0 ��� �����������
+ < 0 ��� ��������� �� ����
SELECTED ELASTICITIES OF DEMAND
ProductProduct Short RunShort Run Long RunLong Run
Clothing 0.9 2.9
Tobacco products 0.46 2.1
10
Medical care and hospitalization 0.3 0.9
Jewelry & Watches 0.41 0.67
Gasoline/Petrol 0.2 0.6
SELECTED INCOME ELASTICITIES OF DEMAND
ProductProduct Short RunShort Run
Household Electricity 1.94
Beef 1.06
11
Beef 1.06
Chicken 0.28
Flour -0.36
SELECTED CROSS ELASTICITIES OF DEMAND
ProductProductCross elasticity Cross elasticity w.r.tw.r.t. price . price
of of
Cross Cross
price price
elasticityelasticity
Margarine Butter 1.53
12
Margarine Butter 1.53
Natural Gas Electricity 0.8
Entertainment Food -0.72
Clothing Food -1.8
USING ELASTICITIES I
A coffee company markets coffee brand X and estimates the following demand function :
�G = 1.5 − 3.0 �G + 0.8 � + 2.0 �� − 0.6 �� + 1.2 P
Qℎ��� �G = R ��� �� ����� �� �� S �� �������� �� ���� � ��
�G = ���� �� ����� �� �� S �� T� ��� ���� � �
� = ������ � ���������� ����� �� �������� �� T������
�� = ���� �� ���������� �� �� �� ����� �� T� ��� � . �� = ���� �� �� � �� T� ��� � . P = P������������ +G��������� ��� ����� �� �� S �� ℎ������� �� �ℎ��� ��� �� T�. R������ �ℎ � �ℎ�� �� � �G = 2, � = 2.5, �� = 1.8, �� = 0.5, P = 1
� = ���� �� �� � �� T� ��� � .P = P������������ +G��������� ��� ����� �� �� S �� ℎ������� �� �ℎ��� ��� �� T�.R������ �ℎ � �ℎ�� �� � �G = 2, � = 2.5, �� = 1.8, �� = 0.5, P = 1
• Find quantity demanded of x and all possible elasticities and interpret them. Is this coffee a normal good? It is
elastic or inelastic?
• What will happen if the advertisement expenditure rises by 2 percent
• What will happen if the advertisement expenditure rises by 2 percent and incomes rise by 5 percent
• What will happen if the advertisement expenditure rises by 2 percent, incomes rise by 5 percent and price of
sugar falls by 8 percent?
• Solve the integrated problem 12 from your text book (Salvatore, given at page 130 in the fourth edition)
Hint:
�G′ = �G + �G �∆�G�G
�+� + �G �∆�� �+� + �G �∆��
���+G� + �G �∆��
���+G� + �G �∆�G
�G�+� + �G �∆P
P �+P
USING ELASTICITIES IIProblem from Salvatore (problem 12 page 130, 4
th edition):
The research department of the corn Flakes Corporation estimated the following regression of the demand
of the cornflakes it sells:
�G = 1.0 − 2.0 �G + 1.5 � + 0.8 �� − 3.0 �� + 1.0 P
Qℎ��� �G = R ��� �� CUC C����� ���, �� �������� �� 10 ���� ��G�� ��� �� �
�G = ���� �� CUC C����� ���, �� ���� �� ��� 10 ���� ��G
� = ������ � ���������� ����� �� �������� �� ���� �� ��� �� �
�� = ���� �� ���������� �� �� �� C����� ���, �� ���� �� ��� 10 ���� ��G
�� = ���� �� ����, �� ���� �� ��� V� ��
P = P������������ +G���������� �� CUC ����� ���, �� ℎ������� �� �ℎ��� ��� �� ���� �� ��� �� �
� = $2, � = $4, � = $2.5, � = $1, �� P = $2
� = ���� �� ����, �� ���� �� ��� V� ��P = P������������ +G���������� �� CUC ����� ���, �� ℎ������� �� �ℎ��� ��� �� ���� �� ��� �� �
This year, �G = $2, � = $4, �� = $2.5, �� = $1, �� P = $2
(a) Calculate the sales of CFC cornflakes this year; (b) calculate the elasticity of sales with respect to
each variable in the demand function; (c) estimate the level of sales next year if CFC reduces �G by
10%; increases advertising by 20%, � rises by 5%, �� is reduced by 10% and �� remains unchanged; (d)
By how much should CFC change its advertising if it wants its sales to be 30% higher than this year?
Also interpret the marginal effects (slope coefficients) of the estimated demand function.
USING ELASTICITIES IIIXYZ corporation estimated the following demand function in 2010:
� = 1500 − 5.4 � + 2.8 � − 1.2 �� + 0.8 P
Where Q = Quantity demanded in thousands per month
P = price of the product in Rs.
Y = per capita disposable income in thousands of rupees
Py = price of a product by ABC corporation
A = Advertisement expenditure in thousands of rupees
Answer the following: Answer the following:
(a) Interpret the marginal effects; (b) During next year per capita income may
increase by 2500 rupees; what effect will this have on the firm’s sales (c) If XYZ
wants to raise its price to offset the effects of increase in income, by how much
should she raise the price?
(d) if P = 20, Y = 5, Py = 18, A = 1 then compute the elasticity with respect to each
independent variable in the equation
(e) What will be the quantity demanded if P increases by 10% and Py decreases by
10%?
(f) Are the products by XYZ and ABC complimentary goods or substitutes?