Demand estimation
Demand estimation shows that how a firm can estimate the demand for the product it sells. We
know that the forces that affect the demand are the price of the commodity, consumer income,
the prices of related goods (substitute and complementary goods) consumer taste and other more
specifics forces that are important for the commodity. In this chapter we will estimate that how
much will be the revenue of a firm change after increasing the price of the commodity by a
certain amount. How much will the quantity demanded of the commodity increases if consumer
income increasing by a specific amount. What if the firm double its advertising expenditures or it
if provides a particular credit incentive to consumers. How much would the demand that a firm
faces for its product fall if competitors lowered their prices increased their advertisement
expenditure. Firm must know the answer to these questions to achieve the objective of
maximizing their value.
For example it is crucial for Altaqwa University to know how much enrollment would decline
with a 10 percent increase in tuition
In this chapter we will focus on regression analysis as the most useful and common method of
demand estimation.
Regression analysis is a statistical technique forth obtaining the line that best fits the data points
according to an objective statistical criterion, so that all researchers looking at the same data
would get exactly the same result.
In order to introduce regression analysis, suppose that a manager wants to determine the
relationship between the firm advertisement expenditure and its sales revenue. The manager
wants to test the hypothesis that higher advertising expenditure lead to higher sales for the firm.
He wants to estimate that how much sales increases for each dollar increase in advertising
expenditures and on sale revenue for the firm over the past ten years. In this case the level of
advertising expenditure (X) is independent or explanatory variable while sales revenue (Y) is the
dependent variable that the manager seeks to explain.
Y= a + bX
Where a is the vertical intercept of the estimated linear relationship and gives the value of Y
when X = 0 while b is the slope of the line and gives an estimate of the increase in Y resulting
from each unit increase in X. the manager could use this information to estimate how much the
sales revenues of the firm would be if its advertising expenditure were anywhere between two
value.
The equation e = (Y1 – y)
Where e show the difference between the estimated value y cap and actual value Y.
Regression Definition:
A regression is a statistical analysis assessing the association between two variables. It is used
to find the relationship between two variables. There are two types of regression i.e. (a) simple
regression and (b) multiple regressions
(a) Simple Regression: Simple linear regression is the least square estimator of a linear
regression model with a single explanatory variable.
Regression Formula:
Regression Equation; y = a + bx
Slope(b) = (nΣXY - (ΣX)(ΣY)) / (nΣX2 - (ΣX)2
Intercept(a) = ( ∑ x 2 ) ( ∑ y )−( ∑ xy ) (∑ x)/n ∑ x 2−(∑ x )2
where
x = independent , explanatory, regress variable
Y = dependent, explained, regressand variable.
b = The slope of the regression line
a = The intercept point of the regression line and the y axis.
n = Number of values or elements
Regression Example: To find the Simple/Linear Regression of
X Values Y Values
60 3.1
61 3.6
62 3.8
63 4
65 4.1
To find regression equation, we will first find slope, intercept and use it to form regression
equation..
Step 1: Count the number of values.
n=5
Step 2: Find XY, X2
See the below table
2
X Value Y Value X*Y X
60 3.1 60 * 3.1 = 186 60 * 60 = 3600
61 3.6 61 * 3.6 = 219.6 61 * 61 = 3721
62 3.8 62 * 3.8 = 235.6 62 * 62 = 3844
63 4 63 * 4 = 252 63 * 63 = 3969
65 * 65 = 4225
65 4.1 65 * 4.1 = 266.5
∑=311 18.6 1159.7 19359
Step 3: Find ΣX, ΣY, ΣXY, ΣX2.
ΣX = 311
ΣY = 18.6
ΣXY = 1159.7
ΣX2 = 19359
Step 4: Substitute in the above slope formula given.
Slope(b) = (nΣXY - (ΣX)(ΣY)) / (nΣX2 - (ΣX)2)
= ((5)*(1159.7)-(311)*(18.6))/((5)*(19359)-(311)2)
= (5798.5 - 5784.6)/(96795 - 96721)
= 13.9/74
= 0.19
Step 5: Now, again substitute in the above intercept formula given.
Intercept(a) = ( ∑ x 2 ) ( ∑ y )−( ∑ xy ) (∑ x)/n ∑ x 2−(∑ x )2
= (19359 ×18.6 ¿−(1159.7 ×311)¿/ ( 5 ×19359 ) −(311)2
= 360077.4−360666.7 /96795−96721
= −589.3/74
= -7.96
Step 6: Then substitute these values in regression equation formula
Regression Equation(y) = a + bx
y = -7.96+ 0.19x.
Suppose if we want to know the approximate y value for the variable x = 64. Then we can
substitute the value in the above equation.
Regression Equation(y) = a + bx
y = -7.96 + 0.19(64).
y= -7.96 + 12.16
y = 4.19
