Managerial Economics in a Global Economy

Chapter 4 The Nature and Scope of Managerial Economics

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The Identification Problem

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Demand Estimation: Marketing Research Approaches

Consumer Surveys Observational Research Consumer Clinics Market Experiments Virtual Shopping Virtual Management
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Regression Analysis
Year 1 2 3 4 5 6 7 8 9 10 X 10 9 11 12 11 12 13 13 14 15 Y 44 40 42 46 48 52 54 58 56 60
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Scatter Diagram

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Regression Analysis
Regression Line: Line of Best Fit
Regression Line: Minimizes the sum of the squared vertical deviations (et) of each point from the regression line. Ordinary Least Squares (OLS) Method
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Regression Analysis

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Ordinary Least Squares (OLS)

Model:
Yt a bX t et

Yt a bX t et Yt Yt

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Ordinary Least Squares (OLS)

Objective: Determine the slope and intercept that minimize the sum of the squared errors.
et2 (Yt Yt ) 2 (Yt a bX t ) 2
t 1 t 1 t 1 n n n

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Ordinary Least Squares (OLS)

Estimation Procedure

(X
t 1 n t 1

X )(Yt Y )
t

(X

a Y bX

X)

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Ordinary Least Squares (OLS)

Estimation Example
Time
1 2 3 4 5 6 7 8 9 10
n

Xt
10 9 11 12 11 12 13 13 14 15 120

Yt
44 40 42 46 48 52 54 58 56 60 500

Xt X
-2 -3 -1 0 -1 0 1 1 2 3
n

Yt Y
-6 -10 -8 -4 -2 2 4 8 6 10

( X t X )(Yt Y )
12 30 8 0 2 0 4 8 12 30 106

( X t X )2
4 9 1 0 1 0 1 1 4 9 30

n 10
X
t 1 n

X t 120
t 1

Yt 500
t 1

(X
t 1 n

X ) 2 30 X )(Yt Y ) 106

106 3.533 b 30
a 50 (3.533)(12) 7.60

X t 120 12 n 10

Yt 500 50 10 t 1 n

(X
t 1

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Ordinary Least Squares (OLS)

Estimation Example
n 10
X
t 1 n n

X t 120 12 n 10

X
t 1

120
2

Y
t 1

500

Yt 500 50 10 t 1 n

(X
t 1 n

X ) 30 X )(Yt Y ) 106

106 3.533 b 30

(X
t 1

a 50 (3.533)(12) 7.60
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Tests of Significance
Standard Error of the Slope Estimate
(Yt Y ) 2 et2

sb

(n k ) ( X t X )

(n k ) ( X t X ) 2

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Tests of Significance
Example Calculation
Time
1 2 3 4 5 6 7 8 9 10

Xt
10 9 11 12 11 12 13 13 14 15

Yt
44 40 42 46 48 52 54 58 56 60

Yt
42.90 39.37 46.43 49.96 46.43 49.96 53.49 53.49 57.02 60.55

et Yt Yt
1.10 0.63 -4.43 -3.96 1.57 2.04 0.51 4.51 -1.02 -0.55

et2 (Yt Yt )2
1.2100 0.3969 19.6249 15.6816 2.4649 4.1616 0.2601 20.3401 1.0404 0.3025 65.4830

( X t X )2
4 9 1 0 1 0 1 1 4 9 30

e (Yt Yt )2 65.4830
t 1 2 t t 1

(X
t 1

X ) 30
2

sb

(Y Y ) ( n k ) ( X X )
2 t t

65.4830 0.52 (10 2)(30)

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Tests of Significance
Example Calculation
et2 (Yt Yt ) 2 65.4830
t 1 t 1 n n

( X t X ) 2 30
t 1

65.4830 sb 0.52 2 ( n k ) ( X t X ) (10 2)(30)

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)2 (Yt Y

Tests of Significance
Calculation of the t Statistic
b 3.53 t 6.79 sb 0.52

Degrees of Freedom = (n-k) = (10-2) = 8

Critical Value at 5% level =2.306

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Tests of Significance
Decomposition of Sum of Squares
Total Variation = Explained Variation + Unexplained Variation

Y )2 (Y Y )2 (Yt Y ) (Y t t
2

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Tests of Significance
Decomposition of Sum of Squares

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Tests of Significance
Coefficient of Determination
R2 Explained Variation TotalVariation (Yt Y )2 (Y Y )2

373.84 R 0.85 440.00

2

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Tests of Significance
Coefficient of Correlation
r R2 withthe signof b

1 r 1
r 0.85 0.92

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Multiple Regression Analysis

Model:

Y a b1 X 1 b2 X 2

bk ' X k '

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Multiple Regression Analysis

Adjusted Coefficient of Determination
(n 1) (n k )

R 2 1 (1 R 2 )

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Multiple Regression Analysis

Analysis of Variance and F Statistic
Explained Variation /(k 1) F Unexplained Variation /(n k )
R 2 /( k 1) F (1 R 2 ) /( n k )

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Problems in Regression Analysis

Multicollinearity: Two or more explanatory variables are highly correlated. Heteroskedasticity: Variance of error term is not independent of the Y variable. Autocorrelation: Consecutive error terms are correlated.
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Durbin-Watson Statistic
Test for Autocorrelation
(et et 1 ) 2
t 2 n

et2
t 1

If d=2, autocorrelation is absent.

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Steps in Demand Estimation

Model Specification: Identify Variables Collect Data Specify Functional Form Estimate Function Test the Results

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Functional Form Specifications

Linear Function:
QX a0 a1 PX a2 I a3 N a4 PY e

Power Function:
b QX a ( PX1 )( PYb2 )

Estimation Format:
ln QX ln a b1 ln PX b2 ln P Y

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