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 13 ESTIMATING DEMAND
Chapter objectives…

Determine a demand function.

Learn how to estimate demand.

Understand statistical measures.
CHAPTER 13 ESTIMATING DEMAND

Interpret the results of statistical
estimation of demand.

Depict a demand curve.

Determine social surplus.
CHAPTER 13 ESTIMATING DEMAND
“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.”
CHAPTER 13 ESTIMATING DEMAND
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.”
CHAPTER 13 ESTIMATING DEMAND
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.”
“In practice… these curves are
not usually known.”
CHAPTER 13 ESTIMATING DEMAND
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.”
CHAPTER 13 ESTIMATING DEMAND
To begin to understand the
measurement of demand,
economists use the tools of
regression analysis.
CHAPTER 13 ESTIMATING DEMAND
“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.
CHAPTER 13 ESTIMATING DEMAND
“Regression analysis is a
technique used to determine the
mathematical relations between a
dependent variable and one or more
____________ variables.”
Christopher Thomas and Charles Maurice,
Managerial Economics, 10th Edition,
McGraw-Hill, p. 121.
CHAPTER 13 ESTIMATING DEMAND
“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.
CHAPTER 13 ESTIMATING DEMAND
“Explanatory variables are the
economic variables that analysts
believe affect the value of the
dependent variable.”
Christopher Thomas and Charles Maurice,
Managerial Economics, 10th Edition,
McGraw-Hill, p. 121.
CHAPTER 13 ESTIMATING DEMAND
Identify four or five explanatory
variables:
1) “own price,” or “price”
2)
3)
4)
5)
CHAPTER 13 ESTIMATING DEMAND
Identify four or five explanatory
variables:
1) “own price,” or “price,”
2) income,
3)
4)
CHAPTER 13 ESTIMATING DEMAND
Identify four or five explanatory
variables:
1) “own price,” or “price,”
2) income,
3) population
4)
CHAPTER 13 ESTIMATING DEMAND
Identify four or five explanatory
variables in Problem 2, p. 338:
1) price,
2) income,
3) population
all.
This problem has just three in
CHAPTER 13 ESTIMATING DEMAND
The analyst’s task…
Collect enough information to
estimate demand – and consumer
surplus – using econometric
techniques.
CHAPTER 13 ESTIMATING DEMAND
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, CostBenefit Analysis, Prentice-Hall, 4th edition, p. 320.
CHAPTER 13 ESTIMATING DEMAND
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, CostBenefit Analysis, Prentice-Hall, 4th edition, p. 320.
CHAPTER 13 ESTIMATING DEMAND
Think…
social surplus
demand
information
CHAPTER 13 ESTIMATING DEMAND
 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.
CHAPTER 13 ESTIMATING DEMAND

The analyst has several observations
of price and quantity.
CHAPTER 13 ESTIMATING DEMAND

The analyst has many observations.
CHAPTER 13 ESTIMATING DEMAND
 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.
CHAPTER 13 ESTIMATING DEMAND


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.
CHAPTER 13

ESTIMATING DEMAND
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.
CHAPTER 13

ESTIMATING DEMAND
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).
CHAPTER 13 ESTIMATING DEMAND

In addition, the analyst was able to
find each town’s population (POP) and
median household income (INCOME)
in the most recent census.
CHAPTER 13 ESTIMATING DEMAND

The assignment…
Observe how changes in the
independent variables may affect this
surplus.
This is an effort to observe demand.
CHAPTER 13 ESTIMATING DEMAND

The assignment…
Observe how changes in the
independent variables may affect this
surplus.
This is an effort to observe demand.
CHAPTER 13 … DATA …
CHAPTER 13 ESTIMATING DEMAND

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?
CHAPTER 13 ESTIMATING DEMAND

Response…
Follow a few basic steps to complete
the analysis of this problem.
Then, present results…
CHAPTER 13
ESTIMATING
DEMAND
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.

CHAPTER 13


ESTIMATING
DEMAND
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.
CHAPTER 13
ESTIMATING
DEMAND
Cross-Sectional Data v. Time
Series Data
Cross-Section Data involves
observations on a number of
comparable units at the same point in
time…
CHAPTER 13
ESTIMATING
DEMAND
Cross-Sectional Data v. Time
Series Data
… Cross-sectional may be subject to
heteroscedasticity problems.
CHAPTER 13
ESTIMATING
DEMAND
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.
CHAPTER 13
ESTIMATING
DEMAND
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
FEE
$12.49
0
182,849
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:
Fee
12.49
Social Benefit
0
Visits
182,849
The gross benefit = 966372+168211 = 1134583
VISITSdv = 182849 – 14638*FEE
Fee
(.5)(168211)(12.49-1)
= 966372
$12.49
VISITSdv = 182849 - 14638*(12.49) = 0
VISITSdv = 182849 - 14638*(0) = 182849
If Fee= 1
VISITSdv = 182849 - 14638*(1) = 168211
Consumer
Surplus
Consumer
$1
surplus
Government Revenue
168211
182849
visits
= (168211)(1)
Additional benefit in the form of reduced excess burden of taxation = (0.25 * 168211) = 42053
Total gross benefit = 1134583 + 42053 = 1176636
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?
CONCLUSIONS
What 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.
CONCLUSIONS
What 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.
CHAPTER 13
ESTIMATING DEMAND
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?
CHAPTER 13
ESTIMATING DEMAND
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?
CHAPTER 13
ESTIMATING DEMAND
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