Question 1
The Smith Corporation is a shoe-maker producing shoes
anded P, while its competito
produces shoes
anded N. It hires an economist to determine the demand for its shoes. Afte
months of hard work and submission of an exo
itant bill, the economist tells the company
that demand for the firm’s shoes is given by the following equation:
QP = a + b PP + c PN + d M
where QPis the number of shoes sold per month, PPis the price of shoes produced by Smith
Corportation, PNis the price of shoes from competing maker, and M is consumer income. In
the market served by Smith Corporation, income is cu
ently $10,000. The following
egression was tested for statistical significance at the 5% level of significance and the results
were based on 24 monthly observations:
DEPENDENT
VARIABLE:
QP
R-SQUARE
F-RATIO
P-VALUE ON F
OBSERVATIONS: 24
VARIABLE
0.9160
PARAMETER
ESTIMATE
46.35
STANDARD
ERROR
0.0001
T-RATIO P-VALUE
INTERCEPT
12,000
245.3
3.67
0.0019
PP–5000
5.22 –3.45
0.0031
M
5
0.036
4.21
0.0006
PN
500
32.5 –2.73
Discuss the relationship between shoe
ands P and N, and also the type of good that
shoes P can be classified as.
(3 marks)
Discuss the meaning of R-square and the t-value for the parameter estimate on the Pp
and PN.
(6 marks)
If Smith Corporation sets the price of shoes (Pp) at $5 per pair and the price of its
competitor’s shoes (PN) are sold at $6 per pair, analyse the impact on the sales of
Smith’s shoes.
(5 marks)
At the prices set in part c above, determine the price elasticity of demand for Smith’s
shoes and explain what the magnitude of its elasticity at this point implies.
(5 marks)
By computing the appropriate measure of elasticity, determine the probable impact if
the competing shoe-maker raises its price.
(3 marks)
In view of the fact that this is a time-series regression, discuss what possible variables
could have been missed by the modeler, and explain
iefly how easy it might be to
include them.
(3 marks)