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Chapter 6 DEMAND ESTIMATION

QUESTIONS & ANSWERS Q6.1 A linear approximation to the market demand curve for Chevy Trail Blazers assumes a constant marginal effect of changes in price on the quantity demanded. Is this assumption valid at extraordinarily high prices, like $75,000, and at giveaway low prices, like $7,500? ANSWER No. Linear demand curves assume a constant marginal effect of changes in price, prices of other goods, income, advertising and other factors. It is vital to remember that this assumption is only valid within the range of observed data. When estimating the market demand curve, it is essential that analysis of the estimated model be confined to the range of data used to derive the model itself. For example, General Motors has very good information about the relationship between price and the quantity demanded of Chevrolet Trail Blazer SUVs, but only within the neighborhood of current prices. When GM offers a $2,500 rebate on Trail Blazers, it is able to gain sufficient information to derive a linear approximation to the underlying market demand curve. Nobody knows how many Trail Blazers would be purchased at an extraordinarily high price, like $75,000, nor at a giveaway low price, like $7,500. Those prices are irrelevant to the company=s present production, pricing and promotion decisions. What a linear approximation to the firm=s market demand curve can do is provide valuable information around the present suggested retail price near $35,000-$40,000. Q6.2 Explain how shifting demand and supply curves make market demand estimation difficult. ANSWER The identification problem relates to the difficulty encountered in properly isolating independent variables (X factors) that influence a given dependent variable (Y factor). To accurately model the demand function for a given product, the effects of all relevant independent variables must be incorporated. Moreover, these independent influences must be reflected using an appropriate linear or...