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The marketing department submits a report to you, the managing director of a large production firm, about the demand for the product you manage. The report has the following estimated demand function:
QD = 2,515 - 12.5P + 0.075INCOME - 5.32POTHER
(130.2) (3.4) (0.016) (1.2)
Where P is the price of your product, INCOME is the average income, POTHER is the price of a related product, and the numbers in parenthesis are the standard errors of the estimated coefficients directly above them. The R2 statistic for the regression is 0.93 (93 percent). Based on the information given, answer the following questions:
i. Giving reason, clearly comment on the fit of the model. (1 pt)
ii. The estimation of the demand function above was done at the 95% confidence level. Assume, therefore that the critical t-value for the test is 1.96. Giving reason and showing any needed workings, comment on the significance of each of the variables used in the demand function specified. (3 pt)
iii. As a manager, would you use the estimated demand function to help make decision? Why or why not? (2 pt)
iv. Is the product a normal good? Why or why not? (2 pt)
v. Is the related product a complement or a substitute for your product? Briefly explain your answer. (2 pt)
vi. The current price of your product is $300, average income is $75,000, and the price of the related product is $500. What is the quantity demanded of your product? (2 pt)
vii. Based on the prices and income given in part vi., what is the price elasticity of demand for your product? Round your answer to one decimal place. Briefly explain the meaning of the value of the price elasticity of demand that you have computed. (3 pt)
viii. If you raise the price of your product, what do you predict will happen to total revenue? Why?
