Question

Ann, owner of Terrific Burgers in Weatherford, Texas decides to estimate the empirical demand function for her firm’s burgers. She collects data on the last 24 months of Burger sales from her own firm records. She knows the price she charged for her Burgers during that time period, and she also has kept a record of the prices charged by one of her close competitor, Stormy Burgers.

Ann is able to obtain average household income figures from the Small Business Development Center in Weatherford. The only other competitor in the neighborhood is the local branch of Burger King selling their Whoppers. Ann is able to find the price of their Whoppers for the last 24 months from advertisements in old newspapers. She adjusts her price and income data for the effects of inflation by deflating the dollar figures, using a deflator she obtained from the Survey of Current Business. To measure the number of buyers in the market area (N), Ann collected data on the number of residents in Weatherford. As it turned out, the number of residents had not changed during the last 24 months, so Ann dropped N from her specification of demand equation.

Since the price of burgers at Terrific Burgers in Weatherford set by Ann- she possesses a degree of market power- she can estimate the empirical demand equation using linear regression.

Ann first estimates the following linear specification of demand using the 24 monthly observations she collected:

Q= a + b (P) +c (M) + d (P_SB) + e P(_W)

Where:

Q= sales price of a Burger at Terrific Burgers

P= price of a burger at Terrific Burgers

M= average annual household income in Weatherford, TX

P_SB= price of a burger at Stormy Burgers

P_W= price of a Whopper at Burger King

The following computer printout shows the results of her least-squares regression:

Dependent Variable	Q	R-Square	F-Ratio	P-Value On F
Observations	24	0.9555	101.90	0.0001

Variable	Parameter Estimate	Standard Error	T-Ratio	P-Value
Intercept	183.80	506.298	2.34	0.0305
P	-21.42	13.4863	-15.83	0.0001
M	4.09109	0.0241	7.34	0.0001
PSB	10.30	38.7478	2.61	0.0171
PW	7.84	27.0997	2.65	0.0158

Ann decides to calculate estimated demand elasticities at values of P, M, P_SB, and P_W that she feels “typify” the Burgers market in Weatherford for the past 24 months.

These values are:

P= $7.50, M= 25 (in thousands),  P_SB= $8.25, and P_W = $4.50       

Using this information, answer the following questions:

1. Using economic rationale and terminology, make recommendation to Ann :

• If she should raise or lower the price she is selling? Explain why or why not
• The impact of the economy heading into a recession on Ann’s sales. Explain.
• Who is her main competitor – Stormy Burgers or Burger King? Hint: Use the magnitude of the cross-price elasticities

Answer 1

1. she should lower her price. because with the regression analysis she found out that the variable "price of her products" are affecting her sales negatively and significantly. hence she should lower her price to increase her sales. according to her result if she decreases the price by 1 unit her sales will go up by 21.42 units.

2. if the economy goes into recession the variable "household income" will go down because of unemployment of people across the economy. hence if the economy hits a recession period then her sales will go down. one unit change in M will decrease her sales by 4.09 units. the result she found was statistically significant. Also, she found a very high positive elasticity of demand for her product with respect to M. hence if M goes down, her sales will also go down.

3. stormy burgers are her main competitor. because according to the elasticity data if stormy burger changes their price by 1%, her change in sales becomes 8.25%(compared to 4.50% of the burger kings one)

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