CONSULTING PROJECT Estimating Industry Demand for Fresh Market Carrots The market for carrots is comprised of two

segments: fresh marketcarrots, which have excellent, uniformcolor and a small core, and processingcarrots, which are larger than fresh market carrots but still have good flavor, color, and sweetness. Annual datafor the years 19832000 in the fresh market segment of the carrot industryare presented below. Qis total annual fresh market carrot production (measured in thousands of hundred weight units, which are 100,000 pound units), Pis average annual real price per hundred weight of fresh market carrots (in constant 1991 dollars), 1 and Wis a weather index based on temperature and rainfall (Wvaries directlywith conduciveness of weather for growing carrots). To account for the increasing popularityof carrots during the sample period, the time variable tis added to the demand equation to reflect growing popularityofcarrots. The production data do not account for imports and exports of carrots. During the period of this sample, however, net exports of carrots (exports minus imports) were quite small in everyyear. t Q P W 1983 7,242 10.03 100.0 1984 8,220 6.62 108.3 1985 8,886 10.47 109.5 1986 9,300 12.59 96.3 1987 9,593 11.54 98.3 1988 10,758 10.56 101.2 1989 10,356 13.88 101.5 1990 11,322 14.01 100.6 1991 11,741 14.71 111.8 1992 12,486 13.15 109.0 1993 13,927 13.16 112.3 1994 15,072 16.14 115.4 1995 14,969 18.06 107.2 1996 14,163 19.45 90.5 1997 15,589 19.65 92.5 1998 16,192 17.29 95.6 1999 15,479 19.22 94.8 2000 17,992 19.24 98.7 Consider the following specification of empirical demand and supplyfunctions in the fresh market segment of the carrot industry: 2 s d Q QabP ct deP fW =++ =++ a. Should the ordinaryleast-squares (OLS) method or the two-stage least-squares method (2SLS) method be employed to estimate market demand for carrots? Explain briefly. b. Which variables are endogenous variables in the system? Which variables are exogenous? For the model specified above, is the demand for freshmarket carrots identified? Explain whyor whynot? 1 Since carrots are planted and harvested year-round, carrot prices are computed as average prices for each year.

2 Typically farmers make production decisions for the currentyear using the previous years crop prices (or a weighted-average of severalprevious years of crop prices). Since carrotsare planted year-round, itisnot unreasonable tospecify currentannualproduction as a function of currentaverage price of carrots. c. Using statistical software, estimate the parameters of the empirical demand function specified in part a. Write the estimated industrydemand equation for carrots. d. Are the estimated slope parameters of demand statisticallysignificant at the 15 percent level of significance?Are the algebraic signs of the parameter estimates and reasonable? Explain. bc e. Would you expect the demand for carrots to be elastic or inelastic when measured at the average price over the period of the sample? (Hint: Consider the discussion in Chapter 3 concerning the factors that influence demand elasticity.) f. Compute the price elasticityof demand for carrots measured at the sample mean values of price (P), quantity(Q), and time (t). Is the demand for fresh market carrots elastic, inelastic, or unitary elastic when measured at the sample mean values of P, Q,and t? g. By approximatelywhat percentage amount would the price of carrots have to fall in order for quantitydemanded to increase by10 percent? h. Explain, in quantitative terms, the meaning of the estimate of the slope parameter on t. ANSWER TO CONSULTING PROJECT Estimating Industry Demand for Fresh Market Carrots a. Since carrot prices and quantities are determined by a system of demand and supply equations, carrot farmers are price-takers and the demand for carrots should be estimated using 2SLS. b. P and Q are endogenous variables in the system while t and W are exogenous variables. Demand is identified because supply contains an exogenous variable (W) that is not contained in the demand equation. c. The printout from STATISTIX 7 looks like:
STUDENT EDITION OF STATISTIX 7.0 CARROT MARKET DAT..., 11/14/2001, 9:46:58 PM TWO STAGE LEAST SQUARES REGRESSION OF Q 2 EXOGENOUS VARIABLES: t, W PREDICTOR VARIABLES --------CONSTANT P t COEFFICIENT -----------1848628 -545.782 938.443 STD ERROR --------459305 346.185 233.103 STUDENT'S T -----------4.02 -1.58 4.03 P -----0.0011 0.1357 0.0011

The estimated demand for carrots is: Q = 1,848,628 545.782P + 938.443t

d

d.

Yes, b and c are statistically significant at the 13.57 percent level or better. The algebraic signs and c are as expected. The law of demand requires that b be negative. Since carrots grew more of b popular with consumers during the period of the sample, Qd t should be positive.

e.

Carrot demand over the range of prices in the 1983-2000 sample, which does not include any periods of unusually high or low prices, should tend to be price inelastic because (1) carrots are relatively inexpensive and so comprise a small fraction of household spending on food, and (2) at the relatively low prices just mentioned, consumers are not likely to be willing to substitute other vegetables if they wish to eat carrots. Qd = 1,848,628 545.782(14.432) + 938.443(1991.5) = 12, 404.51 , which is the sample mean value of Q. 14.432 Ed = 545.782 = 0.635 , so carrot demand is inelastic measured at sample mean 12,407.51 values of P, Q, and t. g. Carrot prices must fall by 15.75 percent: +10% 0.635 = %P = 15.75% %P h. Each passing year ( t = +1 ) is associated with an increase in carrot demand of 938.4 thousand hundred weight (i.e., an increase of 938,400 hundred weight on average for each year.)

f.