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Given this demand curve for coffee in lbs, Q1 = 2 -1*p1 + 0.5* p2 +...

  1. Given this demand curve for coffee in lbs, Q1 = 2 -1*p1 + 0.5* p2 + .01*Y +ε1, where Q1 is the demand for coffee and p1 is the price of coffee per lb, p2 is the price per lb of a related good and Y is the consumer’s weekly budget (20 points)

A. Which variable is the dependent variable and which are independent variables and why?

B. What does each coefficient (parameter) mean as they apply to changes in demand for coffee?

C. What does ε1 mean? Why is it in the equation?

D. Is good 2 a complement or substitute?

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Answer #1

A. In the equation Q1 = 2 -1*p1 + 0.5* p2 + .01*Y +ε1, Quantity demanded of coffee is dependent variable and price of coffee, price of related goods and budget of the consumer are independent variables.

B. The price of coffee depicts that quantity demanded of coffee is negatively related to price of coffee, The quantity demanded of coffee is positively related to the price of related good and demand for coffee is positively related to income of consumers.

C.  ε1 represents the error term in the regression equation. Since we consider sample estimates of the population parameters, thus the value id not eact and the error term helps to incorporate some of the errors that might occur during the estimation of regression equation.

D. Since price of related good and quantity demanded of coffee are positively related to each other, thus, good 2 is a substitute of coffee.

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