Answer to Question #230508 in Microeconomics for maria

Question

Q = β1P + β2PI + β3I + β4Pop + β5i + β6A

Answer 1

complete question

Assume that the Japanese car maker, Toyota has successfully established an assembling plant of cars at Okahandja and its annual production is unknown. Assume that the demand function for the automobile industry is:

Q= β1P + β2PI + β3I + β4Pop + β5i + β6A                                                                                                     where Q is the quantity of cars demanded (dependent variable) and is a linear function of all the independent variables; P is the average price of new domestic cars (in N$); PI is the average price for new import cars (in N$); I is disposable income per household (in N$); Pop is population (in millions); i is average interest rate on car loans (in percent); and A is industry advertising expenditures (in N$ millions).

1. The terms β1, β2, …, β3 are parameters of the demand function. Explain the determinants of quantity of cars demanded as stated in equation 1 and clarify the expected relationship between each parameter and quantity of cars demanded. Motivate the rationale for each of the demand variables in equation 1. 

solution

P represents the average price of new domestic cars. Quantity demanded increases with a price decrease. Pl represents the average price of imported cars. An increase in Pl will lead to a decline of imported cars leading to a substitution effect on the production of the Toyota cars. L represents the disposable income per household. An increase in disposable income will increase demand for the car as people have money for consumption, thereby positively affecting the Q. The Pop represents the population in millions. An increase in population increases the demand for cars. The i represents the average interest rate on car loans. A rise in interest rates decreases demand for cars. The A represents the industry advertisement expenditures. An increase in the advertisement increases demands for the cars as people become aware of it.