Econ 3305 Durmaz CASE – 2 COST STRCTURE and PRICING-PoolVac, Inc. manufactures

Econ 3305 Durmaz CASE – 2

COST STRCTURE and PRICING:

PoolVac, Inc. manufactures and sells a single product called the “Sting Ray,” which is a patent-protected automatic cleaning device for

swimming pools. PoolVac’s Sting Ray faces its closest competitor, Howard Industries, also selling a competing pool cleaner. Using the

last 26 quarters of production and cost data, PoolVac wishes to estimate its average variable costs using the following quadratic

specification:

AVC = a +bQ + cQ

2

The quarterly data on average variable cost (AVC), and the quantity of Sting Rays produced and sold each quarter (Q) are

presented in the data file. PoolVac also wishes to use its sales data for the last 26 quarters to estimate demand for its Sting Ray.

Demand for Sting Rays is specified to be a linear function as the following:

Qd = d + eP + fM + gPH

in which its price (P), average income for households in the U.S. that have swimming pools (M), and the price of the competing

pool cleaner sold by Howard Industries (PH).

QUESTIONS

1. Run the appropriate regression to estimate the average variable cost function (AVC) for Sting Rays. Evaluate

the statistical significance of the three estimated parameters using a significance level of 5 percent. Be sure to

comment on the algebraic signs of the three parameter estimates. (30%)

2. Given your answer in 1, show the estimated total variable cost, average variable cost, and marginal cost

functions (TVC, AVC, and MC) for PoolVac. (15%)

3. Apply dummy variable to construct the time-series quarterly sales estimation of Sting Ray (Hint: Q =

A+Bt+…). Please predict the quantity sold in the first quarter 2013. (10%)

4. Run the appropriate regression to estimate the demand function for Sting Rays.

Evaluate the statistical significance of the three estimated slope parameters using a significance level of 5

percent. Discuss the appropriateness of the algebraic signs of each of the three slope parameter estimates.

(20%)

5. The manager at PoolVac, Inc. believes Howard Industries is going to price its automatic pool cleaner at $250,

and average household income in the U.S. is expected to be $65,000. Using the regression results from

Question 4, write the estimated demand function (with only P as the independent variable), inverse

demand function, and marginal revenue (MR) function. (15%)

6. Given your MC function in question 2 and MR function in question 5, what is the profit-maximizing

unit price PoolVac should charge for Sting Ray? (10%)