Information & Demand

1. Information & Demand Aviral Chopra Dr. David Bessler November 18,2004

2. D S $ Q Demand Estimation Demand Function of A DA= ƒ(PA,PS,PC,Y,S,Z) PA= Price of Product A PS=Price of Substitutes PC=Price of Complements Y=Per Capita Income S= Taste and Preferences Z=Other Factors (Info) DA= ƒ(PA,PS,PC,Y,S,Z) Demand Shifter Movement along demand curve

3. Demand Estimation • Demand shift can be in • Long-term • Short-term • Long-Term shift can be due to • Change in preferences and tastes • Change in Income • Better/Cheaper substitute products Over Period of time Permanent in Nature OPPORTUNITY TO RESPOND ALTERNATIVE OPTIONS

4. Demand Estimation • Short-term shift can be due to • Change in price of the good • Change in price of complement/s • Information (Positive or Negative) Small time horizon Transitory in Nature NO OPPORTUNITY TO RESPOND POTENTIAL FOR PERMANENT CHANGE LOSS MOST IMPORTANT ISIMPACT OF INFORMATIONON DEMAND

5. INFORMATION • Information can be • Good News • Bad News • Good news can increase demand • Red Wine • Bad News can decrease demand

6. INFORMATIONBAD NEWS PROCESS PRODUCT TEMPERING TERRORISM INTENTIONAL X MICROBIOLOGICAL BAD NEWS PROCESS FAULTY PARTS IN AUTO INDUSTRY HARMFUL CHEMICALS IN FOOD PRODUCTS MEDICINES WITH HARMFUL SIDE EFFECTS NON-INTENTIONAL MICROBIOLOGICAL BACTERIAL INFECTION IN FOOD PRODUCTS

7. IMPACT OF BAD NEWS • Depends on • Media Coverage of event • Greater coverage greater impact • Intensity of the event • Severity of the event • Duration of impact • Short term • Temporary change in demand • Long term • Permanent shift in demand of the products

8. RESPONSE • Voluntary Actions • Concerned Industry formulated self regulatory policies • Regulatory Actions • Ex-Post VS Ex-Ante response • Most Policy Changes after the events

9. INTENTIONAL

10. PRODUCT TAMPERING The intentional adulteration or corruption of goods post production • Done to create panic • Extort money through product liability lawsuits

11. THE EARLIEST CASE • Jaffa Oranges injected with Mercury • February 1978 • Palestinian Worker injected Israeli Oranges with Liquid Mercury • Publicity resulted in fruit sales plummeted throughout Europe

12. THE FAMOUS CASE • Tylenol Cyanide Deaths : Chicago 1982 • 7 people died in the Chicago area between September 29th and October 1st • Died because of Cyanide poisoning after having taken Tylenol • Received more television news air time than any incident since the assassination of President Kennedy • The “FEDERAL ANTI-TEMPERING ACT” enacted after Tylenol poisoning • Cost J&J $100 million

13. OTHER CASES • Girl Scout cookies with needles: April 1984 • Candy Cyanide poisoning in Japan: 1984 • Excedrin cyanide deaths in NY : Feb 1986 • Lipton Cup-A-Soup cyanide : 1986 • Tylenol Cyanide : 1986 • Chilean Fruit Scandal: Mar 1989 • Goody’s Headache Powder cyanide : 1992

14. CHILEAN FRUTI SCANDAL • Fruits that are exported from Chile to USA and Japan were injected with Cyanide in March 1989 • Protest against the living condition of poor in Chile • FDA investigation confirmed the claims leading to full inspection of fruits and vegetables from Chile

15. RESPONSE • GOVERNMENT • No policy till TYLNEOL (1983) case became public (Ex-Post Policy) • Enacted Federal Anti-Tempering Act in 1983 • PUBLIC • Sudden drop in consumption • MEDIA • High coverage to these events • Spurious claims (HOAX) across the country Fraudulent tempering claims became a punishable offense

16. NON-INTENTIONAL

17. INDUSTRIES AFFECTED • Main industry impacted by this kind of events are • FOOD • PHARMACEUTICAL • AUTOMOBILE

18. MICROBIOLOGICAL CONTAMINATION • Microbiological contamination arise due to virus, bacteria or Parasites • Causes immediate health concern for the consumers • Brief illness • Severe Sickness • Death • Most severely effects older people, infants or young ones and people with weak immune system

19. MICROBIOLOGICAL CONTAMINATION • Most common contamination in Beef, followed by Pork and then in Poultry • Food Safety Inspection Services (FSIS) started collecting data since 1982. • Most recall started in 1983 and more common after 1988 indicating growth in medical science in identifying these diseases

20. SEVERIETY OF FOOD RECALLS • Three kind of recalls (FDA) • Class 1: With reasonable probability that exposure will cause serious adverse health consequences or death • Class 2: Exposure may cause temporary or medically reversible health consequences • Class 3:Not likely to cause any adverse health consequences

21. RESPONSE • CONSUMERS • Reduction in demand for the category • Short-term • CORPORATIONS • Product Recall • MEDIA • Coverage depends on intensity of the event HIGH COST TO SOCIETY

22. COSTS • Costs associated with food borne diseases • Costs to individuals • Income and Productivity costs • Pain and sufferings • Leisure time losses • Travel Costs • Medical Costs • Industry Costs • Product recall cost • Product liability costs • Reduced product demand

23. COSTS • Public Health costs • Outbreak Investigation • Disease Surveillance • Clean up costs

24. TOTAL COST • Costs related with these food diseases varies by pathogens • Average cost per case for Salmonella estimated to be $700(Most common). • Average cost per case for Listeria estimated to be $135,000 (Highest). • Total food borne bacterial diseases estimated to be $4.8 billion in 1987

25. FOOD INDUSTRY • Product recalled • Hamburgers • Fruit Juices • Prepared Meals • Fruits and Vegetables

26. IMPACT OF FOOD RECALLS • Small companies are affected more by recall • Big Companies are not affected by recall mainly due to • Diversification • Ability to control • Product recall significantly impacts the demand of the products • Severity of contamination affects the company • Media Information does not have any significant impact alone • Product recall induces reallocation of expenditure within the meat group and across non meat group

27. MEAT RECALL & FUTURES PRICE • Beef recalls marginally influences the nearby live cattle prices if the recalls are sizeable and would cause a serious health hazards • Price may decline by $0.38/CWT • It takes roughly five days for the prices to recover to the pre-recall level • Large serious pork recalls may have an immediate impact on nearby lean hog prices

28. DRUG RECALLS Costs associated with Drug Recalls • DIRECT COSTS • Product recall • INDIRECT COSTS • Loss of faith in firms products • Product Liability Suits • Rebuilding the image • Spillover effects on manufacturers of substitute products

29. DRUG RECALLS • Capital market loss is related to publicity surrounding the recall • Tylenol : $100 million ($50 million in product recall and $50 million in rebuilding consumer confidence). • More stringent regulations by FDA in future

30. AUTO RECALLS • COSTS involved with recalls • Direct costs are very small • Indirect costs have loss sales and goodwill loss • Frequency of recall • Resale value is significantly impacted • Industry wide impact of recall as competitors are also affected • Self regulation

31. AGROCHEMICALS • Pesticides/Fungicides affects environment or health • Captan and Iprodione : Human Carcinogens • DDT : Environment • Endosulfan : Hormonal imbalance • Alar : Human Carcinogens

32. IMPACT • GOVERNMENT • Ban agrochemical • MEDIA • Gives prominence to Controversial Studies • CONSUMERS • Generally demand affected in short-term due to media coverage • Long-term demand changes depending on the severity of the problems

33. ALAR & APPLES • Alar pesticide is used in apples and peanuts • High level of exposure can cause cancer • Very high media coverage • Advertisement by National Resource Defense Council • Two episodes of 60 minutes • Cover of Time • Major Newspapers

34. ALAR & APPLES • CONSUMERS • School dropped apples from their menu • Parents poured apple juice down the drains APPLES SALES PLUMMETED • PRODUCERS • Advertised in leading newspaper with technical details of very small level • Advertisement Expenditure $3million

35. VARIOUS STUDY • Impact on • Demand of the product • Price of the product • Share price of the Company

36. IMPACT ON DEMAND • The impact of BSE on the demand of beef and other meats in Great Britain. (Applied Economics, 1996) • Impact of meat product recalls on consumer demand in the USA. (Applied Economics, 2004)

37. DATA & MODEL • U K STUDY • Beef, Pork, Lamb & Poultry • Per capita data on price and Expenditure shares • Quarterly Data from 1961 to 1993 • Almost Ideal Demand System (AIDS) model was used

38. DATA & MODEL • U S A STUDY • Beef, Pork, Poultry & Other Consumption goods • Price and Quantity • Quarterly Data from 1982 to 1998 • ROTTERDAM MODEL

39. MODELS IN DEMAND ANALYSIS • MOST POPULA MEAT DEMAND MODELS ARE • ROTTERDAM MODEL • ALMOST IDEAL DEMAND SYSTEM (AIDS) • ASYMPTOTIC IDEAL MODEL (AIM) • DIRECTED GRAPH MODEL (DGM) • VECTOR ERROR CORRECTION MODEL (VECM)

40. MODELS IN DEMAND ANALYSIS • Forecast Evaluations in Meat Demand Analysis, Agribusiness, 2003 • VECM performs best

41. DEMAND ESTIMATION IN UK

42. DATA • MONTHY DATA • Jan 1985 to Dec 2002 (216 Data points) • MEAT • Beef, Pork, Poultry and Lamb/Mutton • Prices and Quantity • THREE LEVELS • FARM PRICE (PP) • WHOLESELL PRICE (WP) • RETAIL PRICE (RP)

43. MODEL • We will be using • VECTOR ERROR CORRECTION MODEL (VECM) • DIRECTED GRAPHIC METHODS (DGM)

44. BEEF GRAPHS

45. LAMB GRAPHS

46. PORK GRAPHS

47. POULTRY PRICES

48. STATIONAITY TEST

49. DICKY FULLER TEST ΔXT=α0+α1XT-1 H0: α1=0 Critical Value at 5% Significant level is -2.89 α1 estimated using Ordinary Least Square (OLS)

50. AUGUMENTED DICKY FULLER TEST H0: α1=0 Critical Value at 5% Significant level is -2.89 α1 estimated using Ordinary Least Square (OLS) Lags (p) are determined by minimizing Schwarz Loss metrics