CASE 2 – COST STRUCTURE and PRICING: Sting Ray

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 30 quarters of production and cost data, PoolVac wishes to estimate its

average variable costs using the following quadratic specification:

AVC a bQcQ2 .

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 30 quarters to estimate demand for its Sting Ray.

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

d H Q d eP fM gP ,

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.

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.

3. Apply dummy variables to construct the time-series quarterly sales estimation of

Sting Ray (Hint: Q = A+Bt+D1t…). Please predict the quantity sold in the first quarter

2016.

4. Run the log-linear regression to estimate the demand function for Sting Rays.

Evaluate the statistical significance of the three estimated coefficients of parameters

by using a significance level of 5 percent. Discuss the elasticities (price elasticity of

demand, income elasticity and cross-price elasticity) to define the characters of Sting

Ray.

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. Please run a multiple linear regression then explore the

inverse demand function (i.e. Price is dependent variable) and marginal revenue

(MR) function (Hint: Half-way rule).

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? (Hint: Solve the

quadratic equation by quadratic formula