UNIT-2

Introduction to business economics, and demand analysis

Definition; Nature and scope of managerial economics - demand analysis

determinants; Law of demand and its exceptions.

Elasticity of demand and demand forecasting

Definition; Types; Measurement and significance of elasticity of demand;

Demand forecasting; Factors governing demand forecasting; Methods of

demand forecasting - survey methods, statistical methods, expert opinion

method, test marketing, controlled experiments, and judgmental approach to

demand forecasting.

Business Economics, also called Managerial Economics, is the application of economic

theory and methodology to business. Business involves decision-making. Decision

making means the process of selecting one out of two or more alternative courses of

action. The question of choice arises because the basic resources such as capital, land,

labour and management are limited and can be employed in alternative uses. The

decision-making function thus becomes one of making choice and taking decisions that

will provide the most efficient means of attaining a desired end, say, profit

maximation. Different aspects of business need attention of the chief executive. He

may be called upon to choose a single option among the many that may be available to

him. It would the interest of the business to reach an optimal decision- the one that

promotes the goal of the business firm. A scientific formulation of the business

problem and finding its optimals solution requires that the business firm is he

equipped with a rational methodology and appropriate tools.

Definitions:

According to Mc Nair and Meriam:

Business economic consists of the use of economic modes of thought to analyse

business situations.

Prof. Hague: Managerial Economics is concerned with using logic of economics,

mathematics & statistics to provide effective ways of thinking about business decision

problems.

Integration of Business theory and Economic practice.

Business economic meets these needs of the business firm. This is illustrated in the

following presentation.

Economic Theory and

Methodology

Decision problems in

Business

Business Economic Application of

Economic Theory and Methodology to

solving Business problems Optimal

Solution to Business Problems

The Questions/Problems faced by all economies which needs decision:

1. What commodities in what quantities?

2. What methods to produce commodity?

3. How is societys output of goods and services?

4. How efficient is the production and distribution?

5. Are the countrys resources being utilized fully?

6. Is Purchasing power and savings are constant?

7. Is the economys capacity increasing to produce goods & services?

Micro Economics: Microeconomics is the study of decisions that people and businesses make regarding

the allocation of resources and prices of goods and services. This means also taking

into account taxes and regulations created by governments. Microeconomics focuses

on supply and demand and other forces that determine the price levels seen in the

economy. For example, microeconomics would look at how a specific company could

maximize it's production and capacity so it could lower prices and better compete in its

industry.

Microeconomics breaks down into the following tenets:

Individuals make decisions based on the concept of utility. In other words, the

decision made by the individual is supposed to increase that individual's

happiness or satisfaction. This concept is called rational behavior or rational

decision-making.

Businesses make decisions based on the competition they face in the market.

The more competition a business faces, the less leeway it has in terms of

pricing.

Both individuals and consumers take the opportunity cost of their actions into

account when making their decisions.

Macro Economics: Macroeconomics, on the other hand, is the field of economics that studies the

behavior of the economy as a whole and not just on specific companies, but

entire industries and economies. This looks at economy-wide phenomena, such

as Gross National Product (GDP) and how it is affected by changes in

unemployment, national income, rate of growth, and price levels. For example,

macroeconomics would look at how an increase/decrease in net exports would

affect a nation's capital account or how GDP would be affected by

unemployment rate.

Macroeconomists try to forecast economic conditions to help consumers, firms and

governments make better decisions.

Consumers want to know how easy it will be to find work, how much it will cost

to buy goods and services in the market, or how much it may cost to borrow

money.

Businesses use macroeconomic analysis to determine whether expanding

production will be welcomed by the market. Will consumers have enough

money to buy the products, or will the products sit on shelves and collect dust?

Governments turn to the macro-economy when budgeting spending, creating

taxes, deciding on interest rates and making policy decisions.

Nature of Managerial Economics:

Aims at providing decision making:

It is concerned with finding the solutions for different managerial and business

problems. Business economic seeks to establish rules which help business firms attain

their goals. which indeed is also the essence of the word normative. However, if the

firms are to establish valid decision rules, they must thoroughly understand their

environment.

Focus on Micro level in firm and Macro in aggregative level:

It is very Close to microeconomics because it is concerned with finding the solutions for

different managerial problems of a particular firm and the macroeconomics conditions

of the economy are also seen as limiting factors for the firm to operate. In other

words, the managerial economist has to be aware of the limits set by the

macroeconomics conditions such as government industrial policy, inflation and so on.

Applied branch of knowledge:

Models are built to reflect the real life complex business situations and these models

are of immense help to managers for decisionmaking. The different areas where

models are extensively used include inventory control, optimization, project

management etc. In managerial economics, we also employ case study methods to

conceptualize the problem, identify that alternative and determine the best course of

action.

Prescriptive(goal oriented) in Nature and character:

Basically it is aimed at providing solutions and alternative course of actions towards

achieve the goal. It always considered as a goal oriented because it provides an

opportunity to evaluate each alternative in terms of its costs and revenue. The

managerial economist can decide which is the better alternative to maximize the

profits for the firm.

Provide alternative course of action:

Managerial economics provides various alternative course of action for each decision

while assessment of all processes considering the influencing factors. The manager has

to choose the proper ultimate solution for their problems from the alternatives.

Scope:

1. Demand analysis and forecasting:

A business firm is an economic organisation which transform productive resources into

goods to be sold in the market. A major part of business decision making depends on

accurate estimates of demand. A demand forecast can serve as a guide to

management for maintaining and strengthening market position and enlarging profits.

Demands analysis helps identify the various factors influencing the product demand

and thus provides guidelines for manipulating demand.

Demand analysis and forecasting provided the essential basis for business planning

and occupies a strategic place in managerial economic. The main topics covered are:

Demand Determinants, Demand Distinctions and Demand Forecastmg.

2. Production Function:

Production analysis is narrower, in scope than cost analysis. Production analysis

frequently proceeds in physical terms while cost analysis proceeds in monetary terms.

The main topics covered under cost and production analysis are: Cost concepts and

classification, Cost-output Relationships, Economics and Diseconomics of scale,

Production function and Cost control.

3. Cost analysis:

A study of economic costs, combined with the data drawn from the firms accounting

records, can yield significant cost estimates which are useful for management

decisions. An element of cost uncertainty exists because all the factors determining

costs are not known and controllable. Discovering economic costs and the ability to

measure them are the necessary steps for more effective profit planning, cost control

and sound pricing practices.

4. Inventory Management:

Capital is the foundation of business. Lack of capital may result in small size of

operations. Availability of capital from various sources like equity capital, institutional

finance etc. may help to undertake large-scale operations. Hence efficient allocation

and management of capital is one of the most important tasks of the managers. The

major issues related to capital analysis are: 1. The choice of investment project 2.

Evaluation of the efficiency of capital 3. Most efficient allocation of capital

5. Advertising:

To produce a commodity is one thing and to market it is another. Expenditure on

advertising and related types of promotional activities is called selling costs by

economists.

Methods of Advertising:

Percentage of Sales Approach

All You can Afford Approach

Competitive Parity Approach

Objective and task Approach

Return on Investment Approach

6. Price system

Pricing is an important area of business economic. In fact, price is the genesis of a firms

revenue and as such its success largely depends on how correctly the pricing decisions

are taken. The important aspects dealt with under pricing include. Price Determination

in Various Market Forms, Pricing Method, Differential Pricing, Product-line Pricing and

Price Forecasting.

When pricing a commodity, the cost of production has to be taken into account.

Business decisions are greatly influenced by pervading market structure and the

structure of markets that has been evolved by the nature of competition existing in

the market. Pricing is actually guided by consideration of cost plan pricing and the

policies of public enterprises.

7. Capital Budgeting:

Planning and control of capital expenditure is the basic executive function. The capital

budgeting process takes different forms in different industries. It involves the

equimarginal principle. The objective is to assure the most profitable use of funds,

which means that funds must not be applied when the marginal returns are less than

in other uses.

Among the various types business problems, the most complex and troublesome for

the business manager are those relating to a firms capital investments. Relatively

large sums are involved and the problems are so complex that their solution requires

considerable time and labour. Often the decision involving capital management are

taken by the top management. Briefly Capital management implies planning and

control of capital expenditure. The main topics dealt with are: Cost of capital Rate of

Return and Selection of Projects.

Role of ME in decision making:

Managerial. Decision problems

1.Product price and output

2.Make or Buy

3.Production Technique

4.Internet Strategy

5.Advertising Media and

Intensity

6.Investment and Financing

Framework for Decisions:

1.Thoery of Consumer

Behavior

2.Theory of the firm

3.Theory of Market

Structure and Pricing

Tool and Techniques of

Analysis:

1.Cost & Demand analysis

2.Statistical analysis

3.Forecasting

4.Production analysis

5.Advertising Techniques

Managerial Economics

Use of Economic concepts and

Decision Science Methodology to

Solve Managerial Decision

Problems

Optimal solutions to

Managerial Decision Problems

Demand analysis determinants; Definition:

Demand refers to the quantities of goods that consumers are willing and able to

purchase at various prices during a given period of time. For your demand to be

meaningful in the marketplace you must be able to make a purchase; that is, you must

have enough money to make the purchase. There are, no doubt, many items for which

you have a willingness to purchase, but you may not have an effective demand for

them because you dont have the money to actually make the purchase. For example,

you might like to have a 3600-square-foot resort in Mussorie, an equally large beach

house in Goa, and a private jet to travel between these places on weekends and

between semesters. But it is likely that you have a budget constraint that prevents you

from having these items.

Need, & desire backed by adequate purchasing power or Specific quantity of a

commodity actually purchased or bought. There are 3 needs of demand:

Desire of buyer

Willing to pay the price

Ability to pay the price

Demand refers to the quantities of goods that consumers are willing and able to

purchase at various prices during a given period of time.

Types of demand:

1. Consumer Goods Vs. Producer Goods

Consumer goods refer to such products and services which are capable of satisfying

human need. Goods can be grouped under consumer goods and producer goods.

Consumer goods are those which are available for ultimate consumption. These give

direct and immediate satisfaction. Thus the demand for an input or what is called a

factor of production is a derived demand; its demand depends on the demand for

output where the input enters. In fact, the quantity of demand for the final output as

well as the degree of substitutability/complementary between inputs would determine

the derived demand for a given input. For example, the demand for gas in a fertilizer

plant depends on the amount of fertilizer to be produced and substitutability between

gas and coal as the basis for fertilizer production. However, the direct demand for a

product is not contingent upon the demand for other products.

2. Autonomous Demand Vs. Derived Demand

Autonomous demand refers to the demand for products and services directly. The

demand for the services of direct products is called derived demand. Example a super

specialty hospital can be considered as autonomous whereas the demand for the

hotels and medical stores around the hospital related to derived demand.

3. Durable Vs. Perishable Goods

Both consumers goods and producers goods are further classified into

perishable/non-durable/single-use goods and durable/non-perishable/repeated-use

goods. The former refers to final output like bread or raw material like cement which

can be used only once. The latter refers to items like shirt, car or a machine which can

be used repeatedly. In other words, we can classify goods into several categories:

single-use consumer goods, single-use producer goods, durable-use consumer goods

and durable-use producers goods. This distinction is useful because durable products

present more complicated problems of demand analysis than perishable products.

Non-durable items are meant for meeting immediate (current) demand, but durable

items are designed to meet current as well as future demand as they are used over a

period of time. So, when durable items are purchased, they are considered to be an

addition to stock of assets or wealth. Because of continuous use, such assets like

furniture or washing machine, suffer depreciation and thus call for replacement. Thus

durable goods demand has two varieties replacement of old products and expansion

of total stock. Such demands fluctuate with business conditions, speculation and price

expectations. Real wealth effect influences demand for consumer durables.

4. Firm Demand Vs. Industry Demand:

The firm is a single business unit whereas industry refers to the groups of firms

carrying on similar activity. The quantity of goods demanded by a single firm is called

firm demand and the quantity demanded by the industry as a whole is call industry

demand.

5. Short-run Demand Vs. Long-run Demand

Joel Dean defines short-run demand as the demand with its immediate reaction to

price changes, income, fluctuations and so on. Long-run demand is that demand which

will ultimately exist as a result of the changes in pricing, promotion or product

improvement, after enough time is allowed to let the market adjust itself to the given

situation.

6. New Demand vs. replacement Demand

This distinction follows readily from the previous one. If the purchase or acquisition of

an item is meant as an addition to stock, it is a new demand. If the purchase of an item

is meant for maintaining the old stock of capital/asset, it is replacement demand. Such

replacement expenditure is to overcome depreciation in the existing stock. Producers

goods like machines. The demand for spare parts of a machine is replacement

demand, but the demand for the latest model of a particular machine (say, the latest

generation computer) is a new demand. In course of preventive maintenance and

breakdown maintenance, the engineer and his crew often express their replacement

demand, but when a new process or a new technique or a new product is to be

introduced, there is always a new demand. You may now argue that replacement

demand is induced by the quantity and quality of the existing stock, whereas the new

demand is of an autonomous type. However, such a distinction is more of degree than

of kind. For example, when demonstration effect operates, a new demand may also be

an induced demand. You may buy a new VCR, because your neighbor has recently

bought one. Yours is a new purchase, yet it is induced by your neighbors

demonstration.

7. Total Market and Segment Market Demand

This distinction is made mostly on the same lines as above. Different individual buyers

together may represent a given market segment; and several market segments

together may represent the total market. For example, the Hindustan Machine Tools

may compute the demand for its watches in the home and foreign markets separately;

and then aggregate them together to estimate the total market demand for its HMT

watches. This distinction takes care of different patterns of buying behavior and

consumers preferences in different segments of the market. Such market segments

may be defined in terms of criteria like location, age, sex, income, nationality, and so

on

Determinants of Demand or Demand function:

The demand function can be written as:

Qd = f (Po, Pc, Ps, Yd, T, A, CR, R, E, N, 0)

Po = price of the product

Pc = the price of complements

Ps = the price of substitutes

Yd = disposable income

T = Tastes

A = Level of advertising

Cr = Availability of Credit

R = Rate of Interest

E = Expectations

N = No. of potential customers

0 = any miscellaneous factors

1. The first three variables in the function relate to price. They are the own price of

the product (Po), the price of complements (Pc) and the price of substitutes (Ps)

respectively. In the case of the own price of a good, the expected relationship

would be, the higher the price the lower the demand, and the lower the price the

higher the demand. This is the law of demand. In the case of complements, if the

price of complementary goods increases, we would expect demand to fall both for

it and for the good that it is complementary to.

2. The fourth variable in the demand function, Yd stands for disposable income, that

is, the amount of money available to people to spend. The greater the level of

disposable income, the more people can afford to buy and hence the higher the

level of demand for most products will be. This assumes of course that they are

normal goods, purchases of which increase with rising levels of income, as

opposed to inferior goods that are purchased less frequently as income rises.

3. The effect of changes in disposable income on the demand for individual products

will of course be determined by the ways in which it is spent. This is where the fifth

variable, tastes (T), needs to be taken into account. Over a period of time, tastes

may change significantly, but this may incorporate a wide range of factors. For

example, in case of food, greater availability of alternatives may have a significant

effect in changing the national diet.

4. The next set of variables, the A variable, relates to levels of advertising,

representing the level of own product advertising, the advertising of substitutes

and the advertising of complements respectively.

5. The variables CR and R are also related. The former represents the availability of

credit while the latter represents the rate of interest, that is the price of credit.

These variables will be most important for purchases of consumer durable goods,

for example cars. Someones ability to buy a car will depend on his or her ability to

raise money to pay for it. This means that the easier credit is to obtain, the more

likely they are to be able to make the purchase. At the same time credit must be

affordable, that is the rate of interest must be such that they have the money to

pay.

6. The letter E in the demand function stands for expectations. This may include

expectations about price and income changes. For example, if consumers expect

the price of a good to rise in future then they may well bring forward their

purchases of it in order to avoid paying the higher price.

7. The variable N stands for the number of potential customers. Each product is likely

to have a target market, the size of which will vary. The number of potential

customers may be a function of age or location. For example, the number and type

of toys sold in a particular country will be related to its demographic spread, in this

case the number of children within it and their ages.

8. Finally, the 0 which represents any other miscellaneous factors which may

influence the demand for a particular product. For example, it could be used to

represent seasonal changes in demand for a particular product if demand is subject

to such fluctuations rather than spread evenly throughout the year. Examples of

such products might include things such as umbrellas, ice creams and holidays. In

sum, this is a catch all variable which can be used to represent anything else which

the decision maker believes to have an effect on the demand for a particular

product.

Law of demand and its exceptions

The Law of Demand:

For most goods, consumers are willing to purchase more units at a lower price than at

a higher price. The inverse relationship between price and the quantity consumers

will buy is so widely observed that it is called the law of demand. The law of demand

is the rule that people will buy more at lower prices than at higher prices if all other

factors are constant. This idea of the law of demand seems to be a pretty logical and

accurate description of the behaviour we would all expect to observe and for now, this

will suffice.

The law of demand states that the demand for a commodity increases when its price

decreases and it falls when its price rises, other things remaining constant.

Demand Schedule: The law of demand can be presented through a demand

schedule. Demand Schedule is a series of prices placed in descending (or ascending)

order and the corresponding quantities which consumers would like to buy per unit of

time.

Individual Demand:

Price of X in Rs. (Kg) Quantity Demanded

per week in kgs.

30 2

25 4

20 6

15 10

10 16

Market Demand:

Price in

Rs. Per

unit

Units of

commodity per

day

Qty.

demanded in

the market

A+B+C =

4 1+3+3 7

3 2+4+5 11

2 3+5+7 15

1 5+9+10 24

Demand curve: The law of demand can also be presented through a demand curve. A

demand curve is a locus of points showing various alternative price quantity

combinations. Demand curve shows the quantities of a commodity which a consumer

would buy at different prices

The law of demand states that consumers are willing and able to purchase more units

of a good or service at lower prices than at higher prices, other things being equal.

Have you ever thought about why the law of demand is true for nearly all goods and

services? Two influences, known as the income effect and the substitution effect, are

particularly important in explaining the negative slope of demand functions. The

income effect is the influence of a change in a products price on real income, or

purchasing power. If the price of something that we buy goes down, our income will go

farther and we can purchase more goods and services (including the goods for which

price has fallen) with a given level of money income. The substitution effect is the

influence of a reduction in a products price on quantity demanded such that

consumers are likely to substitute that good for others that have thus become

relatively more expensive.

Factors behind the Law of Demand:

1. Substitution Effect: When price of a commodity falls, prices of all other related goods (particularly of substitutes) remaining constant, the goods of latter category

become relatively costlier. Or, in other words, the commodity whose price has

fallen becomes relatively cheaper. Since utility maximizing consumers substitute

cheaper goods for costlier ones, demand for the cheaper commodity increases. The

increase in demand on account of this factor is known a substitution effect.

2. Income Effect: As a result of fall in the price of a commodity, the real income of the consumer increases. Consequently, his purchasing power increases since he is

required to pay less for the same quantity. The increase in real income encourages

the consumer to demand more of goods and services. The increase in demand on

account of increase in real income is known as income effect. It should however be

noted that the income effect is negative in case of inferior goods. In case the price

of an inferior goods accounting for a considerable proportion of the total

consumption expenditure falls substantially, consumers real income increases and

they become relatively richer: Consequently, they substitute the superior goods for

the inferior ones. As a result, the consumption of inferior goods falls. Thus, the

income effect on the demand for inferior goods becomes negative.

3. Utility-Maximizing Behavior: The utility-maximizing behavior of the consumer under the condition of diminishing marginal utility is also responsible for increase in

demand for a commodity when its price falls. As mentioned above, when a person

buys a commodity, he exchanges his money income for the commodity in order to

maximise his satisfaction. He continues to buy goods and services so long as

marginal utility of his money (MUm) is less than the marginal utility of the

commodity (MUo). Given the price of a commodity, the consumer adjusts his

purchases. so that.

MUm = Po = MUo

When price of the commodity falls, (MUm = Po) < MUo, and equilibrium is

disturbed. In order to regain his equilibrium, the consumer will have to reduce the

MUo to the level of MUm. This he can do only by purchasing more of the

commodity. Therefore, the consumer purchases the commodity till Mum = Po =

MUo. This is another reason why demand for a commodity increases when its price

decreases.

Exceptions to the Law of Demand:

The law of demand does not apply to the following cases.

(a) Expectations regarding further prices. When consumers expect a continuous

increase in the price of a durable commodity, they buy more of it despite increase in

its price with a view to avoiding the pinch of a much higher price in future. For

instance, in pre-budget months, prices generally tend to rise. Yet, people buy more of

storable goods in anticipation of further rise in prices due to new levies.

(b) Status Goods. The law does not apply to the commodities which are used as a

status symbol of enhancing social prestige or for displaying wealth and riches, e.g.,

gold, precious stones, rare paintings, antiques, etc. Rich people buy such goods mainly

because their prices are high and buy more of them when their prices move up.

(c) Giffen Goods. Another exception to the law of demand is the classic case of Giffen

goods2. A Giffen good may be any inferior commodity much cheaper than its superior

substitutes, consumed by the poor households as an essential commodity. If price of

such goods increases (price of its substitute remaining constant), its demand increases

instead of decreasing because, in case of a Giffen good, income effect of a price rise is

greater than its, substitution effect. The reason is, when price of, an inferior good

increases, income remaining the same, poor people cut the consumption of the

superior substitute so that they may buy more of the inferior good in order to meet

their basic need.

ELASTICITY OF DEMAND AND DEMAND FORECASTING

We have earlier discussed the nature of relationship between demand and its

determinants. Form a managerial point of view, however, the knowledge of nature of

relationship alone is not sufficient. What is more important is the extent of

relationship or the degree of responsiveness of demand to the changes in its

determinants, it, elasticity of demand. The concept of elasticity of demand plays a

crucial role in business-decisions regarding maneuvering of prices with a view to

making larger profits. For instance, when cost of production is increasing, the firm

would want to pass rising cost on to the consumer by raising the price. Firms may

decide to change the price even without change in cost of production. But whether

this action raising the price following, the, rise in cost or otherwise will prove beneficial

depends on

(a) the price elasticity of demand for the products, i.e., how high or low is the

proportionate change in its demand in response to a certain percentage change in is

price; and

(b) price, elasticity of demand for its substitute because when the price of a product

increases, the demand for its substitutes increases automatically even if their prices

remains unchanged. Raising price will be beneficial only if

(i) demand for a product is less elastic; and (ii) demand for its substitute is much less.

Elasticity is the percentage change in some dependent variable given a one-percent

change in an independent variable, ceteris paribus. If we let Y represent the dependent

variable, X the independent variable, and E the elasticity, then elasticity is represented

as

E = % change in Y / % change in X Forms of elasticity:

1. Arc elasticity: avg. responsiveness of dependent variable to changes in the independent variable

over some interval.

Ep = 2 1 2 1

2 1 2 1

/ 0.5( )// / 0.5( )

Y Y Y YchangeinY avgYchangeinX avgX X X X X

+=

+

= 2 1 2 1

2 1 2 1

Y Y X XX X Y Y

+

+

2. Point elasticity: responsiveness of the dependent variable to the independent variable at one

particular point on the demand curve.

ep = 1

1

XYX Y

if X is independent, Y is dependent,

Y = f(W,X,Z)

ew= Y WW Y

ex= Y XX Y

eZ= Y ZZ Y

Measurement of Elasticity: The elasticity is measured in the following ways:

a) Perfectly elastic demand

When small change in price leads to an infinitely large change is quantity

demand, it is called perfectly or infinitely elastic demand. In this case E=

b) Perfectly inelastic demand:

In this case, even a large change in price fails to bring about a change in quantity

demanded.

c) Relatively elastic demand:

Demand changes more than proportionately to a change in price. i.e. a small

change in price loads to a very big change in the quantity demanded. In this

case

d) Relatively inelastic demand

Quantity demanded changes less than proportional to a change in price. A large

change in price leads to small change in amount demanded. Here E < 1.

Demanded carve will be steeper.

e) Unity elasticity

The change in demand is exactly equal to the change in price. When both are

equal E=1 and elasticity if said to be unitary.

In this section, we will discuss various methods of measuring elasticities of demand.

The concepts of demand elasticities used in business decisions are:

(i) Price-elasticity;

(ii) Cross-elasticity;

(iii) Income-elasticity; and

(iv) Advertisement elasticity,

FACTORS INFLUENCING THE ELASTICITY OF DEMAND:

1) Nature of Commodity: The elasticity of demand depends upon the nature of a

commodity. Generally, the demand for necessaries will be inelastic, where as the

demand for luxuries will be elastic however, we can not make a generalization that the

demand for luxuries is elastic and the demands for necessaries are inelastic due to the

following reasons:

A) Certain goods may be luxuries for some people but necessaries for others.

For example: A car may be luxury for a common man but it is necessary for a doctor.

So, the elasticity for the same commodity may differ from place to place from person

to person.

B) If the Commodity has close substitutes available at reasonable prices, then

the demand for the commodity will be elastic. When commodity has no substitute has

inelastic demand. For example salt has no substitute; therefore, the demand for salt is

always inelastic. Wheat is necessary good, but it has substitutes. The demand for

wheat can be elastic even though it is necessary.

2) Number of uses of Commodity: A commodity having a variety of uses has

comparatively elastic demand i.e electricity on the other hand, the demand is inelastic

for commodity having limited or single use. For Ex: Steel can be used for many

purposes. A slight fall in its price will bring both demand form many quarters and

hence demand is elastic.

3) Availability of Substitutes: If the Commodity has no substitutes its demand will be

inelastic. If commodity has substitutes, the demand will be elastic. Example: If bus fairs

rise, people will use train or any other cheap means of transportation. Therefore bus

passenger services have elastic demand.

4) Durability of Commodity: The demand for durable goods such as Radio, Television

and Fan has elastic demand. When the price of these goods rises, people may prefer to

get the old things repaired than to buy new things. Therefore, the demand for

durables will fall.

5) Possibility of Postponement of Purchase of Product: Price elasticity is also effected

by the possibility of postponement of product purchase. If the consumption of a

commodity can not be postponed than it will have inelastic demand. On the other

hand, if the consumption of a commodity can be postponed then it will have elastic

demand. For example: Salt, food grains can not be postponed. Hence, they have

inelastic demand.

6) Proportion of income spent on commodity: If a consumer spends only a small

amount on the commodity, its demand will be inelastic. For example: The amounts we

spent on news papers, Match Boxes, Shoe polish etc., are very small. Therefore, an

even if the price of these products raises the demand will not fall on the other hand, if

the amount spent on commodity is large the demand will be elastic. Ex: T.V,

Refrigerator etc.,

7) Habitual necessaries: If the consumers are addicted to a commodity due to habit

and customs the demand for commodity will be inelastic. Because once consumer is

addicted to a product, he will not reduce the consumption even price of the product is

increasing, For example: Cigarettes, Liquor etc.,

8) Time Period under Consideration: Time plays an important role in determining

elasticity of demand. Generally, demand is inelastic during short period and elastic

during the long period. This is because in the long- run consumer can changes their

consumption habit in favor of cheaper substitutes against the expensive commodities.

Therefore, in the long- run- elasticity is generally higher for all commodities.

9) Income level: Higher income group people are less affected by price changes than

low income group people. Demand for high priced and quality goods is inelastic for

high income groups where as the same is elastic for low income group people. A rich

man will not certain consumption of Fruits and Milk even if the prices rise significantly

and will continue to purchase the same quantities as before. But a poor man can not

do so. Hence, the demand for the fruits and milk is inelastic.

10) Purchase frequency of a Product: If the frequency of purchase of a product is very

high, its demand is likely to be more price elastic than in the case of a product which is

purchased less often.

IMPORTANCE OF ELASTICITY CONCEPT

The concept of elasticity of demand is of much practical importance.

1. Price fixation:

Each seller under monopoly and imperfect competition has to take into account

elasticity of demand while fixing the price for his product. If the demand for the

product is inelastic, he can fix a higher price.

2. Production:

Producers generally decide their production level on the basis of demand for the

product. Hence elasticity of demand helps the producers to take correct decision

regarding the level of cut put to be produced.

3. Distribution:

Elasticity of demand also helps in the determination of rewards for factors of

production. For example, if the demand for labour is inelastic, trade unions will be

successful in raising wages. It is applicable to other factors of production.

4. International Trade:

Elasticity of demand helps in finding out the terms of trade between two countries.

Terms of trade refers to the rate at which domestic commodity is exchanged for

foreign commodities. Terms of trade depends upon the elasticity of demand of the

two countries for each other goods.

5. Public Finance:

Elasticity of demand helps the government in formulating tax policies. For example, for

imposing tax on a commodity, the Finance Minister has to take into account the

elasticity of demand.

6. Nationalization:

The concept of elasticity of demand enables the government to decide about

nationalization of industries.

PRICE ELASTICITY OF DEMAND

Definition: It is the degree of responsiveness of quantity demanded to a change in

price

Price elasticity of demand measures the responsiveness of the quantity sold to

changes in the products price, ceteris paribus. It is the percentage change in sales

divided by a percentage change in price. The notation Ep will be used for the arc price

elasticity of demand, and ep will be used for the point price elasticity of demand. If the

absolute value of Ep (or ep ) is greater than one, a given percentage decrease (increase)

in price will result in an even greater percentage increase (decrease) in sales.1 In such

a case, the demand for the product is considered elastic; that is, sales are relatively

responsive to price changes. Therefore, the percentage change in quantity demanded

will be greater than the percentage change in the price. When the absolute value of

the price elasticity of demand is less than one, the percentage change in sales is less

than a given percentage change in price. Demand is then said to be inelastic with

respect to price. Unitary price elasticity results when a given percentage changes in

price results in an equal percentage change in sales. The absolute value of the

coefficient of price elasticity is equal to one in such cases. These relationships are

summarized as follows:

If |ep| or |Ep |> 1, demand is elastic

If |ep| or |Ep| < 1, demand is inelastic

If |ep| or |Ep| = 1, demand is unitarily elastic

Formula for calculating:

Pr PrPr Pr Prp

oportionatechangeinQuantityof oducte

oportionateChangein the iceof oduct=

PrPr

p

Changein theQuantity DemandedQuantity DemandedE Changein ice

ice

=

= 2 1 1

2 1 1

( ) /( ) /pQ Q Q

eP P P

=

(i) Q1 = 1,000 Q2 = 1,500

P1 = 100 P2 = 90

(1,500 1,000)1,000 590 100100

pE

= =

Interpretation: A 10% reduction in price will result in 50% increase in quantity demanded and numeric

value is more than 1, then the demand is elastic.

(ii) Q1 = 1,000 Q2 = 1100

P1 = 100 P2 = 70

2 1 1

2 1 1

( ) /( ) /pQ Q Q

eP P P

=

(1,100 1,000)1,000 0.3370 100100

= =

Interpretation: A 30% reduction in price will result in 33% increase in quantity demanded and numeric

value is less than 1, then the demand is elastic.

(iii) Q1 = 1,000 Q2 = 1500

P1 = 100 P2 = 50

2 1 1

2 1 1

( ) /( ) /pQ Q Q

eP P P

=

(1,500 1,000)1,000 150 100100

= =

2. Income-elasticity: It is the degree of responsiveness of quantities demanded to a

given change in income

I

Changein theQuantity DemandedQuantity DemandedE Changein Income

Income

=

= 2 1 1

2 1 1

( ) /( ) /IQ Q Q

eI I I

=

2. Cross-elasticity: The proportionate change in qty demanded of a particular

commodity in response to a change in the price of another related commodity

Pr PrPr Pr PrC

oportionatechangein qty for oduct XEoportionatechangein iceof oduct Y

=

2 1 1

2 1 1

( ) /( ) /c

Q Q Qe

P y P y P y

=

(i) Q1 = 1000 kg. Q2 = 1200 kg.

P1y = Rs.20 ( price before change)

P2y=Rs.30 (price after change)

(1200 1000) /1000 0.4(30 20) / 20Ie

= =

Interpretation: 10% increase in price, it demanded by 4%, where the value of

POINT ELASTICITY:

The algebraic equation for point elasticity:

9.09

0.42

dQdPdPdQ

=

=

pdQ P

edP Q=

109.09 0.25360p

e = =

309.09 0.97280p

e = =

509.09 2.27200p

e = =

709.09 5.3120p

e = =

909.09 20.540p

e = =

No. Elastic Inelastic

1 Luxuries Necessaries

2 Products with more substitutes Products with No substitutes

3 Product by many uses Product by limited use

4 Durable goods Perishable goods

5 Possibility of Postponed products No possibility of Postponement

6 Products of Small income spent Product of large amount spent

7 Habitual necessary producs Non habitual products

8 Short Time period goods Long Time period goods

9 Products of High income level Products of low income level

10 Frequently Purchased products Lass often purchased products

Some of these may be unique elasticity because of fluctuations of the prices.

DEMAND FORECASTING

What is Forecasting?

u Process of predict a future event

u Underlying basis of all business decisions

u Production

u Inventory

u Personnel

u Facilities

Types of Forecasts by Time Horizon

Short-range forecast (Controlling/fine-cut) forecasting usually employs

different methodologies than longer-term forecasting. Short-term forecasts tend

to be more accurate than longer-term forecasts.

Up to 1 year; usually < 3 months

Job scheduling, worker assignments

Medium-range forecast (Tactical/rough-cut) forecasts deal with more

comprehensive issues and support management decisions regarding planning

and products, plants and processes.

3 months to 3 years

Sales & production planning, budgeting

Long-range forecast (Strategic)

3+ years

New product planning, facility location

Types of Forecasts:

Economic forecasts

Address business cycle

e.g., inflation rate, money supply etc.

Technological forecasts

Predict technological change

Predict new product sales

Demand forecasts

Predict existing product sales

Need of Demand Forecasting: Demand forecasting is predicting future demand for a

product. The information regarding future demand is essential for planning and

scheduling production, purchase of raw materials, acquisition of finance and

advertising. It is much more important where a large-scale production is being planned

and production involves a long gestation period. The information regarding future

demand is essential also for the existing firms for avoiding under or over-production.

Most firms are, in fact, very often confronted with the question as to what would be

the future demand for their product. For, they will have to acquire inputs and plan

their production accordingly. The firms are hence required to estimate the future

demand for their product. Otherwise, their functioning will be shrouded with

uncertainty and their objective may be defeated An important point of concern in all

business activities is to assess the future business trend whether it is going to be

favourable or unfavorable. This assessment helps the top management in taking

appropriate policy decisions in advance. If sales are expected to rise substantially after,

say, 10 years, it will call for measures to build adequate productive capacity well in

advance so that future profit potential is not lost to the rival producers. This essentially

relates to long-term planning.

Demand forecasts are first approximations in production planning. These provide

foundations upon which plans may rest and adjustments may be made. Demand

forecast is an estimate of sales in monetary or physical units for a specified future

period under a proposed business plan or program or under an assumed set of

economic and other environmental forces, planning premises outside the business

organisation for which the forecast or estimate is made.

Sales forecast is an estimate based on some past information, the prevailing situation

and prospects of future. It is based on an effective system and is valid only for some

Specific period. The following are the main components of a sales forecasting system :

Market Research Operations to get the relevant and reliable information about the

trends in market.

A data processing and analyzing system to estimate and evaluate the sales

performance in various markets.

Proper co-ordination of steps (i) and (ii) and then to place the findings before the

top management for making final decision.

Factors governing demand forecasting:

1) Nature of forecast: To begin with, you should be clear about the uses of forecast

data- how it is related to forward planning and corporate planning by the firm.

Depending upon its use, you have to choose the type of forecasts: short-run or long-

run, active or passive, conditional or non-conditional etc.

2) Nature of product: The next important consideration is the nature of product for

which you are attempting a demand forecast. You have to examine carefully whether

the product is consumer goods or producer goods, perishable or durable, final or

intermediate demand, new demand or replacement demand type etc. A couple of

examples may illustrate the importance of this factor. The demand for intermediate

goods like basic chemicals is derived from the final demand for finished goods like

detergents. While forecasting the demand for basic chemicals, it becomes essential to

analyze the nature of demand for detergents. Promoting sales through advertising or

price competition is much less important in the case of intermediate goods compared

to final goods. The elasticity of demand for intermediate goods depends on their

relative importance in the price of the final product.

Time factor is a crucial determinant in demand forecasting. Perishable commodities

such as fresh vegetables and fruits can be sold over a limited period of time. Here

skilful demand forecasting is needed to avoid waste. If there are storage facilities, then

buyers can adjust their demand according to availability, price and income. The time

taken for such adjustment varies from product to product. Goods of daily necessities

that are bought more frequently will lead to quicker adjustments. Whereas in case of

expensive equipment which is worn out and replaced after a long period of time,

adaptation of demand will be spread over a longer duration of time.

3) Determinants of demand: Once you have identified the nature of product for which

you are to build a forecast, your next task is to locate clearly the determinants of

demand for the product. Depending on the nature of product and nature of forecasts,

different determinants will assume different degree of importance in different demand

functions.

In the preceding unit, you have been exposed to a number of price-income factors or

determinants-own price, related price, own income-disposable and discretionary,

related income, advertisement, price expectation etc. In addition, it is important to

consider socio-psychological determinants, specially demographic, sociological and

psychological factors affecting demand. Without considering these factors, long-run

demand forecasting is not possible.

Such factors are particularly important for long-run active forecasts. The size of

population, the age-composition, the location of household unit, the sex-composition-

all these exercise influence on demand in. varying degrees. If more babies are born,

more will be the demand for toys; if more youngsters marry, more will be the demand

for furniture; if more old people survive, more will be the demand for sticks. In the

same way buyers psychology-his need, social status, ego, demonstration effect etc.

also effect demand. While forecasting you cannot neglect these factors.

4) Analysis of factors &determinants: Identifying the determinants alone would not

do, their analysis is also important for demand forecasting. In an analysis of statistical

demand function, it is customary to classify the explanatory factors into (a) trend

factors, which affect demand over long-run, (b) cyclical factors whose effects on

demand are periodic in nature, (c) seasonal factors, which are a little more certain

compared to cyclical factors, because there is some regularly with regard to their

occurrence, and (d) random factors which create disturbance because they are erratic

in nature; their operation and effects are not very orderly.

An analysis of factors is specially important depending upon whether it is the

aggregate demand in the economy or the industrys demand or the companys

demand or the consumers; demand which is being predicted. Also, for a long-run

demand forecast, trend factors are important; but for a short-run demand forecast,

cyclical and seasonal factors are important.

5) Choice of techniques: This is a very important step. You have to choose a particular

technique from among various techniques of demand forecasting. Subsequently, you

will be exposed to all such techniques, statistical or otherwise. You will find that

different techniques may be appropriate for forecasting demand for different products

depending upon their nature. In some cases, it may be possible to use more than one

technique. However, the choice of technique has to be logical and appropriate; for it is

a very critical choice. Much of the accuracy and relevance of the forecast data depends

accuracy required, reference period of the forecast, complexity of the relationship

postulated in the demand function, available time for forecasting exercise, size of cost

budget for the forecast etc.

6) Testing accuracy: This is the final step in demand forecasting. There are various

methods for testing statistical accuracy in a given forecast. Some of them are simple

and inexpensive, others quite complex and difficult. This stating is needed to

avoid/reduce the margin of error and thereby improve its validity for practical

decision-making purpose. Subsequently you will be exposed briefly to some of these

methods and their uses.

Methods of forecasting:

Several methods are employed for forecasting demand. All these methods can be

grouped under survey method and statistical method. Survey methods and statistical

methods are further subdivided in to different categories.

A. Survey Methods: Under this method, information about the desires of the

consumer and opinion of exports are collected by interviewing them.

1. Consumer survey Methods: These consumer survey methods are used under

different conditions and for different purposes. The consumer survey method of

demand forecasting involves the following techniques:

a. Opinion survey method

b. Direct Interview Method

c. Complete Enumeration method

a. Opinion survey method: This method is also known as sales-force composite

method (or) collective opinion method. Under this method, the company asks its

salesman to submit estimate of future sales in their respective territories. Since the

forecasts of the salesmen are biased due to their optimistic or pessimistic attitude

ignorance about economic developments etc. these estimates are consolidated,

reviewed and adjusted by the top executives. In case of wide differences, an average is

struck to make the forecasts realistic. This method is more useful and appropriate

because the salesmen are more knowledge. They can be important source of

information. They are cooperative. The implementation within unbiased or their basic

can be corrected.

b. Direct Interview Method: The most direct and simple way of assessing future

demand for a product is to interview the potential consumers or users and to ask them

DEMAND FORECASTING METHODS

SURVEY METHODS STATISTICAL METHODS OTHER METHODS

1. Consumer Survey Methods

a. Opinion survey method

b. Direct Interview Method

c. Complete Enumeration method

2. Survey of Sales Force

1. Trend Projection Method

a. Trend line by observation

b. Least Squares Method

c. Time Series Analysis

d. Exponential Smoothing

2. Barometric Techniques

3. Simultaneous Equations

Method

4. Correlation and Regression

Methods

1. Expert opinion method

2. Delphi Method

3. Test Marketing

4. Controlled Experiments

5. Judgmental Approach

what quantity of the product they would be willing to buy at different prices over a

given period say, one year. This method is known as direct interview method. This

method may, cover almost all the potential consumers or only selected groups of

consumers from different cities or parts of the area of consumer concentration. When

all the consumers are interviewed, the method is known as complete enumeration

survey method, and when only a few selected representative consumers are

interviewed, it is known as sample survey method. In case of industrial inputs,

interview of postal inquiry of only endusers of a conduct may be required.

c. Complete Enumeration method: about their future plan of purchasing the product

in question. The quantities indicated by the consumers are added together to obtain

the probable demand for the product. For example, if only n out of m number of

households in a city report the quantity (d) they are willing to purchase of a

commodity, then total probable demand (D) may be calculated as

Dp = d1 + d2 + d3 + . Dn . (1)

where d1, d2, d3 etc. denote demand by the individual households 1, 2, 3 etc. This

method has certain limitations. It can be used successfully only in case of those

products whose consumers are concentrated in a certain region or locality. In case of a

widely dispersed market, this method may not be physically possible or may prove

very costly in terms of both money and time. Besides, the demand forecast through

this method may not be reliable for many reasons : (i) consumers themselves may not

be knowing their actual demand in future and hence may be unable or not willing to

answer the query; (ii) even if they answer, their answer to hypothetical questions may

be only hypothetical, not real; and (ii) their plans may change with the change in

factors not included in the questionnaire

2. Survey of Sales Force: Another source of getting reliable information about the

possible level of sales or demand for a given product or services is the group of people

who sell the same. The sales people are those who are constant touch with the main

and large buyers of a particular market, and hence they constitute another valid

source of information about the likely sales of a product. The sales people are paid

based on their results. Where the targets are set based on the results of the survey of

the sales force, and the payment is linked to achievement of these targets, incentive is

paid. To prevent the company from fixing higher targets, it is quite likely that they

understate or overstate the demand to eventually get low or high sales quota set for

them.

This method is appropriate when:

Sales persons with high knowledge and having source of information

The salesmen are cooperative

Where the company finds sales position is forecast lower, it may correct it by

adding to it the estimated difference.

2. Statistical Methods: Statistical method is used for long run forecasting. In this

method, statistical and mathematical techniques are used to forecast demand. This

method relies on post data and the methods involved in this are:

1. Trend Projection Method

2. Barometric Techniques

3. Simultaneous Equations Method

4. Correlation and Regression Methods

1. Trend projection methods or Time series analysis: A well-established firm would

have accumulated data. These data are analyzed to determine the nature of existing

trend. Then, this trend is projected in to the future and the results are used as the

basis for forecast. This is called as time series analysis. This data can be presented

either in a tabular form or a graph. In the time series post data of sales are used to

forecast future.

Mostly trend is used for forecasting in practice. There are many methods to determine

trend. Some of the methods are:

a. Trend line by observation or Graphical method

b. Least square method

c. Time Series Analysis

d. Exponential Smoothing

a. Trend line by observation or Graphical method: This method is elementary,

easy and quick as it involves merely the plotting the actual sales data on a chart and

then estimating just by observation where the trend line lies. In this method the period

is taken on X-axis and the corresponding sales values on y-axis and the points are

plotted for given data on graph paper. Then a free hand curve passing through most of

the plotted points is drawn. This curve can be used to forecast the values for future.

b. Least square method: This is one of the best method to determine trend. In most

cases, we try to fit a straight line to the given data. The line is known as Line of best

fit as we try to minimise the sum of the squares of deviation between the observed

and the fitted values of the data. The basic assumption here is that the relationship

between the various factors remains unchanged in future period also.

The estimating linear trend equation of sales is written as: S=x+y (T)

Where x and y have been calculated from past data S is sales and T is the year number

for which the forecast is made. To find the values of x and y, the following normal

equations have to be stated and solved:

2

S Nx TST x T y T

= +

= +

c. Time Series Analysis: One major requirement of administer this technique is that a

product should have actively been traded in the market for quite sometimes in the

past. Time series emerge from such a data when arranged chronologically. Given

significantly large data, the cause and effect relationships can be discovered through

quantitative analysis: the major components of from time series analysis:

Trend (T)

Cyclic Trend(C)

Seasonal Trend (S)

Erratic Trend (E)

Classical time series analysis involved procedures for decomposing the original sales series (Y)

into the components T,C,S,I. There are different models in the time series analysis. While one

model states that these components interact linearly, that is, Y=T+C+S+E, another model

states that Y is the product of all these components that is, Y=T x C x S x C.

d. Exponential Smoothing: This is more popular technique used for short run

forecasts. This method is an improvement over moving averages method. Unlike in

moving averages method, all time period. Here are given varying weights, that is the

value of the given variable in the recent times are given higher weights and the values

of the given variable in the distant past are given relatively lower weights for further

processing. The reason is obvious: it is assumed that the consistent all through the

year, unaffected by wide seasonal fluctuations.

The formula used for exponential smoothing is:

1 (1 )t t tS cS c Sm+ = + Where

1tS + = Exponentially smoothed average for new y4ear St = Actual data in the most recent past

Smt = Most recent smoothed forecast

C = Smoothing constant

2. Barometric Technique: Simple trend projections are not capable of forecasting turning paints. Under Barometric method, present events are used to predict the

directions of change in future. This is done with the help of economics and statistical

indicators. Those are (1) Construction Contracts awarded for building materials (2)

Personal income (3) Agricultural Income. (4) Employment (5) Gross national income (6)

Industrial Production (7) Bank Deposits etc.

3. Simultaneous Equations Method: This method provides all variables which are simultaneously considered, with the conviction that every variable influences the

other variables in an economic environment. Hence, the set of equations equal the

number of dependent (controllable) variable which is also called endogenous

variables. Like two least squares, where regression of investment (I) is found on all pre-

determined variables such a government policy, competition, level of technology and

so on, which are beyond the control of the management. These include the

exogeneous variables such as government policy and logged endogenous variables

such as St-1.

This method is more practical in the sense that it requires to estimate the future

values of only predetermined variables. It is an improvement over regression method

whereas in regression equation, the values of both exogenous and endogenous

variables have to be predicted. It is no better than regression method. It inherits all the

imitation of regression method.

4. Correlation and Regression and method: Regression and correlation are used

for forecasting demand. Based on post data the future data trend is forecasted. If the

functional relationship is analyzed with the independent variable it is simple

correction. When there are several independent variables it is multiple correlation. In

correlation we analyze the nature of relation between the variables while in

regression; the extent of relation between the variables is analyzed. The results are

expressed in mathematical form. Therefore, it is called as econometric model building.

The main advantage of this method is that it provides the values of the independent

variables from within the model itself.

C. Other Methods: 1. Expert opinion method: Apart from salesmen and consumers, distributors or

outside experts may also e used for forecasting. In the United States of America, the

automobile companies get sales estimates directly from their dealers. Firms in

advanced countries make use of outside experts for estimating future demand.

Various public and private agencies all periodic forecasts of short or long term business

conditions.

2. Delphi Method: A variant of the survey method is Delphi method. It is a

sophisticated method to arrive at a consensus. Under this method, a panel is selected

to give suggestions to solve the problems in hand. Both internal and external experts

can be the members of the panel. Panel members one kept apart from each other and

express their views in an anonymous manner. There is also a coordinator who acts as

an intermediary among the panelists. He prepares the questionnaire and sends it to

the panelist. At the end of each round, he prepares a summary report. On the basis of

the summary report the panel members have to give suggestions. This method has

been used in the area of technological forecasting. It has proved more popular in

forecasting. It has provided more popular in forecasting noneconomic rather than

economic variables.

3. Test Marketing: Test Marketing is that the opinions given by buyers, salesmen or

other experts may be times, misleading. This is the reason why most of the

manufacturers favour to test their products or services in a limited market as test-run

before they launch their products nationwide. Based on the results, valuable lessons

can be learnt and will take efficient decisions. In test marketing, the entire product and

marketing programme is tried out for the first time in a small number of well-chosen

and authentic sales environment. The primary objective, here, is to know whether the

customer will accept the product in the present form or not.

4. Controlled Experiments: Controlled experiments refer to such exercises where

some of the major determinants of demand are manipulated to suit to the customers

with different tastes and preferences, income groups, and such others. It is further

assumed that all other factors remain the same. In this method, the product in

introduced with different packages, different prices and different markets or same

markets to assess which combination appeals to the customer most. Regression

equation can be built upon these price-quantity relationships of different markets. This

method can not provide better results, unless these markets are homogeneous in tems

of, tastes and preferences of the customers, their income and so on.

This method is used to gauge the effect of a change in some demand determinant like

price, product, design, advertisement, packaging, and so on.

5. Judgmental Approach: When none of the above methods are directly related to

the given product or service, the management has no alternative other than using its

own judgment. Even when the above methods are used, the forecasting process is

supplemented with the factor of judgment for the following reasons:

Historical data for significantly long period is not available

Turning points in terms of policies or procedures or causal factors cannot be

precisely determined

Sales fluctuations are wide and significant

The sophisticated statistical techniques such as regression and so on, may not

cover all the significant factors.

The results of statistical methods are more reliable at the national level rather

than industry level.

Importance of Demand Forecasting:

1. Management Decisions: An effective demand forecast facilitates the management

to take appropriate steps in factors that are pertinent to decision making such as plant

capacity, raw-material requisites, space and building requirements and availability of

labour and capital. Manufacturing schedules can be drafted in compliance with the

demand requisites; in this manner cutting down on the inventory, production and

other related costs.

2. Evaluation: Demand forecasting furthermore smoothes the process of evaluating

the efficiency of the sales department.

3. Quality and Quantity Controls: Demand forecasting is an essential and valuable

instrument in the control of the management of an organisation to provide finished

goods of correct quality and quantity at the correct time with the least amount of

expenditure.

4. Financial Estimates: As per the sales level as well as production functions, the

financial requirements of an organisation can be calculated using various techniques of

demand forecasting. In addition, it needs a little time to acquire revenue on practical

terms. Sales forecasts will, as a result, make it possible for arranging adequate

resources on practical terms and in advance as well.

5. Avoiding Surplus and Inadequate Production: Demand forecasting is necessary for

the old and new organisations. It is somewhat essential if an organisation is engaged in

large scale production of goods and the development period is extremely time-

consuming in the course of production. In such situations, an estimate regarding the

future demand is essential to avoid inadequate and surplus production.

6. Recommendations for the future: Demand forecast for a specific commodity

furthermore provides recommendations for demand forecast of associated industries.

E.g. the demand forecast for the vehicle industry aids the tyre industry in calculating

the demand for two wheelers, three wheelers and four wheelers.

7. Significance for the government: At the macro-level, demand forecasting is valuable

to the government as it aids in determining targets of imports as well as exports for

various products and preparing for the international business.

***