INTRODUCTION

Managerial Economics consists of that part of economic theory which helps thebusiness manager to take rational
decisions. Economic theories help to analyse the practical problems faced by a business firm. Managerial Economics
integrates economic theory with business practice. It is a special branch of economics that bridges the between abstract
theory and business practice. It deals with the use of economic concepts and principles for decision making in a business
unit It is over wise called Business Economics or Economics of the Firm. The terms Managerial Economics and Business
Economics are used interchangably. The term Managerial Economics is more in use nowa-days. Managerial Economics is
economics applied in business decision-making.
Hence it is also called Applied Economics.
Definition of Business Economics
In simple words, business economics is the discipline which helps a business manager in decision making for acheiving
the desired results. In other words, it deals with the application of economic theory to business management.
According to Spencer and Siegelman, Business economics is "the integration of economic theory with business practise for
the purpose of facilitating decision-making and forward planning by management".
According to Mc Nair and Meriam, "Business economics deals with the use of economic modes of thought to analyse
business situation".
From the above said definitions, we can safely say that business economics makes in depth study of the following
objectives:
ii) Explanation of nature and form of economic analysis
(ii) Identification of the business areas where economic analysis can be applied
(Hi) Spell out the relationship between Managerial Economics and other disciplines outline the methodology of
managerial economics.
CHARACTERISTICS OF BUSINESS ECONOMICS
The following characteristics of business economics will indicate its nature:
1. Micro economics: Managerial economics :s micro economic in character. This is so because it studies the problems of an
individual business unit. It does not study the problems of the entire economy.
2. Normative science: Managerial economics is a normative science. It is concerned with what management should do
under particular circumstances. It determines the goals of the enterprise. Then it develops the ways to achieve these goals.
3. Pragmatic: Managerial economics is pragmatic. It concentrates on making economic theory more application oriented.
It tries to solve the managerial problems in their day-today functioning.
4. Prescriptive: Managerial economics is prescriptive rather than descriptive. It prescribes solutions to various business
problems.
5. Uses macro economics: Marco economics is also useful to business economics. Macro-economics provides an intelligent
understanding of the environment in which the business operates. Managerial economics takes the help of macroeconomics to understand the external conditions such as business cycle, national income, economic policies of
Government etc.
6. Uses theory of firm: Managerial economics largely uses the body of economic concepts and principles towards solving
the business problems. Managerial economics is special branch of economics to bridge the gap between economic theory
and managerial practice.
7. Management oriented: The main aim of managerial economics is to help the management in taking correct decisions
and preparing plans and policies for future. Managerial economics analyses the problems and give solutions just as doctor
tries to give relief to the patient.
8. Multi disciplinary: Managerial economics makes use of most modern tools of mathematics, statistics and operation
research. In decision making and planning principles such accounting, finance, marketing, production and personnel etc.

9. Art and science.-Managerial economics is both a science and an art. As a science, it establishes relationship between
cause and effect by collecting, classifying and analyzing the facts on the basis of certain principles. It points out to the
objectives and also shows the way to attain the said objectives.
OBJECTIVES OF BUSINESS ECONOMICS
Managerial economics provides such tools necessary for business decisions.Managerial economics answers the five
fundamental problems of decision making. These
problem are :
(a) what should be the product mix
(b) which is the least cost production technique and input mix
(c) what should be the level of output and price of the product
(d)how to take investment decisions
(e) how much should be the selling cost.
In order to solve the problems of decision- making, data are to be collected and analysed in the light of business
objectives. Business economics supplies such data to the business economist. As pointed out by Joel Dean "The purpose of
managerial economics is to show how economic analysis can be used in formulating business policies"
The basic objective of managerial economics is to analyse economic problems of business and suggest solutions and help
the managers in decision-making. The objectives of business economics are outlined as below:
1. To integrate economic theory with business practice.
2. To apply economic concepts: and principles to solve business problems.
3. To employ the most modern instruments and tools to solve business problems.
4. To allocate the scarce resources in the optimal manner.
5. To make overall development of a firm.
6. To help achieve other objectives of a firm like attaining industry leadership, expansion of the market share etc.
7. To minimise risk and uncertainty
8. To help in demand and sales forecasting.
9. To help in operation of firm by helping in planning, organising, controlling etc.
10. To help in formulating business policies.
11. To help in profit maximisation.
Business economics is useful because:
(i)

It provides tools and techniques for managerial decisions,

(ii) It gives answers to the basic problems of business management,

(ii)

It supplies data for analysis and forecasting,

(iv) It provides tools for demand forecasting and profit planning,

(v) It guides the managerial economist. Thus, Business economics offers a number of benefits to business managers. It is also useful to individuals, society and
government.
SCOPE OF MANAGERIAL OR BUSINESS ECONOMICS
Managerial economics is a developing science which generates the countless problems to determine its scope in a clear-cut
way. From the following fields, we can examine the scope of business economics.

1. Demand analysis and forecasting. The foremost aspect regarding scope is demand analysis and forecasting. A business
firm is an economic unit which transforms productive resources into saleable goods. Since all output is meant to be sold,
accurate estimates of demand help a firm in minimising its costs of production and storage. A firm must decide its total
output before preparing its production schedule and deciding on the resources to be employed. Demand forecasts serves
as a guide to the management for maintaining its market share in competition with its rivals, thereby securing its profit.
2. Cost and production analysis. A firm's profitability depends much on its costs of production. A wise manager would
prepare cost estimates of a range of output, identify the factors causing variations in costs and choose the cost-minimising
output level, taking also into consideration the degree of uncertainty in production and cost calculations. Production
process are under the charge of engineers but the business manager works to carry out the production function analysis in
order to avoid wastages of materials and time. Sound pricing policies depend much on cost control. The main topics
discussed under cost and production analysis are: Cost concepts, cost-output relationships, Economies and Diseconomies
of scale and cost control.
3. Pricing decisions, policies and practices. Another task before a business manager is the pricing of a product. Since a
firm's income and profit depend mainly on the price decision, the pricing policies and all such decisions are to be taken
after careful analysis of the nature of the market in which the firm operates. The important topics covered in this field of
study are : Market Structure Analysis, Pricing Practices and Price Forecasting.
4. Profit management. Each and every business firms are tended for earning profit, it is profit which provides the chief
measure of success of a firm in the long period. Economists tells us that profits are the reward for uncertainity bearing and
risk taking. A successful business manager is one who can form more or less correct estimates of costs and revenues at
different levels of output. The more successful a manager is in reducing uncertainity, the higher are the profits earned by
him. It is therefore, profit-planning and profit measurement constitute the most challenging area of business economics.
5. Capital management. Still another most challenging problem for a modern business manager is of planning capital
investment. Investments are made in the plant and machinery and buildings which are very high. Therefore, capital
management requires problems.top- level decisions. It means capital management i.e., planning and control of capital
expenditure. It deals with Cost of capital, Rate of Return and Selection of projects.
6. Inventory management: A firm should always keep an ideal quantity of stock. If the stock is too much, the capital is
unnecessarily locked up in inventories At the same time if the level of inventory is low, production will be interrupted due
to non-availability of materials. Hence, a firm always prefers to have an optimum quantity of stock. Therefore, managerial
economics will use some methods such as ABC analysis, inventory models with a view to minimising the inventory cost.
7. Linear programming and theory of games : Linear programming and theory of games have came to be regarded as part
of managerial economics recently.
8. Environmental issues: There are certain issues of macroeconomics which also form a part of managerial economics.
These issues relate to general business, social and political environment in which a business enterprise operates.
9. Business cycles: Business cycles affect business decisions. They refer to regular fluctuations in economic activities in the
country. The different phases of business cycle are depression, recovery, prosperity, boom and recession.
Thus, managerial economics comprises both micro and macro-economic theories. The subject matter of managerial
economics consists of all those economic concepts, theories and tools of analysis which can be used to analyse the business
environment and to find out solution to practical business problems.

CHAP 2
law of demand
There is an inverse relationship between quantity demanded and its price. The people know that when price of a
commodity goes up its demand comes down. When there is decrease in price the demand for a commodity goes up. There
is inverse relation between price and demand . The law refers to the direction in which quantity demanded changes due to
change in price.
A consumer may demand one dozen oranges at $5 per dozen . He may demand two dozens when the price is $4 per dozen.
A person generally buys more at a lower price. He buys less at higher price. It is not the case with one person but all

people liken to buy more due to fall in price and vice versa. This is true for all commodities and under all conditions. The
economists call it as law of demand. In simple words the law of demand states that other things being equal more will be
demanded at lower price and lower will be demanded at higher price.
Definition
1.

Alfred Marshal says that the amount demanded increase with a fall in price, diminishes with a rise in price.

2. C.E. Ferguson says that according to law of demand, the quantity demanded varies inversely with price.
3. Paul A. Samuelson says that law of demand states that people will buy more at a lower prices and buy less at
higher prices, other things remaining the same.
Assumptions of the law
1.

There is no change in income of consumers.

2. There is no change in the price of product.

3. There is no change in quality of product.
4. There is no substitute of the commodity.
5.

The prices of related commodities remain the same.

6. There is no change in customs.

7.

There is no change in taste and preference of consumers.

8. The size of population remains the same.

9. The climate and weather conditions are same.
10. The tax rates and other fiscal measures remain the same.
Explanation of the law
The relationship between price of a commodity and its demand depends upon many factors. The most important factor is
nature of commodity. The demand schedule shows response of quantity demanded to change in price of that commodity.
This is the table that shows prices per unit of commodity ands amount demanded per period of time. The demand of one
person is called individual demand. The demand of many persons is known as market demand. The experts are concerned
with market demand schedule. The market demand schedule means 'quantities of given commodity which all consumers
want to buy at all possible prices at a given moment of time'. The demand schedules of all individuals can be added up to
find out market demand schedule.
Demand schedule
Price in dollars.

Demand in Kg.

100

200

300

400

The table shows the demand of all the consumers in a market. When the price decreases there is increase in demand for
goods and vice versa. When price is $5 demand is 100 kilograms. When the price is $4 demand is 200 kilograms. Thus the
table shows the total amount demanded by all consumers various price levels.

Diagram

There is same price in the market. All consumers purchase commodity according to their needs. The market demand curve
is the total amount demanded by all consumers at different prices. The market demand curve slopes from left down to the
right.
Exceptions to the law
Inferior goods
The law of demand does not apply in case of inferior goods. When price of inferior commodity decreases and its demand
also decrease and amount so saved in spent on superior commodity. The wheat and rice are superior food grains while
maize is inferior food grain.
Demonstration effect

The law of demand does not apply in case of diamond and jewelry. There is more demand when prices are high. There is
less demand due to low prices. The rich people like to demonstrate such items that only they have such commodities.
Ignorance of consumers
The consumer usually judge the quality of a commodity from its price. A low priced commodity is considered as inferior
and less quantity is purchased. A high priced commodity is treated as superior and more quantity is purchased. The law of
demand does not apply in this case.
Less supply
The law of demand does not work when there is less supply of commodity. The people buy more for stock purpose even at
high price. They think that commodity will become short.
Depression
The law of demand does not work during period of depression. The prices of commodities are low but there is increase in
demand. it is due to low purchasing power of people.
Speculation
The law does not apply in case of speculation. The speculators start buying share just to raise the price. Then they start
selling large quantity of shares to avoid losses.
Out of fashion
The law of demand is not applicable in case of goods out of fashion. The decrease in prices cannot raise the demand of
such goods. The quantity purchased is less even though there is falls in prices.
Importance of the law
Price determination
A monopolist can determine price of a commodity on the basis of such law. He can know the effect on demand due to
increase or decrease in price. The demand schedule can help him to determine the most suitable price level.
Tax on commodities
The law of demand is important for tax authorities. The effect of tax on different commodities is checked. The commodity
must be taxed if its demand is relatively inelastic. A commodity cannot be taxed if its sales fall to great extent.
Agricultural prices
The law of demand is useful to determine agricultural prices. When there are good crops, the prices come down due to
change in demand. In case of bad crops, the prices go up if demand remains the same. The poverty of farmers can be
determined.
Planning
Individual demand schedule is used in planning for individual goods and industries. There is need to know the effect of
change in price on the demand of commodity at national and world level. The nature of demand schedule helps to know
such effect

Elasticity of Demand

Meaning:
The elasticity of demand is the degree of responsiveness of demand to change in price. In the words of Prof. Lipsey:
Elasticity of demand may be defined as the ratio of the percentage change in demand to the percentage change in price.
Mrs. Robinsons definition is more clear: The elasticity of demand at any price. is the proportional change of amount
purchased in response to a small change in price, divided by the proportional change of price.Thus, price elasticity of
demand is the ratio of percentage change in amount demanded to a percentage change in price. It may be written as E p =
Percentage change in amount demanded/ Percentage change in price If we use (delta) for a change, q for amount
demanded and p for price, the algebraic equation is

Ep, the coefficient of price elasticity of demand is always negative because when price changes demand moves in the
opposite direction. It is, however, customary to disregard the negative sign. If the percentages for quantity and prices are
known the value of the coefficient Ep can be calculated.
Price elasticity of demand may be unity, greater than unity, less than unity, zero or infinite. These five cases are explained
with the aid of the following figures. Price elasticity of demand is unity when the change in demand is exactly
proportionate to the change in price. For example, a 20% change in price causes 20% change in demand, E = 20%/20% =
1. In the diagrams of Figure 1, p represents change in price, q change in demand? And DD the demand curve. Price
elasticity on the first demand curve in Panel (A) is unity, for q/p = 1.

When the change in demand is more than proportionate to the change in price, price elasticity of demand is greater than
unity. If the change in demand is 40% when price changes by 20% then E = 40%/20% = 2, in Panel (B), i.e. q /> 1. It
is also known as relatively elastic demand.

If, however, the change in demand is less than proportionate to the change in price, price elasticity of demand is less than
unity. When a 20% change in price causes 10% change in demand, then E p= 10%/20% = 1/2 =<1, in Panel (C), i.e.
q/<1. It is also known as relatively inelastic demand.
Zero elasticity of demand is one when whatever the change in price, there is absolutely no change in demand. Price
elasticity of demand is perfectly inelastic in this case. A 20% rise or fall in price leads to no change in the amount
demanded, Ep= 0/20% = 0, in Panel (D), i.e.0/p = 0. It is perfectly inelastic demand.
Lastly, price elasticity of demand is infinity when as infinitesimal small change in price leads to an infinitely large change
in the amount demanded. Visibly, no change in price causes an infinite change in demand, Ep =

/0 =

, in Panel (E), at

OD price, the quantity demanded continues to increase from Ob to Ob1 ..n. It is perfectly elastic demand.
Methods of Measuring Price Elasticity of Demand:
There are four methods of measuring elasticity of demand they are the percentage method, point method, arc method and
expenditure method.

(a) The Percentage Method:

The price elasticity of demand is measured by its coefficient

(Ep). This coefficient (Ep) measures the percentage change in the quantity of a commodity demanded resulting from a
given percentage change in its price. Thus

Where q refers to quantity demanded, p to price and A to change. If Ep> 1, demand is elastic. If Ep <1 demand is inelastic,
and if Ep =1, demand is unitary elastic. With this formula, we can compute price elasticities of demand on the basis of a
demand schedule.
Table. 1: Demand Schedule
Price (Rs.) Per
Combination

Kg. of X

Quantity Kgs. of X

10

20

30

40

50

60

Let us first take combinations and D.

(i)Suppose the price of commodity X falls from Rs. 5 per kg. to Rs. 3 per kg. and its quantity demanded increases from 10
kgs. to 30 kgs. Then

This shows elastic demand or elasticity of demand greater than unitary.

Note:
The formula can be understood like this:
q = q2-q1 where q2 is the new quantity (30 kgs.) and q2 the original quantity (10 kgs.).
P = p2-p1 where p2 is the new price (Rs.3) and p, the original price (Rs. 5).
In the formula, p refers to the original price (p1) and q to original quantity (q1). The opposite is the case in example (ii)
below, where Rs. 3 becomes the original price and 30 kgs. as the original quantity.
(ii) Let us measure elasticity by moving in the reverse direction. Suppose the price of X rises from Rs. 3 per kg. to Rs. 5 per
kg. and the quantity demanded decreases from 30 kgs. to 10 kgs. Then

This shows unitary elasticity of demand. Notice that the value of Ep in example (i) differs from that in example (ii)
depending on the direction in which we move. This difference in the elasticities is due to the use of a different base in
computing percentage changes in each case. Now consider combinations D and F.

(iii) Suppose the price of commodity X falls from Rs. 3 per kg to Re. 1 per kg. and its quantity demanded increases from 30
kgs. to 50 kgs. Then

This is again unitary elasticity.

(iv) Take the reverse order when the price rises from Re. 1 per kg. to Rs. 3 per kg. And the quantity demanded decreases
from 50 kgs. to 30 kgs. Then

This shows inelastic demand or less than unitary.

The value of Ep again differs in this example than that given in example (iii) for the reason stated above.
(b) The Point Method:
Prof. Marshall devised a geometrical method for measuring elasticity at a point on the demand curve. Let RS be a straight
line demand curve in Figure. 2. If the price falls from PB (= OA) to MD (= ), the quantity demanded increases from OB
to OD.

Elasticity at point P on the RS demand curve according to the formula is:

EP= q/p p/q
Where q represents change in quantity demanded p changes in price level while p and q are initial price and quantity
levels.

From Figure 2.

q = BD = QM

p = PQ

p = PB

q = OB

Substituting these values in the elasticity formula:

EP = QM/PQ PB/OB
Moreover, QM/PQ BS/PB

[<PQM=<PBS are similar s]

... BS/PB PB/OB = BS/OB
Since, PBS and ROS are similar,

Ep at point p = BS/OB = OA/AR = PS/PR =Lower Segment/Upper Segment

With the help of the point method, it is easy to point out elasticity at any point along a demand curve. Suppose that the
straight line demand curve DC in Figure. 3 is 6 centimeters. Five points L, M, N, P and Q are taken on this demand curve.
The elasticity of demand at each point can be known with the help of the above method. Let point N be in the middle of the
demand curve. So elasticity of demand at point.

N = CN (Lower Segment) / ND (Upper Segment) = 3/3 = 1 (Unity)

Elasticity of demand at point

M = CM/MD = 5/1 = 5 or > 1.

(Greater than Unity)

Elasticity of demand at point

L = CL/LD = 6/0 = (infinity).

Elasticity of demand at Point

P = CP/PD = 1/5 = (Less than Unity).

Elasticity of demand at point

Q = CQ/QD = 0/6 = 0(Zero)

We arrive at the conclusion that at the mid-point on the demand curve, the elasticity of demand is unity. Moving up the
demand curve from the mid-point, elasticity becomes greater. When the demand curve touches the Y- axis, elasticity is
infinity. Ipso facto, any point below the midpoint towards the X-axis will show elastic demand. Elasticity becomes zero
when the demand curve touches the X -axis.

(c) The Arc method:

We have studied the measurement of elasticity at a point on a demand curve. But when elasticity is measured between two
points on the same demand curve, it is known as arc elasticity. In the words of Prof. Baumol, Arc elasticity is a measure of
the average responsiveness to price change exhibited by a demand curve over some finite stretch of the curve.

Any two points on a demand curve make an arc. The area between P and M on the DD curve in Figure. 4 is an arc which
measures elasticity over a certain range of price and quantities. On any two points of a demand curve, the elasticity
coefficients are likely to be different depending upon the method of computation. Consider the price-quantity
combinations P and M as given in Table. 2.

Table 2: Demand Schedule:

Point

Price (Rs)

Quantity (Kg)

10

12

If we move from P to M, the elasticity of demand is

EP = Q/P p/q = (12 10) / (6-8) 8/10 = 2/-2 8/10 = 4/5

If we move in the reverse direction from M to P, then

(10-20) / (6-8) 6/12 = -2/2 6/12 = -1/2

Thus the point method of measuring elasticity at two points on a demand curve gives different elasticity coefficients
because we used a different base in computing the percentage change in each case.

To avoid this discrepancy, elasticity for the arc (PM in Figure 4) is calculated by taking the average of the two prices [(p 1 +
p2)1/2] and the average of the two quantities [(q1 + q2)1/2]. The formula for price elasticity of demand at the mid-point (C in
Figure 4) of the arc on the demand curve is

On the basis of this formula, we can measure arc elasticity of demand when there is a movement either from point P to M
or from M to P.

From P to M at point P, p1 =8, q1 = 10, and at point M, p2 = 6, q2 = 12.

Applying these values, we get

EP = q/p p1 + p2 / q1 + q2 = (12-10) / 8-6 (8 + 6) (10+12) = 2/-2 14/22 = -7/11

From M to P at point M, P1= 6, q1 = 12 and at point, p2 = 8, q2 = 10.
Now we have EP = (10-12) / (8-6) (6+8)/12+10) = -2/2 14/22 = -7/11
Thus whether we move from M to P or P to M on the arc PM of the DD curve, the formula for arc elasticity of demand gives
the same numerical value. The closer the two points P and M are, the more accurate is the measure of elasticity on the
basis of this formula. If the two points which form the arc on the demand curve are so close that they almost merge into
each other, the numerical value of arc elasticity equals the numerical value of point elasticity.

(d) The Total Outlay Method:

Marshall evolved the total outlay, or total revenue or total expenditure method as a measure of elasticity. By comparing
the total expenditure of a purchaser both before and after the change in price, it can be known whether his demand for a
good is elastic, unity or less elastic.

Total outlay is price multiplied by the quantity of a good purchased:

Total Outlay = Price x Quantity Demanded. This is explained with the help of the demand schedule in Table.3.

(i) Elastic Demand:

Demand is elastic, when with the fall in price the total expenditure increases and with the rise in price the total
expenditure decreases. Table.3 shows that when the price falls from Rs. 9 to Rs. 8, the total expenditure increases from Rs.
18 to Rs. 24 and when price rises from Rs. 7 to Rs. 8, the total expenditure falls from Rs. 28 to Rs. 24. Demand is elastic
(Ep>1) in this case.

(ii) Unitary Elastic Demand:

When with the fall or rise in price, the total expenditure remains unchanged, the elasticity of demand is unity. This is
shown in the table when with the fall in price from Rs. 6 to Rs. 5 or with the rise in price from Rs. 4 to Rs. 5, the total
expenditure remains unchanged at Rs. 30, i.e., Ep =1.

(iii) Less Elastic Demand:

Demand is less elastic if with the fall in price, the total expenditure falls and with the rise in price the total expenditure
rises. In Table 3 when the price falls from Rs. 3 to Rs. 2, total expenditure falls from Rs. 24 to Rs 18, and when the price
rises from Re. 1 to Rs. 2, the total expenditure also rises from Rs. 10 to Rs. 18. This is the case of inelastic or less elastic
demand, Ep< 1.

Table 4 summarises these relationships:

Total 4: Total Outlay Method

The measurement of elasticity of demand in terms of the total outlay method is explained in Fig. 5 where we divide the
relationship between price elasticity of demand and total expenditure into three stages:

In the first stage, when the price falls from OP4 to OP3 and to OP2 respectively, the total expenditure rises from P4 E to P3D
and 2 respectively. On the other hand, when the price increases from OP2 to OP3 and OP4, the total expenditure
decreases from P2 to P3D and P4 E respectively.
Thus EC segment of total expenditure curve shows elastic demand (Ep> 1).

In the second stage, when the price falls from OP2 to OP1 or rises from OP1 to OP2 the total expenditure equals, P2 C = P1B,
and the elasticity of demand is equal to the unity (Ep =1).
In the third stage, when the price falls from Op1 to Op2 the total expenditure also falls from P1 to PA. Thus with the rise
in price from OP to Op1 the total expenditure also increases from PA to P1B and the elasticity of demand is less than unity
(Ep< 1).
Factors Affecting Price Elasticity of Demand:
Elasticity of demand for any commodity is determined or influenced by a number of factors which are
discussed as under:
(1) Nature of the Commodity:

The elasticity of demand for any commodity depends upon the category to which it belongs, i.e., whether it is a necessity,
comfort, or luxury. The demand for necessaries of life or conventional necessaries is generally less elastic. For example,
the demand for necessaries like food, salt, matches, etc. does not change much with rise or fall in their prices. Similar is
the case with commodities which are required at the time of marriage, death ceremonies, etc.

The demand for necessaries of efficiency (such as milk, eggs, butter, etc.), and for comforts is moderately elastic because
with the rise or fall in their prices, the demand for them decreases or increases moderately. On the other hand, the
demand for luxuries is more elastic because with a small change in their prices there is a large change in their demand. But
the demand for prestige goods, like jewels, rare coins, rare stamps, paintings by Tagore or Picasso, etc. is inelastic because
they possess unique utility for the buyers who are prepared to buy them at all costs.

(2) Substitutes:
Commodities having substitutes have more elastic demand because with the change in the price of one commodity, the
demand for its substitute is immediately affected. For example, if the price of coffee rises, the demand for coffee will
decrease and that for tea will increase, and vice versa. But the demand for commodities having no good substitutes is
inelastic.

(3) Variety of Uses:

The demand for a commodity having composite demand or variety of uses is more elastic. Such commodities are coal,
milk, steel, electricity, etc. For example, coal is used for cooking and heating, for power generation, in factories, in
locomotives, etc. If there is a slight fall in the price of coal, its demand will increase from all quarters.

On the other hand, a rise in its price will bring a considerable decrease in demand in less important uses (domestic) and in
more important uses efforts will also be made to economise its use, as in railways and factories. Thus the overall effect will
be a reduction in demand. A commodity which cannot be put to more than one use, has less elastic demand.

(4) Joint Demand:

There are certain commodities which are jointly demanded, such as car and petrol, pen and ink, bread and jam, etc. The
elasticity of demand of the second commodity depends upon the elasticity of demand of the major commodity. If the
demand for cars is less elastic, the demand for petrol will also be less elastic. On the other hand, if the demand for, say,
bread is elastic the demand for jam will also be elastic.

(5) Deferred Consumption:

Commodities whose consumption can be deferred have an elastic demand. This is the case with durable consumer goods,
like cloth, bicycle, fan, etc. If the price of any of these articles rises, people will postpone their consumption. As a result,
their demand will decrease, and vice versa.

(6) Habits:
People who are habituated to the consumption of a particular commodity, like coffee, tea or cigarette of a particular brand,
the demand for it will be inelastic. We find that the prices of coffee, tea and cigarettes increase almost every year but there
has been little effect on their demand because people are in the habit of consuming them.

(7) Income Groups:

The elasticity of demand also depends on the income group to which a person belongs. Persons who belong to the higher
income group, their demand for commodities is less elastic. It is immaterial to a rich man whether the price of a
commodity has fallen or risen, and hence his demand for the commodity will be unaffected.

On the other hand, the demand of persons in lower income groups is generally elastic. A rise or fall in the prices of
commodities will reduce or increase the demand on their part. But this does not apply in the case of necessities, the
demand for which on the part of the poor is less elastic.

(8) Proportion of Income Spent:

If the consumer spends a small proportion of his income on a commodity at a time, the demand for that commodity is less
elastic because he does not bother much about small expenditure. Such commodities are shoe polish, pen, pencil, thread,
needle, etc. But commodities which entail a large proportion of the income of the consumer, the demand of them is elastic,
such as bicycle, watch, etc.

(9) Level of Prices:

The level of prices also influences the elasticity of demand for commodities when the price level is high, the demand for
commodities is elastic, and when the price level is low, and the demand is less elastic.

(10) Time Factor:

Time factor plays an important role in influencing the elasticity of demand for commodities. The shorter the time in which
the consumer buys a commodity, the lesser will be the elasticity of demand tor that product. On the other hand, the longer
the time which the consumer takes in buying a commodity, the higher will be the elasticity of demand for that product.

Prof. Stigler mentions three possible reasons for the long-period elasticity being higher than the short-period elasticity. In
the long run, the consumer has a better knowledge of the price changes, takes time to readjust his budget, and might
change his consumption pattern due to possible technological changes.

(11) Brand:
The price of demand for a given brand of product may be elastic. If its price increases, people turn towards the other
brands easily. This is substitution effect For example, if the price of the Hero bicycle increases, the consumer will buy the
Atlas bicycle.

(12) Recurring Demand:

Goods which have recurring demand, their prices are more elastic than the goods which are not demanded time and again.

(13) Distribution of Income:

If a country has equal distribution of income and wealth, the demand for majority of goods is elastic because there are
more middle class people whose purchasing power is almost equal.
3. Cross Elasticity of Demand:

The cross elasticity of demand is the relation between percentage change in the quantity demanded of a good to the
percentage change in the price of a related good. The cross elasticity of demand between good X and Y

Where, Qx = Quantity of good X, P = Price of good Y and A = change. Given the price of X, this formula measures the
change in the quantity demanded of X as a result of change in the price of Y. The cross elasticity of demand for good X may

be positive, negative or zero which depends on the nature of relation between the goods X and Y. This relation may be as
substitutes, complementary or unrelated goods.
a. Substitute Goods:
If X and Y are substitute goods, a fall in the price of good Y will reduce the quantity demanded of good X. Similarly, an
increase in the price of good Y will raise the demand for good X. Their cross elasticity is positive because, given the price of
X, a change in the price of Y will lead to a change in the quantity demanded of X in the same direction as in the price of Y.
The cross elasticity of substitute goods is explained in Table 5.

Table 5: Cross Elasticity of Substitutes:

Commodit
y

Before Change

After Change
Price in
Rs. Per

Price in Rs. Per K.G.

Quantity (K.G)

(KG.)

Quantity (K.G.)

X (Tea)

20

400

20

500

Y (Coffee)

30

500

40

300

Exy =Qx/Py Py /Qx = 500- 400/40-30 30/400

= 100/10 30/400 = (+) 3/4 or (+) 0.75

It is clear from the above that the coefficient of cross elasticity of substitute goods such as tea (X) and coffee (Y) is positive
(+0.75) when with the rise in price of coffee, the price of tea being constant, the demand for tea also increases.

This is shown in Fig. 6 where the quantity of good X (tea) is taken on X-axis and the quantity of good Y is plotted on Xaxis. When the price of Y increases from OY to OY1the quantity demanded of X rises from OX to OX1. The slope of the
demand curve downwards to the right shows positive elasticity of both the goods.

b. Complementary Goods:

If two goods are complementary (jointly demanded), rise in the price of one leads to a fall in the demand for the other.
Rise in the prices of cars will bring a fall in their demand together with the demand for petrol. Similarly, a fall in the prices
of cars will raise the demand for petrol. Since price and demand vary in the opposite direction, the cross elasticity of
demand is negative.

The cross elasticity of complementary goods is explained in Table 6.

Table 6: Cross Elasticity of Complementary:

Goods Before the Price Change
After the Price Change
Price in Rs. Per K.G.
X (Tea) 150
Y (Sugar)15

Quantity (K.G.)
40
100

Price in Rs. Per

K.G.
150
20

Quantity
(K.G.)
30
80

Exy = Qx/Py Py/Qx = 30-40 / 20-15 15/40

= -10/5 15/40 = -15/20 = -3/4 = (-) 0.75.

In this case, the cross elasticity coefficient of complementary goods such as tea and sugar or car and petrol is negative.

This is explained in Fig.7 where with the rise in the price of Y (Sugar) from OY to OY 1, the demand for X (tea) falls from OX
to OX1. The slope of the demand curve downwards to the right indicates negative cross elasticity.
c. Unrelated Goods:
If the two goods are unrelated, a fall in the price of good has no effect whatsoever on the demand for good X. In such a
case, the cross elasticity of demand is zero. For example, a fall in the price of tea has no effect on the quantity demanded of
car. The cross elasticity of demand for unrelated goods is shown in Fig. 8. Even an increase in the price of good Y from OY
to OY1, the demand for good X remains the same as OD. Hence, the cross elasticity of demand for unrelated goods is zero.

Some Conclusions:
We may draw certain inferences from this analysis of the cross elasticity of demand.

(a) The cross elasticity between two goods, whether substitutes or complementaries, is only a one-way traffic. The cross
elasticity between butter and jam may not be the same as the cross elasticity of jam to butter. A 10% fall in the price of
butter may cause a fall in the demand for jam by 5%. But a 10% fall in the price of jam may lower the demand for butter by
2%. It shows that in the first case the coefficient is 0.5 and in the second case 0.2. The superior the substitute whose price
changes, the higher is the cross elasticity of demand.

This rule also applies in the case of complementary goods. If the price of car falls by 5%, the demand for petrol may go up
by 15%, giving a high coefficient of 3. But a fall in the price of petrol by 5% may lead to a rise in the demand for cars by 1%,
giving a low coefficient of 0.2.

(b) Cross elasticities for both substitutes and complementaries vary between zero and infinity. Generally, cross elasticity
for substitutes is positive, but in exceptional circumstances it may also be negative.

(c) Commodities which are close substitutes have high cross elasticity and commodities with low cross elasticities are poor
substitutes for each other. This distinction helps to define an industry. If some goods have high cross elasticity, it means
that they are close substitutes. Firms producing them can be regarded as one industry.

A good having a low cross elasticity in relation to other goods may be regarded a monopoly product and its manufacturing
firm becomes an industry by determining the boundary of an industry. Thus cross elasticities are simply guidelines.

.
4. Income Elasticity of Demand:

The concept of income elasticity of demand (Ey) expresses the responsiveness of a consumers demand (or expenditure or
consumption) for any good to the change in his income. It may be defined as the ratio of percentage change in the quantity
demanded commodity to the percentage change in income. Thus
Ey = Percentage change in quantity demanded / Percentage change in income
= Q/Q / Y/Y = Q/Q Y/Y = Q/Y Y/Q

Where is change, Q quantity demanded and Y is income.

The coefficient E may be positive, negative or zero depending upon the nature of a commodity. If an increase in income
leads to an increased demand for a commodity, the income elasticity coefficient (Ey) is positive. A commodity whose
income elasticity is positive is a normal good because more of it is purchased as the consumers income increases.
On the other hand, if an increase in income leads to a fall in the demand for a commodity, its income elasticity coefficient
(Ey) is negative. Such a commodity is called inferior good because less of it is purchased as income increases. If the
quantity of a commodity purchased remains unchanged regardless of the change in income, the income elasticity of
demand is zero (Ey =0).
Normal goods are of three types:
Necessaries, luxuries and comforts. In the case of luxuries, the coefficient of income elasticity is positive but high, Ey >1.
Income elasticity of demand is high when the demand for a commodity rises more than proportionate to the increase in
income. Assuming prices of all other goods as constant, if the income of the consumer increases by 5% and as a result his
purchases of the commodity increase by 10%, then Ey = 10/5 = 2(>1). Taking income on the vertical axis and the quantity
demanded on the horizontal axis, the increase in demand Q1 income Q2 in more than the rise in income Y1, Y2 as shown in
Fig 9.The curve Dy shows a positive and elastic income demand.

In the case of necessities, the coefficient of income elasticity is positive but low, Ey <1. Income elasticity of demand is low
when the demand for a commodity rises less than proportionate to the rise in the income. If the proportion of income
spent on a commodity increases by 2% when the consumers income goes up by 5%, E y = 2/5(<1) Figure 10 shows a

positive but inelastic income demand curve Dy because the increase in demand Q1 Q2 is less than proportionate to the rise
in income Y1 Y2.

In the case of comforts, the coefficient of income elasticity is unity (Ey =1) when the demand for a commodity rises in the
same proportion as the increase in income. For example, a 5% increase in income leads to 5% rise in demand, E y=5/5 = 1.
The curve Dy in Figure 11 shows unitary income elasticity of demand. The increase in quantity demanded Q 1 Q2 exactly
equals the increase in income Y1Y2.

The coefficient of income elasticity of demand in the case of inferior goods is negative. In the case of inferior goods, the
consumer will reduce his purchases of it, when his income increases. If a 5% increase in income leads to 2% reduction in
demand, Ey = -2/5 (<0). Figure 12 shows the Dy curve for inferior goods which bends upwards from A to when the
quantity demanded decreases by good with the rise in income by Y1Y2.
If with increase in income, the quantity demanded remains unchanged, the coefficient of income elasticity, E y = 0. If, say,
with 5% increase in income, there is no change in the quantity demanded, then Ey = 0/5 = 6. Figure 13 shows a vertical
income demand curve Dy with zero elasticity.

Determinants of Income Elasticity of Demand:

There are certain factors which determine the income elasticity of demand:
1. The Nature of Commodity:
Commodities are generally grouped into necessities, comforts and luxuries. We have seen above that in the case of
necessities, Ey <1, in the case of comforts, Ey = 1, and in the case of luxuries, Ey > 1.
2. Income Level:
This grouping of commodities depends upon the income level of a country. A car may be a necessity in a high-income
country and a luxury in a poor low-income country.

3. Time Period:
Income elasticity of demand depends on the time period. Over the long-run, the consumption patterns of the people may
change with changes in income with the result that a luxury today may become a necessity after the lapse of a few years.

4. Demonstration Effect:
The demonstration effect also plays an important role in changing the
tastes, preferences and choices of the people and hence the income elasticity of demand for different types of goods.

5. Frequency:
the frequency of increase in income also determines income elasticity of demand for goods. If the frequency is greater,
income elasticity will be high because there will be a general tendency to buy comforts and luxuries.

Chap 3
Demand forecasting

Meaning:

Forecasts are becoming the lifetime of business in a world, where the tidal waves of change are sweeping the most
established of structures, inherited by human society. Commerce just happens to the one of the first casualties. Survival in
this age of economic predators, requires the tact, talent and technique of predicting the future.
Forecast is becoming the sign of survival and the language of business. All requirements of the business sector need the
technique of accurate and practical reading into the future. Forecasts are, therefore, very essential requirement for the
survival of business. Management requires forecasting information when making a wide range of decisions.
The sales forecast is particularly important as it is the foundation upon which all company plans are built in terms of
markets and revenue. Management would be a simple matter if business was not in a continual state of change, the pace of
which has quickened in recent years.
It is becoming increasingly important and necessary for business to predict their future prospects in terms of sales, cost
and profits. The value of future sales is crucial as it affects costs profits, so the prediction of future sales is the logical
starting point of all business planning.
A forecast is a prediction or estimation of future situation. It is an objective assessment of future course of action. Since
future is uncertain, no forecast can be percent correct. Forecasts can be both physical as well as financial in nature. The
more realistic the forecasts, the more effective decisions can be taken for tomorrow.
In the words of Cundiff and Still, Demand forecasting is an estimate of sales during a specified future period which is tied
to a proposed marketing plan and which assumes a particular set of uncontrollable and competitive forces. Therefore,
demand forecasting is a projection of firms expected level of sales based on a chosen marketing plan and environment.
Procedure to Prepare Sales Forecast:
Companies commonly use a three-stage procedure to prepare a sales forecast. They make an environmental forecast,
followed by an industry forecast, and followed by a companys sales forecast, the environmental forecast calls for
projecting inflation, unemployment, interest rate, consumer spending, and saving, business investment, government
expenditure, net exports and other environmental magnitudes and events of importance to the company.
The industry forecast is based on surveys of consumers intention and analysis of statistical trends is made available by
trade associations or chamber of commerce. It can give indication to a firm regarding tine direction in which the whole
industry will be moving. The company derives its sales forecast by assuming that it will win a certain market share.
All forecasts are built on one of the three information bases:
What people say?
What people do?
What people have done?
Types of Forecasting:

Forecasts can be broadly classified into:

(i) Passive Forecast and
(ii) Active Forecast. Under passive forecast prediction about future is based on the assumption that the firm does not
change the course of its action. Under active forecast, prediction is done under the condition of likely future changes in the
actions by the firms.
From the view point of time span, forecasting may be classified into two, viz.,:

(i) Short term demand forecasting and (ii) long term demand forecasting. In a short run forecast, seasonal patterns are of
much importance. It may cover a period of three months, six months or one year. It is one which provides information for
tactical decisions.
Which period is chosen depends upon the nature of business. Such a forecast helps in preparing suitable sales policy. Long
term forecasts are helpful in suitable capital planning. It is one which provides information for major strategic decisions.
It helps in saving the wastages in material, man hours, machine time and capacity. Planning of a new unit must start with
an analysis of the long term demand potential of the products of the firm.
There are basically two types of forecast, viz.,:
(i) External or national group of forecast, and (ii) Internal or company group forecast. External forecast deals with trends
in general business. It is usually prepared by a companys research wing or by outside consultants. Internal forecast
includes all those that are related to the operation of a particular enterprise such as sales group, production group, and
financial group. The structure of internal forecast includes forecast of annual sales, forecast of products cost, forecast of
operating profit, forecast of taxable income, forecast of cash resources, forecast of the number of employees, etc.
At different levels forecasting may be classified into:
(i) Macro-level forecasting,
(ii) Industry- level forecasting,
(iii) Firm- level forecasting and
(iv) Product-line forecasting.
Macro-level forecasting is concerned with business conditions over the whole economy. It is measured by an appropriate
index of industrial production, national income or expenditure. Industry-level forecasting is prepared by different trade
associations.
This is based on survey of consumers intention and analysis of statistical trends. Firm-level forecasting is related to an
individual firm. It is most important from managerial view point. Product-line forecasting helps the firm to decide which
of the product or products should have priority in the allocation of firms limited resources.
.
Forecasting Techniques:

Demand forecasting is a difficult exercise. Making estimates for future under the changing conditions is a Herculean task.
Consumers behaviour is the most unpredictable one because it is motivated and influenced by a multiplicity of forces.
There is no easy method or a simple formula which enables the manager to predict the future.
Economists and statisticians have developed several methods of demand forecasting. Each of these methods has its
relative advantages and disadvantages. Selection of the right method is essential to make demand forecasting accurate. In
demand forecasting, a judicious combination of statistical skill and rational judgement is needed.
Mathematical and statistical techniques are essential in classifying relationships and providing techniques of analysis, but
they are in no way an alternative for sound judgement. Sound judgement is a prime requisite for good forecast.
The judgment should be based upon facts and the personal bias of the forecaster should not prevail upon the facts.
Therefore, a mid way should be followed between mathematical techniques and sound judgment or pure guess work.
The more commonly used methods of demand forecasting are discussed below:
The various methods of demand forecasting can be summarised in the form of a chart as shown in Table 1.

1. Opinion Polling Method:

In this method, the opinion of the buyers, sales force and experts could be gathered to determine the emerging trend in the
market.
The opinion polling methods of demand forecasting are of three kinds:
(a) Consumers Survey Method or Survey of Buyers Intentions:
In this method, the consumers are directly approached to disclose their future purchase plans. I his is done by
interviewing all consumers or a selected group of consumers out of the relevant population. This is the direct method of
estimating demand in the short run. Here the burden of forecasting is shifted to the buyer. The firm may go in for
complete enumeration or for sample surveys. If the commodity under consideration is an intermediate product then the
industries using it as an end product are surveyed.
(i) Complete Enumeration Survey:
Under the Complete Enumeration Survey, the firm has to go for a door to door survey for the forecast period by contacting
all the households in the area. This method has an advantage of first hand, unbiased information, yet it has its share of
disadvantages also. The major limitation of this method is that it requires lot of resources, manpower and time.
In this method, consumers may be reluctant to reveal their purchase plans due to personal privacy or commercial secrecy.
Moreover, at times the consumers may not express their opinion properly or may deliberately misguide the investigators.
(ii) Sample Survey and Test Marketing:
Under this method some representative households are selected on random basis as samples and their opinion is taken as
the generalised opinion. This method is based on the basic assumption that the sample truly represents the population. If
the sample is the true representative, there is likely to be no significant difference in the results obtained by the survey.
Apart from that, this method is less tedious and less costly.
A variant of sample survey technique is test marketing. Product testing essentially involves placing the product with a
number of users for a set period. Their reactions to the product are noted after a period of time and an estimate of likely
demand is made from the result. These are suitable for new products or for radically modified old products for which no
prior data exists. It is a more scientific method of estimating likely demand because it stimulates a national launch in a
closely defined geographical area.
(iii) End Use Method or Input-Output Method:
This method is quite useful for industries which are mainly producers goods. In this method, the sale of the product under
consideration is projected as the basis of demand survey of the industries using this product as an intermediate product,
that is, the demand for the final product is the end user demand of the intermediate product used in the production of this
final product.
The end user demand estimation of an intermediate product may involve many final good industries using this product at
home and abroad. It helps us to understand inter-industry relations. In input-output accounting two matrices used are
the transaction matrix and the input co-efficient matrix. The major efforts required by this type are not in its operation but
in the collection and presentation of data.
(b) Sales Force Opinion Method:
This is also known as collective opinion method. In this method, instead of consumers, the opinion of the salesmen is
sought. It is sometimes referred as the grass roots approach as it is a bottom-up method that requires each sales person
in the company to make an individual forecast for his or her particular sales territory.
These individual forecasts are discussed and agreed with the sales manager. The composite of all forecasts then constitutes
the sales forecast for the organisation. The advantages of this method are that it is easy and cheap. It does not involve any
elaborate statistical treatment. The main merit of this method lies in the collective wisdom of salesmen. This method is
more useful in forecasting sales of new products.
(c) Experts Opinion Method:
This method is also known as Delphi Technique of investigation. The Delphi method requires a panel of experts, who are
interrogated through a sequence of questionnaires in which the responses to one questionnaire are used to produce the
next questionnaire. Thus any information available to some experts and not to others is passed on, enabling all the experts
to have access to all the information for forecasting.

The method is used for long term forecasting to estimate potential sales for new products. This method presumes two
conditions: Firstly, the panellists must be rich in their expertise, possess wide range of knowledge and experience.
Secondly, its conductors are objective in their job. This method has some exclusive advantages of saving time and other
resources.
2. Statistical Method:
Statistical methods have proved to be immensely useful in demand forecasting. In order to maintain objectivity, that is, by
consideration of all implications and viewing the problem from an external point of view, the statistical methods are used.
The important statistical methods are:
(i) Trend Projection Method:
A firm existing for a long time will have its own data regarding sales for past years. Such data when arranged
chronologically yield what is referred to as time series. Time series shows the past sales with effective demand for a
particular product under normal conditions. Such data can be given in a tabular or graphic form for further analysis. This
is the most popular method among business firms, partly because it is simple and inexpensive and partly because time
series data often exhibit a persistent growth trend.
Time series has got four types of components namely, Secular Trend (T), Secular Variation (S), Cyclical Element (C), and
an Irregular or Random Variation (I). These elements are expressed by the equation O = TSCI. Secular trend refers to the
long run changes that occur as a result of general tendency.
Seasonal variations refer to changes in the short run weather pattern or social habits. Cyclical variations refer to the
changes that occur in industry during depression and boom. Random variation refers to the factors which are generally
able such as wars, strikes, flood, famine and so on.
When a forecast is made the seasonal, cyclical and random variations are removed from the observed data. Thus only the
secular trend is left. This trend is then projected. Trend projection fits a trend line to a mathematical equation.
The trend can be estimated by using any one of the following methods:
(a) The Graphical Method,
(b) The Least Square Method.
a) Graphical Method:
This is the most simple technique to determine the trend. All values of output or sale for different years are plotted on a
graph and a smooth free hand curve is drawn passing through as many points as possible. The direction of this free hand
curveupward or downward shows the trend. A simple illustration of this method is given in Table 2.
Table 2: Sales of Firm
Sales (Rs.
Year
Crore)
1995
40
1996

50

1997

44

1998

60

1999

54

2000

62

In Fig. 1, AB is the trend line which has been drawn as free hand curve passing through the various points representing
actual sale values.

(b) Least Square Method:

Under the least square method, a trend line can be fitted to the time series data with the help of statistical techniques such
as least square regression. When the trend in sales over time is given by straight line, the equation of this line is of the
form: y = a + bx. Where a is the intercept and b shows the impact of the independent variable. We have two variables
the independent variable x and the dependent variable y. The line of best fit establishes a kind of mathematical
relationship between the two variables .v and y. This is expressed by the regression on x.
In order to solve the equation v = a + bx, we have to make use of the following normal equations:
y = na + b X
xy =a x+b x2
(ii) Barometric Technique:
A barometer is an instrument of measuring change. This method is based on the notion that the future can be predicted
from certain happenings in the present. In other words, barometric techniques are based on the idea that certain events
of the present can be used to predict the directions of change in the future. This is accomplished by the use of economic
and statistical indicators which serve as barometers of economic change.
Generally forecasters correlate a firms sales with three series: Leading Series, Coincident or Concurrent
Series and Lagging Series:
(a) The Leading Series:
The leading series comprise those factors which move up or down before the recession or recovery starts. They tend to
reflect future market changes. For example, baby powder sales can be forecasted by examining the birth rate pattern five
years earlier, because there is a correlation between the baby powder sales and children of five years of age and since baby
powder sales today are correlated with birth rate five years earlier, it is called lagged correlation. Thus we can say that
births lead to baby soaps sales.
(b) Coincident or Concurrent Series:
The coincident or concurrent series are those which move up or down simultaneously with the level of the economy. They
are used in confirming or refuting the validity of the leading indicator used a few months afterwards. Common examples
of coinciding indicators are G.N.P itself, industrial production, trading and the retail sector.
(c) The Lagging Series:
The lagging series are those which take place after some time lag with respect to the business cycle. Examples of lagging
series are, labour cost per unit of the manufacturing output, loans outstanding, leading rate of short term loans, etc.
(iii) Regression Analysis:
It attempts to assess the relationship between at least two variables (one or more independent and one dependent), the
purpose being to predict the value of the dependent variable from the specific value of the independent variable. The basis
of this prediction generally is historical data. This method starts from the assumption that a basic relationship exists
between two variables. An interactive statistical analysis computer package is used to formulate the mathematical
relationship which exists.
For example, one may build up the sales model as:
Quantum of Sales = a. price + b. advertising + c. price of the rival products + d. personal disposable income +u

Where a, b, c, d are the constants which show the effect of corresponding variables as sales. The constant u represents the
effect of all the variables which have been left out in the equation but having effect on sales. In the above equation,
quantum of sales is the dependent variable and the variables on the right hand side of the equation are independent
variables. If the expected values of the independent variables are substituted in the equation, the quantum of sales will
then be forecasted.
The regression equation can also be written in a multiplicative form as given below:
Quantum of Sales = (Price)a + (Advertising)b+ (Price of the rival products) c + (Personal disposable income Y + u
In the above case, the exponent of each variable indicates the elasticities of the corresponding variable. Stating the
independent variables in terms of notation, the equation form is QS = P8. Ao42 . R.83. Y2.68. 40
Then we can say that 1 per cent increase in price leads to 0.8 per cent change in quantum of sales and so on.
If we take logarithmic form of the multiple equation, we can write the equation in an additive form as
follows:
log QS = a log P + b log A + log R + d log Yd + log u
In the above equation, the coefficients a, b, c, and d represent the elasticities of variables P, A, R and Y d respectively.
The co-efficient in the logarithmic regression equation are very useful in policy decision making by the management.

(iv) Econometric Models:

Econometric models are an extension of the regression technique whereby a system of independent regression equation is
solved. The requirement for satisfactory use of the econometric model in forecasting is under three heads: variables,
equations and data.
The appropriate procedure in forecasting by econometric methods is model building. Econometrics attempts to express
economic theories in mathematical terms in such a way that they can be verified by statistical methods and to measure the
impact of one economic variable upon another so as to be able to predict future events.