Chapter Two

Law of Demand and Demand Forecasting

The term ‘demand’ refers to a ‘desire’ for a commodity backed by ability and willingness to pay
for it. Unless a person has an adequate purchasing power or resources and the preparedness to
spend his resources, his desire for a commodity would not be considered as his demand. For
example, if a man wants to buy a car but he does not have sufficient money to pay for, his want
is not his demand for the car. A want with three attributes - desire to buy, willingness to pay
and ability to pay - becomes effective demand. Only an effective demand figures in economic
analysis and business decisions.
The term ‘demand’ for a commodity (i.e., quantity demanded) has always a reference to ‘a
price’, ‘a period of time’ and ‘a place’. Any statement regarding the demand for a commodity
without reference to its price, time of purchase and place is meaningless and is of no practical
use. For instance, to say ‘demand for TV sets is 50,000' carries no meaning for a business
decision, nor it any use in any kind of economic analysis.
Theory of Demand
The theory and analysis of demand provides several useful insights for business decision
making. Demand is one of the most important aspects of Business Economics, since a firm
would not be established or survive if a sufficient demand for its product didn‘t exist or couldn‘t
be created. That is, a firm could have the most efficient production techniques and the most
effective management, but without a demand for its product that is sufficient to cover at least all
production and selling costs over the long run, it simply would not survive.
Demand is the quantity of a good or service that customers are willing and able to purchase
during a specified period under a given set of economic conditions. The time frame might be an
hour, a day, a month or a year. Conditions to be considered include the price of the good in
question, prices and availability of related goods, expectations of price changes, consumers’
incomes, consumers taste and preferences, advertising expenditures and so on. The amount of the
product that consumers are prepared to purchase, its demand, depends on all these factors.
The ability of goods and services to satisfy consumer wants is the basis for consumer demand.
This is an important topic in micro-economics because managers must know why consumers
demand their products before demand can be met or created.
Consumer behavior theory rests upon three basic assumptions regarding the utility tied to
consumption.
First, ―More is better: - Consumers will always prefer more to less of any good or service.
It is often being referred to as the ―non satiation principle.
Second, ―Preferences are complete: - When preferences are complete, consumers are able to
compare and rank the benefits tied to consumption of various goods and services.
Third, ―Preferences are transitive: - When preferences are transitive, consumers are able to
rank/order the desirability of various goods and services.
Demand forecasting
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.
1
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.
On the other hand, if sales of a product are expected to go up in the very near future, it will be
prudent on the part of the management to make the needed adjustments in production schedule
and take suitable steps immediately to ensure that sufficient stocks are available with given plant
capacity as soon as needed. This involves short-term planning.
Irrespective of the length of future time period one is interested in, the planners and policy
makers need to know the possible future trends in relation to several variables, which is made
possible through forecasting. In this context, forecasting provides knowledge about future trends
and deals with the methods of acquiring this knowledge.
Due to dynamic nature of market phenomenon demand forecasting has become a continuous
process and requires regular monitoring of the situation.
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 organization 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:
(i) Market Research Operations to get the relevant and reliable information about the trends in
market.
(ii) A data processing and analyzing system to estimate and evaluate the sales performance in
various markets.
(iii) Proper co-ordination of steps (i) and (ii) and then to place the findings before the top
management for making final decision.

TECHNIQUES OF FORECASTING DEMAND

Survey Method: Survey method is generally used where purpose is to make short run forecast
of demand. Under this method, surveys are conducted to collect information about consumer’s
intentions and their future purchase-plans. This method includes:
(i) survey of potential consumers to elicit information on their intentions and plan;
(ii) opinion polling of experts, i.e., opinion survey of market experts and sales representative, and
through market studies and experiments.
The following techniques are used to conduct the survey of consumers and experts.
Consumer Survey Methods:

2
The consumer survey method of demand forecasting involves direct interview of the potential
consumers. It may be in the form of:
complete enumeration, or
sample survey.
These consumer survey methods are used under different conditions and for different purposes.
Their advantages and disadvantages are described below.
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 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.

Market Studies and Experiments:

An alternative method of collecting necessary information regarding demand is to carry out
market studies and experiments in consumer’s behavior under actual, though controlled, market
conditions. This method is known in common parlance as market experiment method. Under this
method, firms first select some areas of the representative markets - three or four cities having
similar features, viz., population, income levels, cultural and social background, occupational
distribution, choices and preferences of consumers. Then, they carry out market experiments by
changing prices, advertisement expenditure, and other controllable variables in the demand
function under the assumption that other things remain the same. The controlled variables may
be changed over time either simultaneously in all the markets or in the selected markets. After
such changes are introduced in the market, the consequent changes in the demand over a period
of time (a week, a fortnight, or month) are recorded. On the basis of data collected, elasticity
coefficients are computed. These coefficients are then used along, with the variables of demand
function to assess the demand for the product.