Unit – I

Demand Analysis
Demand is different from need, desire and wants. Needs are the basic necessities which are
essential for survival like food, shelter, water, and clothing. Wants are something we don’t
need actually, but it makes our life better. Desires are the extension of wants, something you
wish to have regardless of need and want. Demand in economics refers to the desire to
purchase the commodity-backed by purchasing power and willingness to pay for it.
The demand for a commodity is based on three elements –
 Willingness to buy
 Ability to buy
 Readiness to buy

Demand – definition
“The quantity of a commodity that consumer is willing to buy at a particular price during a
particular period of time”
The demand definition highlights the price of a commodity, quantity of a commodity and
period of time.
TYPES OF DEMAND
Individual and Market Demand:
Refers to the classification of demand of a product based on the number of consumers in the
market. Individual demand can be defined as a quantity demanded by an individual for a
product at a particular price and within the specific period of time. For example, Mr. X
demands 200 units of a product at Rs. 50 per unit in a week.
The individual demand of a product is influenced by the price of a product, income of
customers, and their tastes and preferences. On the other hand, the total quantity demanded
for a product by all individuals at a given price and time is regarded as market demand.
In simple terms, market demand is the aggregate of individual demands of all the consumers
of a product over a period of time at a specific price, while other factors are constant. For
example, there are four consumers of oil (having a certain price). These four consumers
consume 30 liters, 40 liters, 50 liters, and 60 liters of oil respectively in a month. Thus, the
market demand for oil is 180 liters in a month.
Organization/company and Industry Demand:
Refers to the classification of demand on the basis of market. The demand for the products of
an organization at given price over a point of time is known as organization demand. For
example, the demand for Toyota cars is organization demand. The sum total of demand for
products of all organizations in a particular industry is known as industry demand.
For example, the demand for cars of various brands, such as Toyota, Maruti Suzuki, Tata, and
Hyundai, in India constitutes the industry’ demand. The distinction between organization
demand and industry demand is not so useful in a highly competitive market.
This is due to the fact that in a highly competitive market, organizations have insignificant
market share. Therefore, the demand for an organization’s product is of no importance.
However, an organization can forecast the demand for its products only by analyzing the
industry demand.
Direct/Autonomous and Derived Demand:
Refers to the classification of demand on the basis of dependency on other products. The
demand for a product that is not associated with the demand of other products is known as
autonomous or direct demand. The autonomous demand arises due to the natural desire of an
individual to consume the product.
For example, the demand for food, shelter, clothes, and vehicles is autonomous as it arises
due to biological, physical, and other personal needs of consumers. On the other hand,
derived demand refers to the demand for a product that arises due to the demand for other
products.
For example, the demand for petrol, diesel, and other lubricants depends on the demand of
vehicles. Apart from this, the demand for raw materials is also derived demand as it is
dependent on the production of other products. Moreover, the demand for substitutes and
complementary goods is also derived demand.
Price Demand:
The demand is often studied in parlance to price, and is therefore called as a price demand.
The price demand means the amount of commodity a person is willing to purchase at a given
price. While studying the demand, we often assume that the other factors such as income of
the consumer, their tastes, and preferences, the prices of other related goods remain
unchanged. There is a negative relationship between the price and demand Viz. As the price
increases the demand decreases and as the price decreases the demand increases.
Income Demand:
The income demand refers to the willingness of an individual to buy a certain quantity at a
given income level. Here the price of the product, customer’s tastes and preferences and the
price of the related goods are expected to remain unchanged. There is a positive relationship
between the income and demand. As the income increases the demand for the commodity
also increases and vice-versa.
Cross Demand:
It is one of the important types of demand wherein the demand for a commodity depends not
on its own price, but on the price of other related products is called as the cross demand. Such
as with the increase in the price of coffee the consumption of tea increases, since tea and
coffee are substitutes to each other. Also, when the price of cars increases the demand for
petrol decreases, as the car and petrol are complimentary to each other.
Joint demand
Joint demand refers to the purchasing of one good at the same time as purchasing another
good. For example, in demanding a theatre ticket, transport to the theatre will also be
required, or purchasing a TV at the same time as a subscription to a film streaming service.
These goods are also called complementary goods.
Here, the demand for motor insurance is jointly demanded with motor vehicles. To drive and
own a motor vehicle requires motor insurance.
With joint demand the goods are complementary and the cross elasticity of demand between
them is significant. The cross elasticity of demand between complementary goods is negative
- which means that a fall in the price of motor vehicles results in an increase in demand for
motor insurance.
Composite demand
Composite demand refers to alternative uses of a single resource - most commodities have
many alternative uses. For example, if more sugar is used to make ice cream there is less
available to make chocolate. In this case, an increase in the demand for one good leads to a
fall in the supply available for another good.
Here, sugar is used as an ingredient for many products, each 'competing' to use it. In this case,
the demand for sugar to make ice creams reduces the available supply for other uses.
To conclude, many markets are interconnected, and it is nearly always the case that changes
in market conditions for one good in one market affect other goods in other markets.
Demand for Perishable and Durable Goods:
Refers to the classification of demand on the basis of usage of goods. The goods are divided
into two categories, perishable goods and durable goods. Perishable or non-durable goods
refer to the goods that have a single use. For example, cement, coal, fuel, and eatables. On the
other hand, durable goods refer to goods that can be used repeatedly.
For example, clothes, shoes, machines, and buildings. Perishable goods satisfy the present
demand of individuals. However, durable goods satisfy both present as well as future demand
of individuals. Therefore, consumers purchase durable items by considering its durability.
In addition, durable goods need replacement because of their continuous use. The demand for
perishable goods depends on the current price of goods and customers’ income, tastes, and
preferences and changes frequently, while the demand for durable goods changes over a
longer period of time.
Short-term and Long-term Demand:
Refers to the classification of demand on the basis of time period. Short-term demand refers
to the demand for products that are used for a shorter duration of time or for current period.
This demand depends on the current tastes and preferences of consumers.
For example, demand for umbrellas, raincoats, sweaters, long boots is short term and
seasonal in nature. On the other hand, long-term demand refers to the demand for products
over a longer period of time.
Generally, durable goods have long-term demand. The long-term demand of a product
depends on a number of factors, such as change in technology, type of competition,
promotional activities, and availability of substitutes. The short-term and long-term concepts
of demand are essential for an organization to design a new product.
DETERMINANTS OF DEMAND:

These are the factors that influence the decision of consumers to purchase a product or
service.
It is essential for organisations to understand the relationship between the demand and its
each determinant to analyse and estimate the individual and market demand for a commodity
or service.

The quantity demanded for a commodity or service is influenced by various factors, such as
price, consumers’ income and preferences, and growth of population.

For example, the demand for apparel changes with changes in fashion and tastes and
preferences of consumers.
This can be expressed as follows:

DA = f (PA, PO,………I, T)
where,
PA = Demand for commodity A
f = Function
PO = Price of other related products
I= Income of consumers
T= Tastes and preferences of consumers

Factors Influencing Individual Demand

When an individual intends to purchase a particular product, he/she may take into
consideration various factors, such as the price of the product, the price of substitutes, level of
income, tastes and preferences, and the features of the product.
These considerations determine the individual demand of the product. Let us now discuss the
factors that influence individual demand as follows:

Price of a commodity
The price of a commodity or service is generally inversely proportional to the quantity
demanded while other factors are constant. As per the law of demand, it implies that when the
price of the commodity or service rises, its demand falls and vice versa.
Price of related goods
The demand for a good or service not only depends on its own price but also on the price of
related goods. Two items are said to be related to each other if the change in price of one item
affects the demand for the other item. Related goods can be categorised as follow

 Substitute or competitive goods: These goods can be used interchangeably as

they serve the same purpose; thus, are the competitors of each other.

For example, tea and coffee, cold drink and juice, etc. The demand for a good or
service is directly proportional to the price of its substitute.

 Complementary goods: Complementary goods are used jointly; for example, car
and petrol.

There is an inverse relationship between the demand and price of complementary

goods. This implies that an increase in the price of one good will result in fall in
the demand of the other good.

For example, an increase in the price of mobile phones not only would lead to fall
in the quantity demanded but also lower the demand for mobile cover or scratch
guards.
Income of consumers
The level of income of individuals determines their purchasing power. Generally, income and
demand are directly proportional to each other. This implies that rise in the consumers’
income results in rise in the demand for a commodity.

However, the relationship depends on the type of commodities, which are listed below:

Let us discuss different types of commodities in detail.

 Normal goods: These are goods whose demand rises with an increase in the level
of income of consumers.

For example, the demand for clothes, furniture, cars, mobiles, etc. rises with an
increase in individuals’ income.

 Inferior goods: These are goods whose demand falls with an increase in
consumers’ income.
 For example, the demand for cheaper grains, such as maize and barley, falls when
individuals’ income increases as they prefer to purchase higher quality grains.
These goods are known as Giffen goods in economic parlance.

 Inexpensive goods or necessities of life: These are basic necessities in an

individual’s life, such as salt, matchbox, soap, and detergent. The demand for
inexpensive goods rises with an increase in consumers’ income until a certain level
after that it becomes constant.

Tastes and preferences of consumers

The demand for commodity changes with changes in the tastes and preferences of consumers
(which depend on customers’ customs, traditions, beliefs, habits, and lifestyles).

For example, the demand for burqas is high in gulf countries. In such countries, there may be
less or no demand for short skirts.

Consumers expectations
Demand for commodities also depends on the consumers’ expectations regarding the future
price of a commodity, availability of the commodity, changes in income, etc. Such
expectations usually cause rise in demand for a product.
For example, if a consumer expects a rise in the price of a commodity in the future, he/she
may purchase larger quantities of the commodity in order to stock it. Similarly, if a consumer
expects a rise in his/her income, he/she may purchase a commodity that was relatively
unaffordable earlier.

Credit policy
It refers to terms and conditions for supplying various commodities on credit. The credit
policy of suppliers or banks also affects the demand for a commodity. This is because
favourable credit policies generally result in the purchase of commodities that consumers
may not have purchased otherwise.

Favourable credit policies generally increase the demand for expensive durable goods such as
cars and houses.

For example, easy home and car loans offered by banks have led to a steep rise in the
demand for homes and cars respectively.

Factors Influencing Market Demand

Market demand is the sum total of all household (individual) demands. Therefore, all the
factors that affect individual demand also affect market demand as well. However, there are
certain other factors that affect market demand, which is as follows:

Size and composition of the population

Population size refers to the actual number of individuals in a population. An increase in the
size of a population increases the demand for commodities as the number of consumers
would increase.

Population composition refers to the structure of the population based on characteristics, such
as age, sex, and race. The composition of a population affects the demand for commodities as
different individuals would have different demands.
For example, a population with more youngsters will have higher demand for commodities
like t-shirts, jeans, guitars, bikes, etc. compared to the population with more elderly people.

Income distribution
Income distribution shows how the national income is divided among groups of individuals,
households, social classes, or factors of production. Unequal distribution of income results in
differences in the income status of different individuals in a nation.

For example, luxury goods will have higher demand. On the other hand, nations having
evenly distributed income would have higher demand for essential goods.

Climatic factors
The demand for commodities depends on the climatic conditions of a region such as cold,
hot, humid, and dry.

For example, the demand for air coolers and air conditioners is higher during summer while
the demand for umbrellas tends to rise during monsoon.

Government policy
This includes the actions taken by the government to determine the fiscal policy and
monetary policy such as taxation levels, budgets, money supply, and interest rates.
Government policies have direct impact on the demand for various commodities.

For example, if the government imposes high taxes (sales tax, VAT, etc.) on commodities,
their prices would increase, which would lead to a fall in their demand.

On the contrary, if the government invests in building of roads, bridges, schools, and
hospitals, the demand for bricks, cement, labour, etc., would rise.

LAW OF DEMAND:

The law of demand is given as, “If the price of a product falls, its quantity demanded
increases and if the price of the commodity rises, its quantity demanded falls, other things
remaining constant.”

Law of Demand Example

Take the example of an individual, who needs to purchase soft drinks. In the market, a pack
of three soft drinks is priced at ₹120 and the individual purchases the pack. In the next week,
the price of the pack is reduced to ₹105. This time the individual purchases two packs of soft
drinks. In the third week, the price of the pack has risen to ₹130.
This time the individual does not purchase the pack at all. It is a common observation that
consumers purchase a commodity in greater quantities when its price is low and vice versa.

This inverse relationship between the demand and price of a commodity is called the law of
demand.
Law of Demand Definition
The following are some popular definitions of the law of demand given by experts:
Robertson defines law of demand as “Other things being equal, the lower the price at which
a thing is offered, the more a man will be prepared to buy it.”
Marshall defines law of demand as “The greater the amount to be sold, the smaller must be
the price at which it is offered in order that it may find purchasers; or in other words, the
amount demanded increases with a fall in price and diminishes with a rise in price.”
Ferguson defines law of demand as “Law of Demand, the quantity demanded varies
inversely with price.”

Law of Demand Meaning

The law of demand represents a functional relationship between the price and quantity
demanded of a commodity or service.

The law states that the quantity demanded of a commodity increase with a fall in the price of
the commodity and vice versa while other factors like consumers’ preferences, level of
income, population size, etc. are constant.

Demand is a dependent variable, while the price is an independent variable.

Therefore, demand is a function of price and can be expressed as follows:

D= f (P)
Where,
D= Demand
P= Price
f = Functional Relationship

Assumptions of Law of Demand

The law of demand follows the assumption of ceteris paribus, which means that the other
factors remain unchanged or constant.
As mentioned earlier, the demand for a commodity or service not only depends on its price
but also on several other factors such as price of related goods, income, and consumer tastes
and preferences.

In the law of demand, other factors are assumed to remain constant while only the price of the
commodity changes.

Following are the assumptions of law of demand:

1. No expectation of future price changes or shortages
2. No change in consumer’s preferences
3. No change in the price of related goods
4. No change in consumer’s income
5. No change in size, age composition and sex ratio of the population
6. No change in the range of goods available to the consumers
7. No change in government policy

No expectation of future price changes or shortages

The law requires that the given price change for the commodity is a normal one and has no
speculative consideration. That is to say, the buyers do not expect any shortages in the supply
of the commodity in the market and consequent future changes in the prices. The given price
change is assumed to be final at a time.

No change in consumer’s preferences

The consumer’s taste, habits and preferences should remain constant. 4. No change in the
fashion: If the commodity concerned goes out the fashion the buyer may not buy more of it
even at a substantial price is reduced.

No change in the price of related goods

Prices of other goods like substitutes and supportive, i.e., complementary or jointly demanded
products remain unchanged. If the prices of other related goods change, the consumer’s
preferences would change which may invalidate the law of demand.

No change in consumer’s income

Throughout the operation of the law, the consumer’s income should remain the same. If the
level of a buyer’s income changes, he may buy more even at a higher price, invalidating the
law of demand.

No change in size, age composition and sex ratio of the population

For the operation of the law in respect of total market demand, it is essential that the number
of buyers and their preferences should remain constant. This necessitates that the size of
population as well as the age structure and sex ratio of the population should remain the same
throughout the operation of the law.

Otherwise, if the population changes, there will be additional buyers in the market, so the
total market demand may not contract with a rise in price.

No change in the range of goods available to the consumers

This implies that there is no innovation and arrival of new varieties of product in the market
which may distort consumer’s preferences.

No change in government policy

The level of taxation and fiscal policy of the government remains the same throughout the
operation of the law. Otherwise, changes in income-tax, for instance, may cause changes in
consumer’s income or commodity taxes and may lead to distortion in consumer’s preferences

The law of demand can be understood with the help of certain concepts, such as demand
schedule and demand curve.

Demand Schedule:
It is a tabular representation of different quantities of commodities that consumers are willing
to purchase at a specific price and time while other factors are constant.
Demand Schedule Definition
A full account of the demand, or perhaps we can say, the state of demand for any goods in a
given market at a given time should state what the volume (weekly) of sales would be at each
of a series of prices. Such an account, taking the form of a tabular statement, is known as a
demand schedule. - Benham
Types of Demand Schedule
Two types of demand schedule are:

1. Individual Demand Schedule

2. Market Demand Schedule
Individual demand schedule
It is a tabular representation of quantities of a commodity demanded by an individual at a
particular price and time, provided all other factors remain constant.
Market demand schedule
There is more than one consumer of a commodity in the market. Each consumer has his/her
own individual demand schedule. If the quantities of all individual demand schedules are
consolidated, it is called market demand schedule.

Demand Schedule Example

Assume that there are two individuals A and B in the market. They have a particular
individual demand for Apple. The individual demand schedules for A and B and the
consequent market demand are shown in Table

PRICE PER QUANTITY QUANTITY TOTAL MARKET

DOZEN DEMANDED BY A DEMANDED BY B DEMAND
(IN ₹ PER (IN DOZENS PER (IN DOZENS PER (A + B)
DOZEN) WEEK) WEEK) (IN DOZENS PER
WEEK)

(1) (2) (3) (4)

80 2 4 2+4=6

70 4 6 4 + 6 = 10

60 6 10 6 + 10 = 16

50 9 15 9 + 15 = 24

40 14 22 14 + 22 = 36

In Table, the individual demand schedule of A and B are depicted in the columns (2) and (3)
at different price levels shown in column (1). Column (4) depicts the market demand
schedule, which is the sum total of the individual demands of A and B. As shown in Table, at
a price level of ₹80 per dozen of apple, individual demand by A and B are 2 dozens per week
and 4 dozens per week respectively.
The market demand (assuming there are only two individuals in the market) is the sum total
of individual demands i.e. 6 dozens a week.

Demand Curve:
In economics, Demand curve is a graphical presentation of the demand schedule. It is
obtained by plotting a demand schedule.
The demand schedule can be converted into a demand curve by graphically plotting the
different combinations of price and quantity demanded of a product.
Types of Demand Curve
Similar to demand schedule, there are two types of demand curve.
2 Types of Demand Curve are:
1. Individual demand curve
2. Market demand curve
Individual demand curve
It is the curve that shows different quantities of a commodity which an individual is willing to
purchase at all possible prices in a given time period with an assumption that other factors are
constant.
Refer to Table 1 below, the individual demand schedules of A and B, when plotted on a
graph, will represent the individual demand curves, which are shown in Figures:

An individual demand curve slopes downwards to the right, indicating an inverse

relationship between the price and quantity demanded of a commodity.
Market demand curve
This curve is the graphical representation of the market demand schedule. A market demand
curve shows different quantities of a commodity which all consumers in a market are willing
to purchase at different price levels at a given time period, while other factors remaining
constant.
A market demand curve can be plotted by consolidating individual demand curves.
Therefore, market demand curve is the horizontal summation of individual demand curves.

Therefore, market demand curve is the horizontal summation of individual demand curves. In
the example given in Table 1 below, plotting the price of eggs (column 1) against the
summation of quantities demanded by A and B (column 4) would represent a market demand
curve. This is shown in Figure below:
A market demand curve, just like the individual demand curves, slopes downwards to the
right, indicating an inverse relationship between the price and quantity demanded of a
commodity.

The negative slope of a demand curve is a reflection of the law of demand.

However, it is important to understand the reasons why the demand curve slopes
downward to the right.
PRICE PER QUANTITY QUANTITY TOTAL MARKET
DOZEN DEMANDED BY A DEMANDED BY B DEMAND
(IN ₹ PER (IN DOZENS PER (IN DOZENS PER (A + B)
DOZEN) WEEK) WEEK) (IN DOZENS PER
WEEK)

(1) (2) (3) (4)

80 2 4 2+4=6

70 4 6 4 + 6 = 10

60 6 10 6 + 10 = 16

50 9 15 9 + 15 = 24

40 14 22 14 + 22 = 36

Why the demand curve slopes downward?

Generally, the demand curves slope downwards. It signifies that consumer buy more at lower
prices. We shall now try to understand why the demand curve slopes downward?

Exception of Law of Demand

There are certain exceptions to the law of demand that with a fall in price, the demand also
falls and there is an increase in demand with an increase in price.
In case of exceptions, the demand curve shows an upward slope and referred to
as exceptional demand curve. Figure shows an exceptional demand curve:

Exception to law of demand refers to conditions where the law of demand is not applicable.
1. Giffen goods
2. Articles of distinction goods
3. Consumers ignorance
4. Situations of crisis
5. Future price expectations

Giffen goods
Giffen good is a commodity that is unexpectedly consumed more as its price increases. Thus,
it is an exception to the law of demand. In the case of Giffen goods, the income effect
dominates over the substitution effect.

After the Irish Famine (1845), the potato crop failed due to plant disease, late blight, which
destroys both the leaves and the edible roots, or tubers, of the potato plant. Due to this, the
price of potatoes increased tremendously.

Despite the fact that the price increase made people to find substitutes of potatoes, they
moved away from luxury products so that their overall consumption of potatoes increased.
Articles of distinction goods
Named after economist, Thorstein Veblen, these commodities satisfy the desires of the upper-
class people in society. Veblen goods include those commodities whose demand is
proportional to their price and thus, they are exceptions to the law of demand.

These articles are purchased only by a few rich people to feel superior to the rest. For
example, diamonds, rare paintings, vintage cars, and antique goods are examples of Veblen
goods.

Consumers ignorance
Consumer ignorance is another factor that motivates people to purchase a commodity at a
higher price, which violates the law of demand. This results out of the consumer biases that a
high-priced commodity is better in quality than a low-priced commodity.

Situations of crisis
Crisis such as war and famine negate the law of demand. During crisis, consumers tend to
purchase in larger quantities with the purpose of stocking, which further accentuates the
prices of commodities in the market. They fear that goods would not be available in the
future.

On the other hand, at the time of depression, a fall in the price of commodities does not
induce consumers to demand more.

Future price expectations

When consumers expect a rise in the prices of commodities, they tend to purchase
commodities at existing high prices. For example, speculation of market strategists on an
increase in gold prices in the future induces consumers to purchase higher quantities in order
to stock gold.

On the contrary, if consumers expect a fall in the price of a commodity, they postpone the
purchase for the future.

ELASTICITY OF DEMAND:

Elasticity is a general measure of the responsiveness of an economic variable in response to a

change in another economic variable. Economists utilize elasticity to gauge how variables
affect each other. The three major forms of elasticity are price elasticity of demand, cross-
price elasticity of demand, and income elasticity of demand.
PRICE ELASTICITY OF DEMAND:
Price elasticity of demand demonstrates how a change in price affects the quantity demanded.
It is computed as the percentage change in quantity demanded over the percentage change in
price, and it will commonly result in a negative elasticity because of the law of demand.
The law of demand states that an increase in price reduces the quantity demanded, and it is
why demand curves are downwards sloping unless the good is a Giffen good. It is common to
simply drop the negative of the quotient.
Types of Price Elastic Demand:
There are 5 types of price elasticity of demand, mentioned in the figure below:
1. Perfectly Elastic Demand
2. Relatively Elastic Demand
3. Unitary Elastic Demand
4. Relatively Inelastic Demand
5. Perfectly Inelastic Demand
Perfectly Elastic Demand
When a small change (rise or fall) in the price results in a large change (fall or rise) in the
quantity demanded, it is known as perfectly elastic demand.
Under such type of elasticity of demand, a small rise in price results in a fall in demand to
zero, while a small fall in price causes an increase in demand to infinity. In such a case, the
demand is perfectly elastic or ep =∞.
Suppose product X is manufactured by a large number of sellers in the market. If a person
wants to buy the product X, he could choose among different firms for the purchase. Let’s
say, firm A increased the price of product X, above market equilibrium. As a result, the
demand for the product X for the firm would decrease to a great extent as the same product is
available with other sellers too at cheaper prices. Thus, the demand for product X of the firm
A is perfectly elastic.
The extent or degree of elasticity of demand defines the shape and slope of the demand curve.
Therefore, the elasticity of demand can be determined by the slope of the demand curve.
Flatter the slope of the demand curve, higher the elasticity of demand. In perfectly elastic
demand, the demand curve is represented as a horizontal straight line (in parallel to X-axis),
which is shown in Figure.
In Figure, DD is the demand curve. Thus, demand rises from OQ to OQ1 and so on, if the
price remains at OD. A slight fall in price will increase the demand to OX, whereas a slight
rise in price will bring demand to zero.
Example of perfectly elastic demand
Example: The demand schedule for bread is given below
PRICE OF BREAD (₹ PER PACKET) QUANTITY DEMANDED (PER MONTH)

23 100

23.4 70
Calculate the price elasticity of demand and determine the type of price elasticity.

Solution:
P= 23
Q = 100
P1= 23.04
Q1 =70
Therefore, change in the price of milk is:
ΔP = P1 – P
ΔP = 23.04 – 23
ΔP = 0.04
A change of ₹ 0.04 is a negligible change; thus, can be considered as zero.
Similarly, change in quantity demanded of bread is:
ΔQ = Q1–Q
ΔQ = 70–100
ΔQ = –30
In the above calculation, a change in demand shows a negative sign, which is ignored. This is
because price and demand are inversely related which can yield a negative value of demand
(or price).
Price elasticity of demand for bread is:
ep = ΔQ/ ΔP × P/ Q
ep = 30/0 × 23/100
ep = ∞
The price elasticity of demand for bread is ∞. Therefore, in such a case, the demand for bread
is perfectly elastic.

Relatively Elastic Demand

When a proportionate or percentage change (fall or rise) in price results in greater than the
proportionate or percentage change (rise or fall) in quantity demanded, the demand is said to
be relatively elastic demand.
In other words, a change in demand is greater than the change in price. Therefore, in this
case, elasticity of demand is greater than 1 and represented as ep > 1. The demand curve of
relatively elastic demand is gradually sloping, which is shown in Figure.

In Figure, DD is the demand curve that slopes gradually down with a fall in price. When
price falls from OP to OP1, demand rises from OQ to OQ1. However, the rise in demand
QQ1 is greater than the fall in price PP1.
Example of Relatively Elastic Demand
Example: The demand schedule for pens is given below:
PRICE OF PEN (₹ PER PEN) QUANTITY DEMANDED

25 50

20 100
Calculate the price elasticity of demand and determine the type of price elasticity.
Solution:
P= 25
Q = 50
P1= 20
Q1 =100
Therefore, a change in the price of pens is:
ΔP = P1 – P
ΔP = 20– 25
ΔP = – 5
In the above calculation, a change in price shows a negative sign, which is ignored. This is
because price and demand are inversely related which can yield a negative value of price (or
demand).
Similarly, a change in quantity demanded of pens is:
ΔQ = Q1–Q
ΔQ = 100–50
ΔQ = 50
Price elasticity of demand for pens is:
ep = ΔQ/ ΔP * P/ Q
ep = 50/5 * 25/50
ep = 5
The price elasticity of demand for bread is 5, which is greater than one. Therefore, in such a
case, the demand for pens is relatively elastic.

Unitary Elastic Demand

Unitary elastic demand occurs when a change (rise or fall) in price results in equivalent
change (fall or rise) in demand.
The numerical value for unitary elastic demand is equal to one, i.e., ep =1. The demand curve
for unitary elastic demand is a rectangular hyperbola, which is shown in Figure.

In Figure, DD is the unitary elastic demand curve sloping uniformly from left to the right.
Here, the demand falls from OQ to OQ2 when the price rises from OP to OP2. On the
contrary, when price falls from OP to OP1, demand rises from OQ to OQ1.
Example of Unitary Elastic Demand
Example: The demand schedule for cloth is given as follows:
PRICE OF CLOTH (₹ PER LITRE) QUANTITY DEMANDED

30 100

15 150
Calculate the price elasticity of demand and determine the type of price elasticity.
Solution:
P= 30
Q = 100
P1 = 15
Q1 = 150

Therefore, change in the price of cloth is:

ΔP = P1 – P
ΔP = 15 – 30
ΔP = –15
In the above calculation, a change in price shows a negative sign, which is ignored. This is
because price and demand are inversely related which can yield a negative value of price (or
demand).
Similarly, change in quantity demanded of cloth is:
ΔQ = Q1 – Q
ΔQ = 150 –100
ΔQ = 50
Price elasticity of demand for cloth is:
ep = ΔQ/ ΔP × P/ Q
ep = 50/15 × 30/100
ep = 1
The price elasticity of demand for cloth is 1. Therefore, in such a case, the demand for milk is
unitary elastic.

Relatively Inelastic Demand

When a percentage or proportionate change (fall or rise) in price results in less than the
percentage or proportionate change (rise or fall) in demand, the demand is said to
be relatively inelastic demand.
In other words, a change in demand is less than the change in price. Therefore, the elasticity
of demand is less than 1 and represented as ep < 1. The demand curve of relatively inelastic
demand is rapidly sloping, which is shown in Figure.

In Figure, DD is the demand curve that slopes steeply with a fall in price. When price falls
from OP to OP1, the demand rises from OQ to OQ1. However, the rise in demand QQ1 is
less than the fall in price PP1.
Example of Relatively Inelastic Demand
Example: The demand schedule for milk is given below:
PRICE OF MILK(₹ PER LITRE) QUANTITY DEMANDED

15 90

20 85
Calculate the price elasticity of demand and determine the type of price elasticity.
Solution: P= 15
Q = 90
P1= 20
Q1 =85
Therefore, a change in the price of milk is:
ΔP = P1 – P
ΔP = 20 – 15
ΔP = 5
Similarly, a change in quantity demanded of milk is:
ΔQ = Q1 – Q
ΔQ = 85 – 90
ΔQ = –5
In the above calculation, a change in demand shows a negative sign, which is ignored. This is
because price and demand are inversely related which can yield a negative value of demand
(or price).
Price elasticity of demand for milk is:
ep =DQ/DP × P/ Q
ep = 5/5 × 15/90
ep = 0.2
The price elasticity of demand for milk is 0.2, which is less than one. Therefore, in such a
case, the demand for milk is relatively inelastic.

Perfectly Inelastic Demand

When a change (rise or fall) in the price of a product does not bring any change (fall or rise)
in the quantity demanded, the demand is called perfectly inelastic demand.
In this case, the elasticity of demand is zero and represented as ep = 0. Graphically, perfectly
inelastic demand curve is represented as a vertical straight line (parallel to Y-axis). Figure
shows the perfectly inelastic demand curve.

In Figure, DD is the demand curve. Thus, it can be observed that even when there is a change
in the price from OP1 to OP2, quantity demanded remains the same at OQ1.
Let us understand perfectly inelastic demand with the help of an example.
Example of Perfectly Inelastic Demand
Example: The demand schedule for notebooks is given below:
PRICE OF NOTEBOOK (₹ PER QUANTITY DEMANDED (PER
NOTEBOOK) MONTH)

40 100

30 100
Calculate the price elasticity of demand and determine the type of price elasticity.
Solution:
P= 40
Q = 100
P1= 30
Q1 =100

Therefore, a change in the price of notebooks is:

ΔP = P1 – P
ΔP = 30 – 40
ΔP = –10
In the above calculation, the change in price shows a negative sign, which is ignored. This is
because price and demand are inversely related which can yield a negative value of price (or
demand).
Similarly, a change in quantity demanded of notebooks is:
ΔQ = Q1 – Q
ΔQ = 100 – 100
ΔQ =0
Price elasticity of demand for notebook is:
ep = ΔQ/ ΔP × P/ Q
ep = 0/10 ×40/100
ep = 0

The price elasticity of demand for notebook is 0. Therefore, in such a case, the demand for a
notebook is perfectly inelastic.

Types of Price Elasticity of Demand: Condition

NUMERICAL TYPE OF PRICE CONDITION
VALUE ELASTICITY OF
DEMAND

=∞ Perfectly elastic Greater change in demand in response to

demand percentage or smaller change in the price.

=0 Perfectly inelastic No change in demand in response to percentage

demand or smaller change in the price.

>1 Relatively elastic A change in demand is greater than the change

demand in price.

<1 Relatively inelastic A change in demand is less than the change in

demand price.

=1 Unitary elastic A change in demand is equivalent to change in

demand price.

INCOME ELASTICITY OF DEMAND:

Income elasticity of demand measures the relationship between the consumer’s income and
the demand for a certain good. It may be positive or negative, or even non-responsive for a
certain product. The consumer’s income and a product’s demand are directly linked to each
other, dissimilar to the price-demand equation.
Demand for a normal good grows with an increase in customer wages and vice versa,
assuming other factors of demand are constant. Income elasticity of demand is the level of
response in demand to the adjustment in customer income. The larger the income elasticity of
demand for a certain product, the greater the shift in demand there is from a change in
consumer income.
Income Elasticity of Demand Measurement
The following formula is used:
Income Elasticity of Demand = % Change in Demand Quantity / % Change in Income
of Consumer
Where:
 % Change in Demand Quantity = Change in Demand Quantity / Original Demand
Quantity
 % Change in Income of Consumer = Change in Income of Consumer / Original
Income of Consumer
Income Elasticity of Demand Types
Based on numerical value, the income elasticity of demand is divided into three classes as
follows:
1. Positive income elasticity of demand
It refers to a condition in which demand for a commodity rises with a rise in consumer
income and declines with a decline in consumer income. Commodities with positive income
elasticity of demand are normal goods.

The upward slope implies that the rise in income contributes to a rise in demand and vice
versa. There are three forms of positive income elasticity of demand stated as follows:
 Unitary – The positive income elasticity of demand will be unitary if the
proportionate change in the amount of a product demanded equals the change in
consumer income in due proportion.
 More than unitary – The positive income elasticity of demand will be more than
unitary if the proportionate change in the amount of a product demanded is higher
than the change in consumer income in due proportion.
 Less than unitary – If the change in the amount of a product demanded in due
proportion is less than the change in consumer income in due proportion, positive
income elasticity of demand will be less than unitary.
2. Negative income elasticity of demand
It refers to a condition in which demand for a commodity decreases with a rise in consumer
income and increases with a fall in consumer income. Inferior goods are such commodities.
For example, the demand for millet will decrease if the income of consumers increases since
they will prefer to purchase wheat instead of millet. Thus, millet is an inferior good to wheat
for customers.
The downward slope implies that the increase in income contributes to a fall in demand, and
a decrease in income causes a rise in demand.

3. Zero income elasticity of demand

It corresponds to the situation when there is no impact of rising household income on
commodity production. Such goods are termed essential goods. For example, a high-income
consumer and a low-income consumer will need salt in the same quantity.

Uses of Income Elasticity of Demand

1. Forecasting demand
Forecasting demand applies to the idea that the income elasticity of demand tends to predict
demand for commodities in the future. If there is a substantial change in wages, the change in
demand for products will also be significant. This is because when buyers become aware of a
shift in income, they will change their preferences and expectations for such products.
2. Investment decisions
The idea of national income is very important to businesses as it helps them to decide which
sectors they should invest their money in. In general, investors tend to invest in markets
where they can predict that the demand for commodities is related to a growth in national
income or where the income elasticity of demand is greater than negligible.

CROSS ELASTICITY OF DEMAND:

Cross-price elasticity measures how sensitive the demand of a product is over a shift of a
corresponding product price. Often, in the market, some goods can relate to one another. This
may mean a product’s price increase or decrease can positively or negatively affect the other
product’s demand.

Understanding Cross-Price Elasticity

While explaining cross-price elasticity, there are three categories of product relationships to
examine.

1. First, there are products that are closely related to one another – sometimes known as
substitute products. These products compete for the same customers in the market.
2. Second, there are products that are consumed together. The demand for one product
directly affects the consumption of related products. These products are known as
complementary products.
3. The final group belongs to products that are entirely unrelated to one another. These
products do not affect the consumption of one another.
4. By having a clear understanding of the concepts behind product relationships,
business owners can strategically compete in their industry or stock their inventories
accordingly. For example, lowering the price of printers could lead to increased
purchases of toners and ink. The more printers consumers buy, the more revenues are
generated by selling complementary products.

Cross-Price Elasticity Formula

Where:

 Qx = Average quantity between the previous quantity and the changed quantity,
calculated as (new quantityX + previous quantityX) / 2
 Py = Average price between the previous price and changed price, calculated as (new
pricey + previous pricey) / 2
 Δ = The change of price or quantity of product X or Y

Note: In cross-price elasticity, unlike in income elasticity, the ΔQx and ΔPy are calculated by
finding the averages between the change in either price or quantity demanded.
Cross-Price Elasticity of Substitute Products

For substitute products, an increase in the price of a substitute product increases the demand
for the competing product. This is often because consumers always try to maximize utility.
The less they spend on something, the higher the perceived satisfaction.

Similarly, when the competing product price is reduced, the mirroring effect is depicted by an
increase in demand for the substitute product. In either of these scenarios, the change will
either drive a negative or a positive cross-price elasticity. For cross-price elasticity, where
there is an increase in the price of the competing products, there will be a positive coefficient.

Practical Example

Two competing airlines – A and B – are a perfect example of substitute products. If Airline A
decides to increase their flights’ round-trip ticket price by even a small margin, consumers
will likely notice the difference. As a result, more people will opt for Airline B because it is
cheaper.

Categories of Substitute Products

Substitute products can be categorized as either close or weak.

Close Substitutes

A close substitute is realized when a minimal increase in price leads to a large demand
increase of the substitute product. The graph below shows this interpretation.

Weak Substitutes

For a weak substitute, a large increase in the price of product X will lead to only a small
increase in demand for product Y. See the graph below for the interpretation.
Cross-Price Elasticity of Complementary Products

Complementary products have the opposite effect. If the price of one product increases, the
demand for the complementary product decreases. To consumers, the increased joint cost will
force them to buy less.

Practical Example

An example of a complementary product is an eBook reader. If the price of an eBook reader

drops, the consumption of eBooks and audiobooks will increase because more consumers can
afford the reader.

Categories of Complementary Products

Complementary products can either be close or weak complements.

Close Complements

In the case of a strong complement product, a minimal price decrease leads to a large increase
in demand for the complement product. The graph below shows this impact.
Weak Complements

For weak complementary products, a large price decrease leads to a small increase in demand
for the complementing products. The graph below shows this shift.

Cross-Price Elasticity of Unrelated Products

Unrelated products do not affect one another. This means the cross-effect elasticity is zero,
and the graph would be represented by a vertical line.

DEMAND FORECASTING:
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 firm’s 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 company’s 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

company’s 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 firm’s limited resources.

Forecast may be classified into (i) general and (ii) specific. The general forecast may
generally be useful to the firm. Many firms require separate forecasts for specific products
and specific areas, for this general forecast is broken down into specific forecasts.

There are different forecasts for different types of products like:

(i) Forecasting demand for nondurable consumer goods,

(ii) Forecasting demand for durable consumer goods,

(iii) Forecasting demand for capital goods, and

(iv) Forecasting demand for new-products.

Non-Durable Consumer Goods:

These are also known as ‘single-use consumer goods’ or perishable consumer goods. These
vanish after a single act of consumption. These include goods like food, milk, medicine,
fruits, etc. Demand for these goods depends upon household disposable income, price of the
commodity and the related goods and population and characteristics. Symbolically,

Dc =f(y, s, p, pr) where

Dc = the demand for commodity с

у = the household disposable income

s = population

p = price of the commodity с

pr = price of its related goods

(i) Disposable income expressed as Dc = f (y) i.e. other things being equal, the demand for
commodity с depends upon the disposable income of the household. Disposable income of
the household is estimated after the deduction of personal taxes from the personal income.
Disposable income gives an idea about the purchasing power of the household.

(ii) Price, expressed as Dc = f (p, p r) i.e. other things being equal, demand for commodity с
depends upon its own price and the price of related goods. While the demand for a
commodity is inversely related to its own price of its complements. It is positively related to
its substitutes.’ Price elasticities and cross elasticities of non-durable consumer goods help in
their demand forecasting.

(iii) Population, expressed as Dc= f (5) i.e. other things being equal, demand for commodity с
depends upon the size of population and its composition. Besides, population can also be
classified on the basis of sex, income, literacy and social status. Demand for non-durable
consumer goods is influenced by all these factors. For the general demand forecasting
population as a whole is considered, but for specific demand forecasting division of
population according to different characteristics proves to be more useful.

Durable Consumer Goods:

These goods can be consumed a number of times or repeatedly used without much loss to
their utility. These include goods like car, T.V., air-conditioners, furniture etc. After their
long use, consumers have a choice either these could be consumed in future or could be
disposed of.

The choice depends upon the following factors:

(i) Whether a consumer will go for the replacement of a durable good or keep on using it after
necessary repairs depends upon his social status, level of money income, taste and fashion,
etc. Replacement demand tends to grow with increase in the stock of the commodity with the
consumers. The firm can estimate the average replacement cost with the help of life
expectancy table.
(ii) Most consumer durables are consumed in common by the members of a family. For
instance, T.V., refrigerator, etc. are used in common by households. Demand forecasts for
goods commonly used should take into account the number of households rather than the
total size of population. While estimating the number of households, the income of the
household, the number of children and sex- composition, etc. should be taken into account.

(iii) Demand for consumer durables depends upon the availability of allied facilities. For
example, the use of T.V., refrigerator needs regular supply of power, the use of car needs
availability of fuel, etc. While forecasting demand for consumer durables, the provision of
allied services and their cost should also be taken into account.

(iv) Demand for consumer durables is very much influenced by their prices and their credit
facilities. Consumer durables are very much sensitive to price changes. A small fall in their
price may bring large increase in demand.

Forecasting Demand for Capital Goods:

Capital goods are used for further production. The demand for capital good is a derived one.
It will depend upon the profitability of industries. The demand for capital goods is a case of
derived demand. In the case of particular capital goods, demand will depend on the specific
markets they serve and the end uses for which they are bought.

The demand for textile machinery will, for instance, be determined by the expansion of
textile industry in terms of new units and replacement of existing machinery. Estimation of
new demand as well as replacement demand is thus necessary.

Three types of data are required in estimating the demand for capital goods:

(a) The growth prospects of the user industries must be known,

(b) the norm of consumption of the capital goods per unit of each end-use product must be
known, and

(c) the velocity of their use.

Forecasting Demand for New Products:

The methods of forecasting demand for new products are in many ways different from those
for established products. Since the product is new to the consumers, an intensive study of the
product and its likely impact upon other products of the same group provides a key to an
intelligent projection of demand.

Joel Dean has classified a number of possible approaches as follows:

(a) Evolutionary Approach:

It consists of projecting the demand for a new product as an outgrowth and evolution of an
existing old product.

(b) Substitute Approach:

According to this approach the new product is treated as a substitute for the existing product
or service.

(c) Growth Curve Approach:

It estimates the rate of growth and potential demand for the new product as the basis of some
growth pattern of an established product.

(d) Opinion-Poll Approach:

Under this approach the demand is estimated by direct enquiries from the ultimate
consumers.

(e) Sales Experience Approach:

According to this method the demand for the new product is estimated by offering the new
product for sale in a sample market.

(f) Vicarious Approach:

By this method, the consumers’ reactions for a new product are found out indirectly through
the specialised dealers who are able to judge the consumers’ needs, tastes and preferences.

The various steps involved in forecasting the demand for non-durable consumer goods are the
following:

(a) First identify the variables affecting the demand for the product and express them in
appropriate forms, (b) gather relevant data or approximation to relevant data to represent the
variables, and (c) use methods of statistical analysis to determine the most probable
relationship between the dependent and independent variables.

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) Consumer’s Survey Method or Survey of Buyer’s 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 producer’s 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 curve—upward or downward—
shows the trend. A simple illustration of this method is given in Table 2.

Table 2: Sales of Firm

Year Sales (Rs. 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 у on x.

In order to solve the equation v = a + bx, we have to make use of the following normal
equations:

Σ y = na + b ΣX

Σ xy =a Σ x+b Σ 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 firm’s 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 =
P°8. 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 + с 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 Yd 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.

Utility of Forecasting:

Forecasting reduces the risk associated with business fluctuations which generally produce
harmful effects in business, create unemployment, induce speculation, discourage capital
formation and reduce the profit margin. Forecasting is indispensable and it plays a very
important part in the determination of various policies. In modem times forecasting has been
put on scientific footing so that the risks associated with it have been considerably minimised
and the chances of precision increased.

Forecasts in India:

In most of the advanced countries there are specialised agencies. In India businessmen are not
at all interested in making scientific forecasts. They depend more on chance, luck and
astrology. They are highly superstitious and hence their forecasts are not correct. Sufficient
data are not available to make reliable forescasts. However, statistics alone do not forecast
future conditions. Judgment, experience and knowledge of the particular trade are also
necessary to make proper analysis and interpretation and to arrive at sound conclusions.

Conclusion:

Decision support systems consist of three elements: decision, prediction and control. It is, of
course, with prediction that marketing forecasting is concerned. The forecasting of sales can
be regarded as a system, having inputs apprises and an output.

This simplistic view serves as a useful measure for the analysis of the true worth of sales
forecasting as an aid to management. In spite of all these no one can predict future economic
activity with certainty. Forecasts are estimates about which no one can be sure.

Criteria of a Good Forecasting Method:

There are thus, a good many ways to make a guess about future sales. They show contrast in
cost, flexibility and the adequate skills and sophistication. Therefore, there is a problem of
choosing the best method for a particular demand situation.

There are certain economic criteria of broader applicability. They are:

(i) Accuracy, (ii) Plausibility, (iii) Durability, (iv) Flexibility, (v) Availability, (vi) Economy,
(vii) Simplicity and (viii) Consistency.

(i) Accuracy:

The forecast obtained must be accurate. How is an accurate forecast possible? To obtain an
accurate forecast, it is essential to check the accuracy of past forecasts against present
performance and of present forecasts against future performance. Accuracy cannot be tested
by precise measurement but buy judgment.

(ii) Plausibility:
The executive should have good understanding of the technique chosen and they should have
confidence in the techniques used. Understanding is also needed for a proper interpretation of
results. Plausibility requirements can often improve the accuracy of results.

(iii) Durability:

Unfortunately, a demand function fitted to past experience may back cost very greatly and
still fall apart in a short time as a forecaster. The durability of the forecasting power of a
demand function depends partly on the reasonableness and simplicity of functions fitted, but
primarily on the stability of the understanding relationships measured in the past. Of course,
the importance of durability determines the allowable cost of the forecast.

(iv) Flexibility:

Flexibility can be viewed as an alternative to generality. A long lasting function could be set
up in terms of basic natural forces and human motives. Even though fundamental, it would
nevertheless be hard to measure and thus not very useful. A set of variables whose co-
efficient could be adjusted from time to time to meet changing conditions in more practical
way to maintain intact the routine procedure of forecasting.

(v) Availability:

Immediate availability of data is a vital requirement and the search for reasonable
approximations to relevance in late data is a constant strain on the forecasters patience. The
techniques employed should be able to produce meaningful results quickly. Delay in result
will adversely affect the managerial decisions.

(vi) Economy:

Cost is a primary consideration which should be weighted against the importance of the
forecasts to the business operations. A question may arise: How much money and managerial
effort should be allocated to obtain a high level of forecasting accuracy? The criterion here is
the economic consideration.

(vii) Simplicity:

Statistical and econometric models are certainly useful but they are intolerably complex. To
those executives who have a fear of mathematics, these methods would appear to be Latin or
Greek. The procedure should, therefore, be simple and easy so that the management may
appreciate and understand why it has been adopted by the forecaster.

(viii) Consistency:

The forecaster has to deal with various components which are independent. If he does not
make an adjustment in one component to bring it in line with a forecast of another, he would
achieve a whole which would appear consistent.

Conclusion:
In fine, the ideal forecasting method is one that yields returns over cost with accuracy, seems
reasonable, can be formalised for reasonably long periods, can meet new circumstances
adeptly and can give up-to-date results. The method of forecasting is not the same for all
products.

There is no unique method for forecasting the sale of any commodity. The forecaster may try
one or the other method depending upon his objective, data availability, the urgency with
which forecasts are needed, resources he intends to devote to this work and type of
commodity whose demand he wants to forecast.