UNIT – II

DEMAND ANALYSIS
1. What is demand? Explain its types of demand?

INTRODUCTION

It is necessary to estimate the demand for the goods or services before they are
produced and provided. The producers, for this purpose, heavily depend upon the data
relating to the pattern of consumption of these goods and services. The demand analysis
provides them the basis to take decisions relating to volume of production (How many
products required to produce), capital to be invested (How much amount to be invested) and
so on.

DEMAND:

A product or service is said to have demand when three conditions are satisfied.

(a) Desire to acquire - Desire of the consumer to buy the + Product

(b) Willingness to pay - His willingness to buy the product and
(c) Ability to pay - Ability to pay the specified price for it.

TYPES OF DEMAND:
(1) Consumer goods v/s producer goods:

Consumer Goods:

Consumer goods refers to such products and services which are satisfying
consumer need. Consumer goods are those which are available for ultimate
consumption. Consumer goods are needed for direct consumption and gives direct and
immediate satisfaction.

For Ex : Bread, Apple, Rice and so on

Producer Goods:

Producer goods are those which are used for producing other goods. Producer
goods are those which are used for further processing or production of goods services to cash
income. These goods gives satisfaction indirectly.

For Ex: Machines, Steel, Tools, etc.

There could be cases where a given product may be both producer and also
consumer goods.

For Ex:
 A farmer having ten bags of paddy may use five bags for his personal
consumption and other five bags as seeds for the next crop. In such a case, paddy is both
producer good and consumer good.

2. Autonomous Demand v/s Derived Demand:

Autonomous Demand:

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

For Ex : Demand for two wheelers is autonomous demand.

Derived Demand:

In case of derived demand, the demand for a product arises due to purchase of
another product.
For Ex: (1) Demand for petrol because two wheelers
(2) If there is a demand for house, then there is
a demand for cement, iron and bricks.

3. Durable Goods v/s Perishable Goods:

Durable Goods:

Durable Goods are those which give service relatively for a long period.

For Ex : T.V., Washing Machine, etc.

Perishable Goods:

Perishable Goods are those which give service relatively for a short period.

For Ex: Milk, vegetables, fish, rice, etc.

4. Firm Demand v/s Industry Demand:

Firm Demand:

The firm is a single business unit (single company). The term “Firm Demand”
denotes demand for a particular product of a particular firm (company).
For Ex: The demand of LG TVs is referred as Firm Demand
Or Company Demand.
Industry Demand:

Industry refers to the group of companies producing same type of

product. Industry Demand refers to the total demand for the product of a particular industry.
 For Ex: Demand for TVs produced by all companies is
Referred as Industry Demand.

5. New Demand v/s Replacement :

New Demand refers to the demand for the new products and it is addition to the
existing stock.

Replacement Demand:

Replacement demand may also refer to the demand resulting out of replacing the
existing asset with the new ones.
For Ex: Purchasing a new TV and replacing with old is
Referred as replacement demand.
6. Total market and segment market demand :

Total Market Demand :

Total market demand means the total demand for a product in a given total
market.
For Ex: If a product selling in Andhra Pradesh total demand
means that total demand to the that product in A.P.

Segment Market Demand:

Segment market demand refers to the demand of product in particular market

segment of a total market.

Market segment demand means the demand in a particular area.

For Ex : Demand in Nellore segment of total A.P. Market.

2. What is demand analysis? Explain determinants of demand?

DEMAND ANALYSIS:
Demand analysis is a research done to estimate or find out the customer demand for a
product or service in a particular market. Demand analysis is one of the important
consideration for a variety of business decisions like determining sales forecasting, pricing
products/services, marketing and advertisement spending, manufacturing decisions,
expansion planning etc.
For a new company, the demand analysis can tell whether a substantial demand
exists for a product/ service and given the other information like number of competitors, size
of competitors, industry growth etc. it helps to decide if the company could enter the market
and generate enough returns to sustain its business.
FEATURES OF DEMAND ANALYSIS:
The following are the main features or characteristics of demand that the marketer must keep
in mind while analyzing the demand for its product:

1. Specific quantity:
The demand is the specific quantity that a consumer is willing to purchase. Thus, it
is expressed in numbers.
2. Demand per unit of time:
The demand must mean the demand per unit of time, per month, per week, per day.
3. Price:
The demand is always at a price, i.e. any change in the price of a commodity will
bring about a certain change in its quantity demanded.
4. Market:
The demand is always in a market, a place where a set of buyers and sellers meet.
The market needs not to be a geographical area.
Thus, demand plays a crucial role in the success of any business enterprise. And it must
be remembered that demand is always at a price and a particular time period in which it is
created. Such as demand for woolen clothes will be more in winters than in any other season.
Hence, demand analysis is always done in terms of the price and the relevant time period.

Objectives of Demand analysis:

(1) Forecasting sales,

(2) Salesman’s Performance.

(1) Forecasting sales:

Forecasting refers to predicting the future level of sales on the basis of current and past
trends. This is perhaps the most important use of demand studies. True, sales forecast is the
foundation for planning all phases of the company’s operations.

(2) Salesman’s Performance.

It provides basis for appraising salesman’s performance and for setting his quote.

*** Factors determining the Demand (or)Demand Determined:

The demand for a particular product depends on several factors. The following factors
determine the demand for a given product.
(a) Price of the product (P)
(b) Income of the consumer (I)
(c) Taste and performance of the consumer (T)
(d) Price of related goods (Substitute or complementary) (Pr)
 (e) Expectations about the prices in future (Ep)
(f) Expectations about the income in future (Ei)
(g) Size of the population (Sp)
(h) Distribution of consumers over different regions (Dei)
(i) Advertising effort (Ac)
(j) Any other factors capable of affecting the demand (O)

(1) Price of the product (P) :

The most important factor which influence the demand is price. A decrease in the
price of a normal good leads to rise in demand of a product. Similarly, an increase in the
price will reduce the demand for a commodity. The relation between price and demand is
inverse relationship.

(2) Income of the consumer (I)

When the income of the consumer is increased, the consumer purchase more
quality of goods. When the income of consumer is decreased, the consumer purchase less
quality of goods. The income of the consumer and demand of a product moves in the same
direction.

(3) Tastes and preference of the consumer (T) :

We know it quit well that the change in tastes and preferences of a consumer in
favor of a commodity results in increasing demand for a commodity, while if this change is
against the commodity it results in smaller demand for the commodity.

(4) Price of the related goods (Pr) (Substitute and complementary

Goods):
When a change in the price of one commodity influences the demand for other
commodity. The related commodities are two types :
(a) Substitutes
(b) Complements

(a) Substitute Goods :

When the price of one commodity increase, then the demand for another product
will increase.
For Ex: In case of Tea and Coffee, when coffee price increased then the
demand for tea will increase. Likewise (i.e., both increase together or decrease together)

(b) Complementary goods :

When the price of one commodity, will increase, then the demand for another
product will decrease.
For Ex: Bread and butter
Pen and ink
 Petrol and automobiles

(5) Expectations about future price of the product (Ep) :

If the consumer expects future price of the product will increase, then the
consumer purchase more quantity of goods at present. Similarly, if the price of the product in
the future will decrease, then the demand at present will decrease.
(6) Expectations about future income of the consumer (Ef)
In case, the consumer expects a higher income in future, he spends more at
present to purchase more quantity of goods. Similarly, the consumer expects a lower income
in future, he spends less at present to purchase less quantity of goods.
(7) Advertisement (AE):
If we can spent more amount on advertisement to influence the consumer, the
demand will increase, if advertisement expenditure is less, then the demand will decrease

(8) Consumer-Credit Facility: The availability of credit to the consumer also determines the
demand for a product. The credit extended by sellers, banks, friends, relatives or from other
sources induces a consumer to buy more than what would have not been possible in the
absence of the credit. Thus, the consumers with more borrowing capacity consumes more
than the ones who borrow less.

3. Explain law of demand?

LAW OF DEMAND:

Meaning:

When the price of a product will increase, then the demand for the product will
decrease. Similarly, when the price of the product decreased, the demand will increase when
remaining things are constant.

Example:

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.

Definitions:

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 lower
prices and buy less at higher prices, other things remaining the same.

Law of Demand:

According to the law of demand, there is inverse relationship between price and
quantity demanded, other things remaining the same. These other things which are
assumed to be constant are the tastes and preferences of the consumer, the income of the
consumer, and the prices of related goods.

The chart below depicts the law of demand using a demand curve, which is always
downward sloping. Each point on the curve (A, B, C) reflects a direct correlation between
quantity demanded (Q) and price (P). So, at point A, the quantity demanded will be Q1 and
the price will be P1, and so on.

Reasons for the Law of Demand: Why does Demand Curve Slope Downward?
We have explained abovethat, when price falls the quantity demanded of a commodity rises
and vice versa, other things remaining the same. It is due to this law of demand that demand
curve slopes downward to the right. Now, the important question is why the demand curve
slopes downward, or in other words, why the law of demand which describes inverse price-
demand relationship is valid.

It may however be mentioned here that there are two factors due to which quantity
demanded increases when price falls:
(1) Income effect,

(2) Substitution effect.

(1) Income Effect:

When the price of a commodity falls the consumer can buy more quantity of the commodity
with his given income. Or, if he chooses to buy the same amount of quantity as before, some
money will be left with him because he has to spend less on the commodity due to its lower
price.
In other words, as a result of fall in the price of a commodity, consumer’s real income or
purchasing power increases. This increase in real income induces the consumer to buy more
of that commodity. This is called income effect of the change in price of the commodity. This
is one reason why a consumer buys more of a commodity when its price falls.

(2) Substitution Effect:

The other important reason why the quantity demanded of a commodity rises as its price falls
is the substitution effect. When price of a commodity falls, it becomes relatively cheaper than
other commodities. This induces the consumer to substitute the commodity whose price has
fallen for other commodities which have now become relatively dearer. As a result of this
substitution effect, the quantity demanded of the commodity, whose price has fallen, rises.

Understanding law of demand using demand schedule:

This law can be explained with the help of demand schedule and demand curve as presented
below:

Demand Schedule is a tabular representation of various combinations of price and quantity

demanded by a consumer during a particular period of time. An imaginary demand schedule
is given below:

Price/kg (in Rs.) Quantity Demanded(in

KG)

10 10

8 20

6 30

4 40

2 50

The above demand schedule shows negative relationship between price and quantity
demanded for a commodity.

Initially, when a price of a good is Rs.10 per kg, quantity demanded by the consumer is 10
kg.

As the price decrease from Rs.10 per kg to Rs.8 per kg and then to Rs.6 per kg, quantity
demanded by the consumer increases from 10 kg to 20 kg and then to 30 kg respectively.

Further, fall in price from Rs.6 per kg to Rs.4 per kg and then to Rs.2 per kg, results in
increase in quantity demanded by the consumer from 30 kg to 40 kg and then to 50 kg,
respectively.
Thus, from the above schedule we can conclude that there is opposite inverse relationship in
between price and quantity demanded for a commodity.

Exceptions to the law of Demand :

There are certain exceptions to the law of demand in other words, the law of
demand is not applicable in the following cases.
(1) Giffen Goods:
People whose incomes are low purchase more of a commodity such broken rice,
bread, potato (which is their staple food) when its prices rises. Inversely when its price falls,
instead of buying more, they buy less of this commodity and use the savings for the purchase
of better goods such as meat. This phenomenon is called Giffens paradox and such goods are
giffen goods.
(2) Veblen Goods:
Products such as jewels, diamonds and so on confer distinction on the part of the
user. In such case, the consumers tend to buy more goods when price increased, and less
purchase when price decreased. Such goods are called Veblen Goods.
3. Fear of Shortage:
If the consumers expect a shortage or scarcity of a particular commodity in the near future,
then they would start buying more and more of that commodity in the current period even if
their prices are rising. The consumers demand more due to fear of further rise in prices. For
example, during emergencies like war, famines, etc., consumers demand goods even at higher
prices due to fear of shortage and general insecurity.

4. Fashion related goods:

Goods related to fashion do not follow the law of demand and their demand increases even
with a rise in their prices. For example, if any particular type of dress is in fashion, then
demand for such dress will increase even if its price is rising.

5. Necessities of Life:
Another exception occurs in the use of such commodities, which become necessities of life
due to their constant use. For example, commodities like rice, wheat, salt, medicines, etc. are
purchased even if their prices increase.

6. Change in Weather:
With change in season/weather, demand for certain commodities also changes, irrespective of
any change in their prices. For example, demand for umbrellas increases in rainy season even
with an increase in their prices. It must be noted that in normal conditions and considering the
given assumptions, ‘Law of Demand’ is universally applicable.

7. In case of ignorance of price changes:

When the customer is not familiar with the changes in the price, he tends to buy
even if there is increase in price.
8. 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.

4. Explain different types of elasticity of demand?

A. ELASTICITY OF DEMAND:

Introduction
The law of demand show that there is an inverse relation between price and quantity
demanded i.e. when price falls demand is more and when price rises demand is less. The law
of demand does not explain the extent of change in demand due to a change in price. In other
words the law of demand fails to explain quantitative relation between price and demand.
Therefore, Dr. Alfred Marshall explained the concept of elasticity of demand.
Meaning:
The term elasticity means responsiveness or sensitivity. The concept of elasticity of demand
measures the responsiveness of quantity demanded to a change in price.
Definition:
According to Prof. Marshall:
"Elasticity of demand is great or small according to the amount demand which increases
much or little for a given fall in price, and quantity demanded decreases much or little for a
given rise in price."
According to P.A. Samuelson:
"Price elasticity is a concept for measuring how much the quantity demanded responds to
changing price."
TYPES OF ELASTICITY OF DEMAND

1. Price Elasticity of demand:

"Price elasticity of demand is a ratio of proportionate changes in the quantity

demanded of a commodity to a given proportionate change in its price."
Thus, price elasticity is responsiveness of change in demand due to a change in price
only. Other factors such as income, population, tastes, habits, fashions, prices of substitute
and complementary goods are assumed to be constant. Therefore, price elasticity of demand
is written as:
The formula for computing elasticity of demand is

Price elasticity of demand = (% Change in Quantity) / (% Change in Price)

Types of Price elasticity of demand:

a. Relatively Elastic Demand (ep>1): An elastic demand is one in which the change in
quantity demanded due to a change in price is large. A small change in price results in a large
change in quantity demanded. An example of products with an elastic demand is consumer
durables. Products with close substitutes tend to have elastic demand.
Elastic demand

b. Relatively Inelastic Demand (ep<1): An inelastic demand is one in which the change
in quantity demanded due to a change in price is small. A change in price results in only a
small change in quantity demanded. In other words, the quantity demanded is not very
responsive to changes in price. Examples of this are necessities like food and fuel.
Inelastic Demand

c. Unitary Elasticity (ep=1):

When a change in price leads to proportionate change in quantity demanded then
demand is unitary elastic. For example, if price falls by 50% the demand will rise by 50%.

C. Unitary Elastic
d. Perfectly Elastic Demand (EP = ∞)

The demand is said to be perfectly elastic if the quantity demanded increases infinitely (or by
unlimited quantity) with a small fall in price or quantity demanded falls to zero with a small
rise in price. Thus, it is also known as infinite elasticity. It does not have practical importance
as it is rarely found in real life.

In perfectly elastic demand, the demand curve is represented as a horizontal straight

line, which is shown in Figure:

It can also be interpreted from Figure that at price P consumers are ready to buy as much
quantity of the product as they want. However, a small rise in price would resist consumers to
buy the product.

e. Perfectly Inelastic Demand:

A perfectly inelastic demand is one when there is no change produced in the demand of a
product with change in its price. The numerical value for perfectly inelastic demand is zero
(ep=0).
In case of perfectly inelastic demand, demand curve is represented as a straight vertical
line, which is shown in Figure:
It can be interpreted from Figure-3 that the movement in price from OP1 to OP2 and OP2 to
OP3 does not show any change in the demand of a product (OQ). The demand remains
constant for any value of price. Perfectly inelastic demand is a theoretical concept and cannot
be applied in a practical situation. However, in case of essential goods, such as salt, the
demand does not change with change in price. Therefore, the demand for essential goods is
perfectly inelastic.

2. Income Elasticity of Demand:

The Income Elasticity of Demand (YED) measures the rate of response of quantity demand
due to a raise (or lowering) in a consumer’s income.

Income elasticity of demand = (ΔQ/ ΔY) (Y/Q)

% change in quantity demanded
Income elasticity of demand=
% Change in Income

Types of Income elasticity of demand

[Link] to unity: There is unity income elasticity of demand when percentage change in
demand is equal to the percentage change in price. The demand curve for this income
elasticity has upward slope. The increase in quantity demanded is equal to increase in
income.

2. Greater than unity: The income elasticity is greater than unity when percentage change in
demand is greater than percentage change in price.

3. Less than unity: The income elasticity is less than unity when percentage change in
demand is less than percentage change in price.

4. Zero elasticity: There is zero income elasticity when demand remains unchanged due to
change in income in any direction. The income of a consumer increases (say) 20% but there
is no change in demand for commodity.

5. Negative elasticity: There is negative income elasticity when increase in income brings
decrease in demand. The consumer can reduce his purchase of inferior commodity when
there is increase in income.
3. Cross Elasticity of Demand

Cross elasticity of demand (XED) is the responsiveness of demand for one product to a
change in the price of another product. Many products are related, and XED indicates just
how they are related.
The formula for cross elasticity of demand is
% change in quantity demanded of good X
Cross elasticity of demand = % Change in price of good Y

5. Explain the factors determining elasticity of demand?

A. FACTORS DETERMINING ELASTICITY OF DEMAND

Below are the important factors that directly or indirectly influence the degree of demand to
any small change in price:

1. Nature of commodity:

Elasticity of demand of a commodity is influenced by its nature. A commodity for a person

may be a necessity, a comfort or a luxury.

i. When a commodity is a necessity like food grains, vegetables, medicines, etc., its demand

is generally inelastic as it is required for human survival and its demand does not fluctuate

much with change in price.

ii. When a commodity is a comfort like fan, refrigerator, etc., its demand is generally elastic
as consumer can postpone its consumption.

iii. When a commodity is a luxury like AC, DVD player, etc., its demand is generally more

elastic as compared to demand for comforts.

iv. The term ‘luxury’ is a relative term as any item (like AC), may be a luxury for a poor

person but a necessity for a rich person.

2. Availability of substitutes:

Demand for a commodity with large number of substitutes will be more elastic. The reason is

that even a small rise in its prices will induce the buyers to go for its substitutes. For example,

a rise in the price of Pepsi encourages buyers to buy Coke and vice-versa.
Thus, availability of close substitutes makes the demand sensitive to change in the prices. On

the other hand, commodities with few or no substitutes like wheat and salt have less price

elasticity of demand.

3. Income Level:

Elasticity of demand for any commodity is generally less for higher income level groups in

comparison to people with low incomes. It happens because rich people are not influenced

much by changes in the price of goods. But, poor people are highly affected by increase or

decrease in the price of goods. As a result, demand for lower income group is highly elastic.

4. Level of price:

Level of price also affects the price elasticity of demand. Costly goods like laptop, Plasma

TV, etc. have highly elastic demand as their demand is very sensitive to changes in their

prices. However, demand for inexpensive goods like needle, match box, etc. is inelastic as

change in prices of such goods do not change their demand by a considerable amount.

5. Postponement of Consumption:

Commodities like biscuits, soft drinks, etc. whose demand is not urgent, have highly elastic

demand as their consumption can be postponed in case of an increase in their prices.

However, commodities with urgent demand like life saving drugs, have inelastic demand

because of their immediate requirement.

6. Number of Uses:

If the commodity under consideration has several uses, then its demand will be elastic. When

price of such a commodity increases, then it is generally put to only more urgent uses and, as

a result, its demand falls. When the prices fall, then it is used for satisfying even less urgent

needs and demand rises.

For example, electricity is a multiple-use commodity. Fall in its price will result in substantial

increase in its demand, particularly in those uses (like AC, Heat convector, etc.), where it was
not employed formerly due to its high price. On the other hand, a commodity with no or few

alternative uses has less elastic demand.

7. Share in Total Expenditure:

Proportion of consumer’s income that is spent on a particular commodity also influences the

elasticity of demand for it. Greater the proportion of income spent on the commodity, more is

the elasticity of demand for it and vice-versa.

Demand for goods like salt, needle, soap, match box, etc. tends to be inelastic as consumers

spend a small proportion of their income on such goods. When prices of such goods change,

consumers continue to purchase almost the same quantity of these goods. However, if the

proportion of income spent on a commodity is large, then demand for such a commodity will

be elastic.

8. Time Period:

Price elasticity of demand is always related to a period of time. It can be a day, a week, a

month, a year or a period of several years. Elasticity of demand varies directly with the time

period. Demand is generally inelastic in the short period.

It happens because consumers find it difficult to change their habits, in the short period, in

order to respond to a change in the price of the given commodity. However, demand is more

elastic in long run as it is comparatively easier to shift to other substitutes, if the price of the

given commodity rises.

9. Habits:

Commodities, which have become habitual necessities for the consumers, have less elastic

demand. It happens because such a commodity becomes a necessity for the consumer and he

continues to purchase it even if its price rises. Alcohol, tobacco, cigarettes, etc. are some

examples of habit forming commodities.

Finally it can be concluded that elasticity of demand for a commodity is affected by number

of factors. However, it is difficult to say, which particular factor or combination of factors

determines the elasticity. It all depends upon circumstances of each case.

6. What is demand forecasting? Explain its objectives and factors affecting demand
forecasting?

A. Demand Forecasting:

An organization faces several internal and external risks, such as high competition, failure
of technology, labor unrest, inflation, recession, and change in government laws.

An organization can lessen the adverse effects of risks by determining the demand or sales
prospects for its products and services in future. Demand forecasting is a systematic process
that involves anticipating the demand for the product and services of an organization in future
under a set of uncontrollable and competitive forces.

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.

Definitions:

According to Evan J. Douglas, “Demand estimation (forecasting) may be defined as a process

of finding values for demand in future time periods.”

In the words of Cundiff and Still, “Demand forecasting is an estimate of sales during a
specified future period based on proposed marketing plan and a set of particular
uncontrollable and competitive forces.”

Objectives of Demand Forecasting:

Demand forecasting constitutes an important part in making crucial business decisions.

The objectives of demand forecasting are divided into short and long-term objectives,
which are shown in Figure-1:
The objectives of demand forecasting (as shown in Figure-1) are discussed as follows:
i. Short-term Objectives:
Include the following:
a. Formulating production policy:
Helps in covering the gap between the demand and supply of the product. The demand
forecasting helps in estimating the requirement of raw material in future, so that the regular
supply of raw material can be maintained. It further helps in maximum utilization of
resources as operations are planned according to forecasts. Similarly, human resource
requirements are easily met with the help of demand forecasting.

b. Formulating price policy:

Refers to one of the most important objectives of demand forecasting. An organization sets
prices of its products according to their demand. For example, if an economy enters into
depression or recession phase, the demand for products falls. In such a case, the organization
sets low prices of its products.

c. Controlling sales:
Helps in setting sales targets, which act as a basis for evaluating sales performance. An
organization make demand forecasts for different regions and fix sales targets for each region
accordingly.

d. Arranging finance:
Implies that the financial requirements of the enterprise are estimated with the help of
demand forecasting. This helps in ensuring proper liquidity within the organization.

ii. Long-term Objectives:

Include the following:
a. Deciding the production capacity:
Implies that with the help of demand forecasting, an organization can determine the size of
the plant required for production. The size of the plant should conform to the sales
requirement of the organization.
b. Planning long-term activities:
Implies that demand forecasting helps in planning for long term. For example, if the
forecasted demand for the organization’s products is high, then it may plan to invest in
various expansion and development projects in the long term.

Factors Influencing Demand Forecasting:

Demand forecasting is a proactive process that helps in determining what products are needed
where, when, and in what quantities. There are a number of factors that affect demand
forecasting.

Some of the factors that influence demand forecasting are shown in Figure-2:

The various factors that influence demand forecasting (“as shown in Figure-2) are
explained as follows:
i. Types of Goods:
Affect the demand forecasting process to a larger extent. Goods can be producer’s goods,
consumer goods, or services. Apart from this, goods can be established and new goods.
Established goods are those goods which already exist in the market, whereas new goods are
those which are yet to be introduced in the market.

Information regarding the demand, substitutes and level of competition of goods is known
only in case of established goods. On the other hand, it is difficult to forecast demand for the
new goods. Therefore, forecasting is different for different types of goods.

ii. Competition Level:

Influence the process of demand forecasting. In a highly competitive market, demand for
products also depend on the number of competitors existing in the market. Moreover, in a
highly competitive market, there is always a risk of new entrants. In such a case, demand
forecasting becomes difficult and challenging.

iii. Price of Goods:

Acts as a major factor that influences the demand forecasting process. The demand forecasts
of organizations are highly affected by change in their pricing policies. In such a scenario, it
is difficult to estimate the exact demand of products.

iv. Level of Technology:

Constitutes an important factor in obtaining reliable demand forecasts. If there is a rapid
change in technology, the existing technology or products may become obsolete. For
example, there is a high decline in the demand of floppy disks with the introduction of
compact disks (CDs) and pen drives for saving data in computer. In such a case, it is difficult
to forecast demand for existing products in future.

v. Economic Viewpoint:
Play a crucial role in obtaining demand forecasts. For example, if there is a positive
development in an economy, such as globalization and high level of investment, the demand
forecasts of organizations would also be positive.

Apart from aforementioned factors, following are some of the other important factors
that influence demand forecasting:
a. Time Period of Forecasts:
Act as a crucial factor that affect demand forecasting. The accuracy of demand forecasting
depends on its time period.

Forecasts can be of three types, which are explained as follows:

1. Short Period Forecasts:
Refer to the forecasts that are generally for one year and based upon the judgment of the
experienced staff. Short period forecasts are important for deciding the production policy,
price policy, credit policy, and distribution policy of the organization.

2. Long Period Forecasts:

Refer to the forecasts that are for a period of 5-10 years and based on scientific analysis and
statistical methods. The forecasts help in deciding about the introduction of a new product,
expansion of the business, or requirement of extra funds.

3. Very Long Period Forecasts:

Refer to the forecasts that are for a period of more than 10 years. These forecasts are carried
to determine the growth of population, development of the economy, political situation in a
country, and changes in international trade in future.
Among the aforementioned forecasts, short period forecast deals with deviation in long
period forecast. Therefore, short period forecasts are more accurate than long period
forecasts.

4. Level of Forecasts:
Influences demand forecasting to a larger extent. A demand forecast can be carried at three
levels, namely, macro level, industry level, and firm level. At macro level, forecasts are
undertaken for general economic conditions, such as industrial production and allocation of
national income. At the industry level, forecasts are prepared by trade associations and based
on the statistical data.

Moreover, at the industry level, forecasts deal with products whose sales are dependent on the
specific policy of a particular industry. On the other hand, at the firm level, forecasts are done
to estimate the demand of those products whose sales depends on the specific policy of a
particular firm. A firm considers various factors, such as changes in income, consumer’s
tastes and preferences, technology, and competitive strategies, while forecasting demand for
its products.

5. Nature of Forecasts:
Constitutes an important factor that affects demand forecasting. A forecast can be specific or
general. A general forecast provides a global picture of business environment, while a
specific forecast provides an insight into the business environment in which an organization
operates. Generally, organizations opt for both the forecasts together because over-
generalization restricts accurate estimation of demand and too specific information provides
an inadequate basis for planning and execution.

7. Explain Methods of demand forecasting?

A. Methods or Techniques of Demand forecasting:

Forecasting Techniques:

Demand forecasting is a difficult exercise. Making estimates for future under the changing

conditions is a Herculean task. Consumers’ behavior 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.

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.

(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.

(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.

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
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 weighed 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.

Measurement (or Degrees) of Elasticity of Demand

Elasticity of demand can be measured in different degrees based on how responsive

consumers are to changes in price.

(a) Perfectly Elastic Demand (Ep = ∞)

Meaning:
Even a very small change in price leads to an infinite change in quantity demanded.
Consumers will buy the product only at one specific price; if price rises even slightly, demand
falls to zero.

Graph:
A horizontal demand curve — perfectly flat.

Real-life Example:

 In foreign exchange markets, if ₹1 = $0.012, people will exchange currency only at

that rate. Even a slight change makes them shift to another exchange.

 Agricultural products in perfect competition — farmers can sell at market price only;
if they increase price, buyers go elsewhere.

(b) Perfectly Inelastic Demand (Ep = 0)

Meaning:
Demand does not change at all, no matter how much the price changes.

Graph:
A vertical demand curve — quantity demanded remains constant.

Real-life Example:
  Life-saving medicines such as insulin for diabetics or heart disease drugs — patients
must buy them regardless of price.

 Basic necessities like salt or drinking water (in some conditions) also show this
behavior.

(c) Relatively Elastic Demand (Ep > 1)

Meaning:
A small change in price leads to a larger change in quantity demanded.
Consumers are very sensitive to price changes.

Graph:
A flatter demand curve.

Real-life Example:

 Luxury goods such as air conditioners, smartphones, or branded clothes — if price

drops slightly, demand rises sharply.

 Movie tickets — lower prices can attract a lot more people.

(d) Relatively Inelastic Demand (Ep < 1)

Meaning:
A large change in price causes only a small change in quantity demanded.
Consumers are less responsive to price changes.

Graph:
A steeper demand curve.

Real-life Example:

 Petrol or diesel: Even if prices rise, people still buy almost the same quantity as they
need it for daily travel.

 Cigarettes and liquor: Addicted consumers continue buying despite higher prices.

(e) Unitary Elastic Demand (Ep = 1)

Meaning:
The percentage change in demand equals the percentage change in price — total
expenditure (P × Q) remains the same.
Graph:
A rectangular hyperbola-shaped demand curve.

Real-life Example:

 Suppose a shopkeeper reduces the price of pens by 10% and as a result, the quantity
sold increases by 10%.
→ Total revenue remains constant, indicating unitary elasticity.

 Common in moderate necessity goods — for example, mid-range shoes or

household items.

Summary Table for Teaching

Type of Symbol
Demand Curve Responsiveness Real-life Example
Elasticity (Ep)

Extremely Currency exchange

Perfectly Elastic ∞ Horizontal
responsive rates

Perfectly
0 Vertical Not responsive Life-saving medicine
Inelastic

Relatively Luxury goods, movie

>1 Flatter Highly responsive
Elastic tickets

Relatively
<1 Steeper Less responsive Petrol, cigarettes
Inelastic

Rectangular Proportionate Mid-range household

Unitary Elastic = 1
hyperbola change goods