Managerial Economics and Financial Analysis

IV semester CSE
UNIT-I: Managerial Economics Introduction
Syllabus: Managerial Economics Introduction – meaning, nature, meaning, significance, functions, and advantages,
ME and its role in other fields. Demand - Concept, Function, Law of Demand - Demand Elasticity- Types –
measurement. Demand Forecasting- Factors governing forecasting, Methods.

Introduction to Economics: Economics is a study of human activity both at individual and national
level. The economists of early age treated economics merely as the science of wealth. The reason for this is
clear. Every one of us in involved in efforts aimed at earning money and spending this money to satisfy our
wants such as food, Clothing, shelter, and others. Such activities of earning and spending money are called
“Economic activities”. It was only during the eighteenth century that Adam Smith, the Father of Economics,
defined economics as the study of nature and uses of national wealth’. “Economics is a study of man’s actions
in the ordinary business of life: it enquires how he gets his income and how he uses it”. Thus, it is one side, a
study of wealth; and on the other, and more important side; it is the study of man. Lord Keynes defined
economics as ‘the study of the administration of scarce means and the determinants of employments and
income”.
Microeconomics: The study of an individual consumer or a firm is called microeconomics (also called the
Theory of Firm). Micro means ‘one millionth’. Microeconomics deals with behavior and problems of single
individual and of micro organization. Managerial economics has its roots in microeconomics and it deals with
the micro or individual enterprises. It is concerned with the application of the concepts such as price theory,
Law of Demand and theories of market structure and so on.
Macroeconomics: The study of ‘aggregate’ or total level of economics activity in a country is called
macroeconomics. It studies the flow of economics resources or factors of production (such as land, labour,
capital, organization and technology) from the resource owner to the business firms and then from the business
firms to the households. It deals with total aggregates, for instance, total national income total employment,
output and total investment. It deals with the price level in general, instead of studying the prices of individual
commodities
Management: Management is the science and art of getting things done through people in formally organized
groups. It is necessary that every organization be well managed to enable it to achieve its desired goals.
Management includes a number of functions: Planning, organizing, staffing, directing, and controlling. The
manager while directing the efforts of his staff communicates to them the goals, objectives, policies, and
procedures; coordinates their efforts; motivates them to sustain their enthusiasm; and leads them to achieve
the corporate goals.
Managerial Economics Meaning & Definition: In the words of E. F. Brigham and J. L. Pappas Managerial
Economics is “the applications of economics theory and methodology to business administration practice”.
Managerial Economics bridges the gap between traditional economics theory and real business practices in
two days.
C. I. Savage & T. R. Small therefore believes that managerial economics “is concerned with business
efficiency”. M. H. Spencer and Louis Siegelman explain the “Managerial Economics is the integration of
economic theory with business practice for the purpose of facilitating decision making and forward planning
by management”.

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Managerial economics may therefore, be defined as a body of knowledge, techniques and practices which give
substance to those economic concepts which are useful in deciding the business strategy of a unit of
management.

Nature of Managerial Economics: It has the basis features of economics, such as assuming that other
things remaining the same. This assumption is made to simplify the complexity of the managerial phenomenon
under study in a dynamic business environment so many things are changing simultaneously. This set a
limitation that we cannot really hold other things remaining the same. In such a case, the observations made
out of such a study will have a limited purpose or value. Managerial economics also has inherited this problem
from economics. Further, it is assumed that the firm or the buyer acts in a rational manner (which normally
does not happen). The buyer is carried away by the advertisements, brand loyalties, incentives and so on, and,
therefore, the innate behaviour of the consumer will be rational is not a realistic assumption.
The other features of managerial economics are explained as below:
(a) Close to microeconomics: Managerial economics is concerned with finding the solutions for different
managerial problems of a particular firm. Thus, it is more close to microeconomics.
(b) Operates against the backdrop of macroeconomics: The macroeconomics conditions of the economy are
also seen as limiting factors for the firm to operate. In other words, the managerial economist has to be aware
of the limits set by the macroeconomics conditions such as government industrial policy, inflation and so on.
(c) Normative statements: A normative statement usually includes or implies the words ‘ought’ or ‘should’.
They reflect people’s moral attitudes and are expressions of what a team of people ought to do. For instance,
it deals with statements such as ‘Government of India should open up the economy. Such statement are based
on value judgments and express views of what is ‘good’ or ‘bad’, ‘right’ or ‘ wrong’.
(d) Prescriptive actions: Prescriptive action is goal oriented. Given a problem and the objectives of the firm,
it suggests the course of action from the available alternatives for optimal solution. If does not merely mention
the concept. For instance, the fact that variable costs are marginal costs can be used to judge the feasibility of
an export order.
(e) Applied in nature: ‘Models’ are built to reflect the real life complex business situations and these models
are of immense help to managers for decision-making. The different areas where models are extensively used
include inventory control, optimization, project management etc.
(f) Offers scope to evaluate each alternative: Managerial economics provides an opportunity to evaluate each
alternative in terms of its costs and revenue. The managerial economist can decide which is the better
alternative to maximize the profits for the firm.
(g) Interdisciplinary: The contents, tools and techniques of managerial economics are drawn from different
subjects such as economics, management, mathematics, statistics, accountancy, psychology, organizational
behavior, sociology and etc.
(h) Assumptions and limitations: Every concept and theory of managerial economics is based on certain
assumption and as such their validity is not universal. Where there is change in assumptions, the theory may
not hold good at all.

Scope of the Managerial Economics: The scope of managerial economics refers to its area of study.
Managerial economics refers to its area of study. Managerial economics is primarily concerned with the
application of economic principles and theories to five types of resource decisions made by all types of
business organizations. From analyzing demands and forecasting future demand to capital management,
managerial economics provides help with almost everything. It also helps companies in Pricing Decisions,
Policies, and Practices, cost and production analysis, and manage their profits.

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Micro-Economics Applied to Operational Issues: Operational issues refer to those, which wise within the
business organization and they are under the control of the management.
To resolve the organization’s internal issues arising in business operations, the various theories or principles
of microeconomics applied are as follows:
1. Theory of Demand Analysis and Forecasting:
A firm relies on converting inputs into outputs and generates revenue from them. A clear and accurate
estimation of demand ensures a continuous efficiency of the firm. Several external factors like price, income,
affect the demand that need to be analyzed. Upon analyzing these factors affecting the demand for a product,
managers can decide on the production. After estimating the current demands, manager move ahead to predict
future demands for the product. This is referred to as demand forecasting.
The ability to forecast demands allows the management to capitalize on the opportunities available and
strengthen the market position of the firm. During the process of demand analysis, the management also gets
to know about the external factors affecting it and hence work on them to nullify any negative effect.
2. Theory of Production and Cost Analysis
Cost Analysis is yet another function of Managerial economics. A company makes a profit in two ways: by
increasing the demand or by reducing the cost. The determinants of assessing costs, the connection between
cost and yield, the gauge of cost and benefit are indispensable to a firm.
Cost analysis is an important exercise for any company. A component of cost vulnerability always exists since
all the elements deciding expenses are not generally known or controllable.
By taking the help of managerial economics, the management of a company identifies the factors causing a
variation in costs. The company then uses the cost estimates in their decision making like pricing a product.
Production analysis is more of a physical exercise. It involves examining the factors of production, also known
as inputs, and obtaining the best combination so as to get the least cost combination.
In case of price rise in the inputs, the management looks beyond and tries out the alternatives. The analysis
helps them get instant ideas in such uncertain situations.
The topics covered during cost and production analysis are production function, least-cost combination of
factor inputs, factor productiveness, returns to scale, cost concepts and classification, cost-output relationship,
and linear programming.
3. Pricing Theory and Analysis of Market Structure: Among the 4Ps of marketing, Price finds an important
place. For any firm, Pricing is a very important aspect of Managerial Economics as a firm's revenue earnings
largely depend on its pricing policy. However, it is a bit challenging as other players are competing in the
same price segment.

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When pricing a product is done, the costs of production are also taken into account. Managerial economics
helps the management to go through all the analyses and then price a product. In an oligopoly market
condition, the knowledge of pricing a product is essential.
4. Profit Analysis and Management: A business firm is an organization designed with an intention to make
profits and profits reflect the success of a company. After all the analyses, it all rolls down to profits. To
maximize profits a firm needs to manage certain things like pricing, cost aspects, resource allocation, and
long-run decisions. This would mean that the firm should work from the very beginning, evaluate its
investment decisions and frame the best capital budgeting policies. Profit management is considered as a
difficult area of managerial economics.
5. Theory of Capital and Investment Decisions
Every asset a business owns is known as its capital. Capital management thus becomes an important practice.
Planning and control of capital expenditures is a basic executive function. It involves the Equi-marginal
principle. The prime objective is to ensure the sustainable use of capital. This means that funds should be kept
at a bay when the managerial returns are less than in other uses.
The main topics dealt with during capital management are Cost of Capital, Rate of Return, and Selection of
Projects.

Macro-Economics Applied to Business Environment

Environmental or External Issues: An environmental issue in managerial economics refers to the general
business environment in which the firm operates. They refer to general economic, social and political
atmosphere within which the firm operates. A study of economic environment should include:
a. The type of economic system in the country.
b. The general trends in production, employment, income, prices, saving and investment.
c. Trends in the working of financial institutions like banks, financial corporations, insurance companies
d. Magnitude and trends in foreign trade;
e. Trends in labour and capital markets;
f. Government’s economic policies viz. industrial policy monetary policy, fiscal policy, price policy etc.

 Economic Environment: The economic conditions of a country, GDP, economic policies, etc.
indirectly impacts the business and its operations.
 Social Environment: The society in which the organization functions also affects it like employment
conditions, trade unions, consumer cooperatives, etc.
 Political Environment: The political structure of a country, whether authoritarian or democratic;
political stability; and attitude towards the private sector, influence organizational growth and
development.

Managerial economics provides an essential tool for determining the business goals and targets, the actual
position of the organization, and what the management should do fill the gap between the two.

Managerial economics relationship with other disciplines:

1. Relationship with economics: The relationship between managerial economics and economics theory may
be viewed form the point of view of the two approaches to the subject Viz. Micro Economics and Marco
Economics. Microeconomics is the study of the economic behavior of individuals, firms and other such micro
organizations. Managerial economics is rooted in Micro Economic theory. Managerial Economics makes use
to several Micro Economic concepts such as marginal cost, marginal revenue, elasticity of demand as well as
price theory and theories of market structure to name only a few. Macro theory on the other hand is the study
of the economy as a whole. It deals with the analysis of national income, the level of employment, general
price level, consumption and investment in the economy and even matters related to international trade,
Money, public finance, etc.

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2. Management theory and accounting: Managerial economics has been influenced by the developments in
management theory and accounting techniques. Accounting refers to the recording of pecuniary transactions
of the firm in certain books. A proper knowledge of accounting techniques is very essential for the success of
the firm because profit maximization is the major objective of the firm. Managerial Economics requires a
proper knowledge of cost and revenue information and their classification.
3. Managerial Economics and mathematics: The use of mathematics is significant for managerial
economics in view of its profit maximization goal long with optional use of resources. The major problem of
the firm is how to minimize cost, how to maximize profit or how to optimize sales. Mathematical concepts
and techniques are widely used in economic logic to solve these problems. Also mathematical methods help
to estimate and predict the economic factors for decision making and forward planning. Mathematical symbols
are more convenient to handle and understand various concepts like incremental cost, elasticity of demand
etc., Geometry, Algebra and calculus are the major branches of mathematics which are of use in managerial
economics.
4. Managerial Economics and Statistics: Statistical tools are used in collecting data and analyzing them to
help in the decision making process. Statistical tools like the theory of probability and forecasting techniques
help the firm to predict the future course of events. Managerial Economics also make use of correlation and
multiple regressions in related variables like price and demand to estimate the extent of dependence of one
variable on the other. The theory of probability is very useful in problems involving uncertainty.
5. Managerial Economics and Operations Research: Operations research is concerned with the complex
problems arising out of the management of men, machines, materials and money. Operation research provides
a scientific model of the system and it helps managerial economists in the field of product development,
material management, and inventory control, quality control, marketing and demand analysis. The varied tools
of operations Research are helpful to managerial economists in decision-making.
6. Managerial Economics and the theory of Decision- making: The Theory of decision-making is a new
field of knowledge grown in the second half of this century. Most of the economic theories explain a single
goal for the consumer i.e., Profit maximization for the firm. But the theory of decision-making is developed
to explain multiplicity of goals and lot of uncertainty. As such this new branch of knowledge is useful to
business firms, which have to take quick decision in the case of multiple goals.
7. Managerial Economics and Computer Science: Computers have changes the way of the world functions
and economic or business activity is no exception. Computers are used in data and accounts maintenance,
inventory and stock controls and supply and demand predictions. In fact computerization of business activities
on a large scale has reduced the workload of managerial personnel. Managerial economics, which is an
offshoot traditional economics, has gained strength to be a separate branch of knowledge. It strength lies in its
ability to integrate ideas from various specialized subjects to gain a proper perspective for decision-making.
A successful managerial economist must be a mathematician, a statistician and an economist.

Importance of Managerial Economics: In the modern era, the business decision is increasing. So, the
Role and Importance of Managerial Economics also increase. Because it is helpful and helpful for many types
of business decisions. And the salient features and significance of managerial economics are also good.
1. Useful in Business Organization In any institution or firm.
2. Helpful in Chalking Out Business Policies
3. Help in Business Planning & Business economics
4. Helpful in Cost Control
5. Useful in Coordination of Business Activities
6. Useful In Demand for Costing
7. Helpful in Profit Planning and Control
8. Helpful for Business Prediction
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9. Helpful in Price Determination
10. Helpful in Solutions of Business Taxation Problems
11. Useful in Understanding the Mechanism of Economic System
12. Helpful in Analysis of Effects of Government Policies
13. Attempt to put out the friendly business
14. Supporting the Manufacture and use of Models
15. Useful in showing the path of Economic
16. Gives the Right Direction Inside the business
17. Maintains of Costs
18. Distribute Profit Inside
19. Measurement of the Efficiency of the Firm.

Demand Analysis
Demand: A product or service is said to have demand when three conditions are satisfied:
• Desire on the part of the buyer to buy
• Willingness to pay for it
• Ability to pay the specified price for it.
Unless all this conditions are fulfilled, the product is not said to have any demand.
Nature and Types of Demand:
1. Consumer Demand Vs Producer Goods:
Consumer goods refers to such products and services which are capable of satisfying human needs.
Examples are bread, apple, rice and so on .This gives direct and immediate satisfaction.
2. Autonomous demand vs derived demand:
Autonomous demand refers to the demand for products and services directly.
Super specialty hospital can be considered as autonomous whereas the demand for the hotels around that is
called derived demand.
If there is no demand for houses, there may not be demand for steel, cement, bricks and so on.
3. Durable vs perishable goods:
Here the demand for goods is classified based on their durability.
Examples of perishable goods are milk, vegetables, fish, and such.
Rice, wheat, sugar such others can be examples of durable goods.
4. Firm demand vs industry demand:
The firm is single business unit whereas industry refers to the group of firms carrying on similar activity.
5. Short-run demand VS long-run demand:
Joel Dean defines short-run demand as ‘the demand with its immediate reaction to price changes, income
fluctuations and so on. Long-run demand is that demand which will ultimately exist as a result of the changes
in pricing, promotion or product improvement, after enough time is allowed to let the market adjust itself to
the given situation’.
6. New demand VS Replacement Demand:
New demand refers to the demand for the new products and it is the addition to the existing stock. In
replacement demand, the item is purchased to maintain the asset in good condition.
7. Total market and segment market demand:
Let us take the consumption of sugar in a given region.
The total demand for sugar in the region is the total market demand. The demand for sugar from the sweet-
making industry from this region is the segment market demand.

Demand Function:
Demand function is a function which describes a relationship between one variable and its determinants. It
describes how much quantity of goods is bought at alternative prices of good and related goods, alternative
income levels, and alternative values of other variables affecting demand. Thus, the demand function for a
good relates the quantity of a good which consumers demand during a given period to the factors which
influence the demand. The above factors can be built up into a demand function.

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Mathematically, the demand function for a product A can be expressed as follows:

Qd= f(P, I, T, PR, EP, EI , SP, DC, A, O)

Factors Determining Demand or Demand determinants:

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 level of the consumer (I)
c) Tastes and preferences of the consumer (T)
d) Prices of related goods which may be substitutes/complementary (PR)
e) Expectations about the prices in future (EP)
f) Expectations about the incomes in future (EI)
g) Size of population (SP)
h) Distribution of consumers over different regions (DC)
i) Advertising efforts (A)
j) Any other factor capable of affecting the demand (O)

Determinants of demand are factors that influence how much of a product or service people want to buy. In
simpler terms, they are the things that make people decide whether to buy more or less of something.
1. Price of the product (P): The most obvious one is the price of a product. When prices go down, people tend
to buy more. For example, when Indian smartphone companies like Xiaomi offer lower-priced phones with
good features, more people buy them.
2. Income level of the consumer (I): People's income levels affect their buying decisions. When people in
India have higher incomes, they may choose to buy more expensive cars like those from Tata Motors or
Mahindra & Mahindra, as opposed to lower-priced alternatives.
3. Tastes and preferences of the consumer (T): Different people like different things. For instance, some might
prefer traditional Indian clothing from companies like Fab India, while others might prefer Western-style
clothing from brands like Zara.
4. Population and Demographics: The size and characteristics of the population matter. With a growing
population of tech-savvy youth in India, IT companies like Infosys and TCS have a larger market for their
services.
5. Advertising efforts (A): How much a company advertises and promotes its products can influence demand.
If a company like Amul promotes its dairy products heavily, more people may buy them.
6. Substitute Goods: If there are similar products available, people might switch between them based on price
and quality. For example, consumers may choose between different brands of tea like Tata Tea and Brooke
Bond based on taste and price.
7. Prices of related goods which may be substitutes/complementary (PR): Some products go well together. If
you buy a mobile phone, you might also need a charger. So, if phone companies offer bundles with chargers,
it can boost demand for both products.
8. Expectations about the prices in future (EP): If people expect prices to go up in the future, they might buy
more now. This can be seen in the gold market, where consumers in India often buy more gold when they
anticipate higher future prices.
9. Distribution of consumers over different regions (DC): Sometimes, cultural or social trends can influence
demand. For instance, the popularity of yoga in India has led to increased demand for yoga mats and clothing.
Others factors:
10. Government Policies and Regulations: Government decisions, like taxes or subsidies, can impact demand.
For example, when the Indian government reduced the Goods and
Services Tax (GST) on certain products, it made those products more affordable and boosted demand.
11. Consumer Confidence: When people feel confident about the economy and their own financial situation,
they tend to spend more. For instance, if consumers in India have high confidence in the economy, they may
be more willing to buy big-ticket items like cars from Maruti Suzuki.
12. Brand Loyalty: Some consumers are loyal to specific brands. For example, fans of
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Royal Enfield motorcycles often remain loyal to the brand and continue to buy their products.
13. Peer Influence: People are often influenced by the choices of their friends and peers. If a popular Indian
celebrity endorses a particular brand of clothing, it can lead to increased demand for that brand's products.
14. Availability of Credit: The ease of getting credit or loans can impact demand for products. When banks
offer favorable loan terms for home purchases, it can boost demand for real estate, benefiting companies like
DLF Limited.
15. Seasonal Factors: Demand for certain products can be seasonal. For example, demand for air conditioners
from companies like Voltas tends to rise during the hot summer months in India.
16. Technological Advancements: New and innovative products can create higher demand. When companies
like Reliance Jio introduced affordable 4G internet services in India, it led to increased demand for
smartphones and data usage.
17. Natural Disasters and Crises: Unexpected events like floods or the COVID-19 pandemic can impact
demand. During the pandemic, pharmaceutical companies like Serum Institute of India saw increased demand
for vaccines.
18. Government Subsidies: Government subsidies can encourage demand for specific products. For example,
subsidies on agricultural equipment can boost demand for tractors manufactured by companies like Mahindra
& Mahindra.
19. Ethical and Environmental Concerns: Consumers may choose products based on ethical or environmental
factors. For instance, companies in the organic food industry like Nature's Basket benefit from consumers'
preference for eco-friendly and healthy products.
20. Foreign Exchange Rates: Exchange rates can affect demand for imported and exported goods. A
favourable exchange rate for the Indian Rupee can lead to increased demand for imported luxury goods like
watches from Titan Company Limited.

LAW of Demand and Demand Curve:

Law of demand shows the relation between price and quantity demanded of a commodity in the market. In
the words of Marshall, “the amount demand increases with a fall in price and diminishes with a rise in price”.
A rise in the price of a commodity is followed by a reduction in demand and a fall in price is followed by an
increase in demand, if a condition of demand remains constant.
The law of demand may be explained with the help of the following demand schedule
Demand Schedule:
Price of Oranges (In. Rs.) Quantity Demanded
10 1
8 2
6 3
4 4
2 5

When the price falls from Rs. 10 to 8 quantity demand increases from 1 to 2. In the same way as price falls,
quantity demand increases on the basis of the demand schedule we can draw the demand curve.

Demand Curve: The demand curve is a line graph utilized in economics, that shows how many units of
a good or service will be purchased at various prices. The price is plotted on the vertical (Y) axis while the
quantity is plotted on the horizontal (X) axis.

Demand curves are used to determine the relationship between price and quantity, and follow the law of
demand, which states that the quantity demanded will decrease as the price increases. In addition, demand
curves are commonly combined with supply curves to determine the equilibrium price and equilibrium
quantity of the market.

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The demand curve shows the inverse relation between price and quantity demand of apple. It is downward
sloping.

Assumptions: Law is demand is based on certain assumptions:

The law of demand is thus, based on the following ceteris paribus assumptions:
1. No Change in Consumer’s Income
2. No Change in Consumer’s Preferences
3. No Change in the Fashion
4. No Change in the Price of Related Goods
5. No Expectation of Future Price Changes or Shortages
6. No Change in Size, Age Composition and Sex Ratio of the Population
7. No Change in the Range of Goods Available to the Consumers
8. No Change in the Distribution of Income and Wealth of the Community
9. No Change in Government Policy
10. No Change in Weather Conditions

Elasticity of Demand:
The term ‘elasticity’ is defined as the rate of responsiveness in the demand of a commodity of a given change
in price or any other determinants of demand. In other words, it explains the extent of change in quantity
demanded because of a given change in the other determining factors, may be price or any other factor(s). The
elasticity of demand at any price or at any output is the proportional change in quantity demanded divided by
the proportional change of price of that quantity. It is represented by Ed

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

a) Perfectly elastic demand
b) Perfectly inelastic demand
c) Relatively elastic demand d) Relatively inelastic demand
e) Unity elasticity

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a) Perfectly Elastic Demand: When any quantity can be sold at a given price, and when there is no need to
reduce price, the demand is said to be perfectly elastic. In such cases, even a small increase in price will lead
to complete fall in demand.

b) Perfectly Inelastic Demand: When a significant degree of change in price leads to little or no change in
the quantity demanded, then the elasticity is said to be perfectly inelastic. In other words, the demand is said
to be perfectly inelastic when there is no change in the quantity demanded even though there is a big change
(increase or decrease) in price.

c) Relatively Elastic Demand: The demand is said to be relatively elastic when the change in demand is more
than the change in the price.

d) Relatively Inelastic Demand:

The demand is said to be relatively inelastic when the change in demand is less than the change in the price.

e) Unity Elasticity: The elasticity in demand is said to be unity when the change in demand is equal to the
change in price.
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Types of Elasticity:
The following are the four types of elasticity of demand:
a. Price elasticity of demand
b. Income elasticity of demand
c. Cross elasticity of demand
d. Advertising elasticity of demand

a. Price Elasticity of demand: Elasticity of demand in general refers to price elasticity of demand. In
other words, it refers to the quantity demanded of a commodity in response to a given change in price. Price
elasticity is always negative which indicates that the customer tends to buy more with every fall in the price.
The relationship between the price and the demand is inverse.
It is measured as follows:

b. Income Elasticity of Demand: Income elasticity of demand refers to the quantity demanded of a
commodity in response to a given change in income of the consumer. Income elasticity is normally positive,
which indicates that the consumer tends to buy more and more with every increase in income.
It is measured as follows:

c. Cross Elasticity of Demand: Cross elasticity of demand refers to the quantity demanded of a commodity
in response to a change in the price of a related good, which may be substitute or complement.
It is measured as follows:

d. Advertising Elasticity: It refers to increase in the sales revenue because of change in the advertising
expenditure. In other words, there is a direct relationship between the amount of money spent on advertising
and its impact on sales. Advertising elasticity is always positive.

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Factors Governing Elasticity of Demand
1. Nature of product
2. Time frame
3. Degree of postponement
4. Number of alternative uses
5. Tastes and Preferences of the consumer
6. Availability of close substitutes
7. Complimentary or joint goods
8. Level of prices
9. Availability of subsidies
10. Expectation of prices
11. Durability of the product
12. Government policy

1. Nature of product or commodity: Elasticity or in-elasticity of demand depends on the nature of the
commodity i.e. whether a commodity is a necessity, comfort or luxury, normally; the demand for Necessaries
like salt, rice etc. is inelastic. On the other band, the demand for comforts and luxuries is elastic.
2. Time frame: In short run demand for goods is generally less elastic because a consumer changes his habits
in long-run and but not in short run more over supply of output cannot be increased readily in Short run.
3. Degree of Postponement: If the consumption of a commodity can be postponed, than it will have elastic
demand. On the contrary, if the demand for a commodity cannot be postpones, than demand is in elastic. The
demand for rice or medicine cannot be postponed, while the demand for Cycle or umbrella can be postponed.
4. Number of alternative uses: If a commodity can be used for several purposes, than it will have elastic
demand. i.e. electricity. On the other hand, demanded is inelastic for commodities, which can be put to only
one use.
5. Tastes and Preferences of the consumer: Consumer tastes and preferences significantly impact the
elasticity of demand, as they directly influence how much of a good or service a consumer is willing to buy at
a given price, meaning if their preferences shift strongly towards a product, even a price increase might not
deter them from purchasing it, leading to a more inelastic demand; conversely, if their preferences change
away from a product, even a small price decrease might not incentivize them to buy it, leading to a more
elastic demand.
6. Availability of close substitutes: Elasticity of demand depends on availability or non-availability of
substitutes. In case of commodities, which have substitutes, demand is elastic, but in case of commodities,
which have no substitutes, demand is in elastic.
7. Complementary or Joint Demand of Goods: - Few goods are demanded along with other goods. These
are called complementary goods and their demand is inelastic. For example scooter-petro shoes- socks etc.
8. Level of Price: Elasticity of demand also depends on price level of the goods. Elasticity of demand will be
greater at high price level and less of low level of price.
9. Availability of subsidies: The availability of subsidies can significantly impact the elasticity of demand
for a good, making it more elastic because when subsidies are present, consumers are more sensitive to price
changes as they have the option to switch to alternative goods if the price of the subsidized good increases
slightly; essentially, subsidies create a greater incentive for consumers to seek out cheaper options when prices
fluctuate.
10. Expectation of prices: Price elasticity of demand measures how much the quantity demanded of a product
changes when its price changes. Demand is elastic if a price change causes a large change in demand, and
inelastic if a price change causes a small change in demand.
11. Durability of the product: A product's durability is a significant factor governing its elasticity of demand,
meaning that highly durable goods tend to have a more elastic demand because consumers can postpone
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purchases when prices rise due to the ability to use their existing stock for a longer period; conversely, less
durable goods have a more inelastic demand as consumers need to replace them more frequently regardless of
price changes.
12. Government policy: Factors governing the elasticity of demand that are directly influenced by
government policy include: taxation levels, price controls, subsidies, information campaigns, and regulations
on substitute goods, as these policies can significantly impact the perceived availability and affordability of a
product, thereby affecting how sensitive consumers are to price changes.

Demand forecasting:
The information about the future is essential for both new firms and those planning to expand the scale of their
production. It is an ‘objective assessment of the future course of demand”. In recent times, forecasting plays
an important role in business decision-making. Demand forecasting has an important influence on production
planning. It is essential for a firm to produce the required quantities at the right time Demand forecasting refers
to an estimate of future demand for the product. Demand forecasting is helpful not only at the firm level but
also at the national level.

Types of demand Forecasting: Based on the time span and planning requirements of business firms,
demand forecasting can be classified in to
1. Short-term demand forecasting and
2. Long – term demand forecasting.
1. Short-term demand forecasting: Short-term demand forecasting is limited to short periods, usually for
one year. It relates to policies regarding sales, purchase, price and finances. It refers to existing production
capacity of the firm. Short-term forecasting is essential for formulating is essential for formulating a suitable
price policy. If the business people expect of rise in the prices of raw materials of shortages, they may buy
early. This price forecasting helps in sale policy formulation. Production may be undertaken based on expected
sales and not on actual sales. Further, demand forecasting assists in financial forecasting also. Prior
information about production and sales is essential to provide additional funds on reasonable terms.
2. Long – term forecasting: In long-term forecasting, the businessmen should now about the long-term
demand for the product. Planning of a new plant or expansion of an existing unit depends on long-term
demand. Similarly a multi-product firm must take into account the demand for different items. When forecast
are mode covering long periods, the probability of error is high. It is vary difficult to forecast the production,
the trend of prices and the nature of competition. Hence quality and competent forecasts are essential.

Importance of demand forecasting:

There are several reasons why demand forecasting is essential for companies:
1. It supports pricing strategies, business planning, goal setting, budgeting, and profit margin estimation.
By anticipating future sales, companies can create informed, strategic plans. It also enables more
effective production and capacity planning, ensuring that supply aligns with demand.
2. It allows companies to optimize inventory, increase turnover rates and reduce warehousing costs.
3. It provides valuable insights into future cash flow, enabling more precise budgeting for suppliers and
operational expenses. This foresight also facilitates better allocation of resources, allowing companies
to invest more in growth opportunities, such as capital expenditures.
4. It helps identify and address potential issues within the sales pipeline and supply chain, ensuring
smooth operations. For e-commerce companies, this is especially important, as excess cash tied up in
stock can hinder operational efficiency.
5. By anticipating demand, companies can also better plan for staffing and resource needs, ensuring they
are adequately prepared for peak times. This proactive approach keeps operations running smoothly,
even during periods of high demand.

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 6. Without demand forecasting, businesses risk making poor pricing decisions, leading to higher
warehousing costs, decreased customer satisfaction, and inefficiencies in supply chain management.
Ultimately, this negatively impacts profitability.

Advantages of demand forecasting

Demand forecasting is vital for e-commerce companies, particularly those using dynamic pricing or
promotional campaigns. Understanding demand and its relationship with pricing enables smarter business
decisions. Here are some key benefits of demand forecasting:

1. Identify seasonal trends: Analyzing past monthly sales performance can help identify seasonal
fluctuations, such as peak seasons. However, it is equally important to identify the seasons with less
customer demand. Lowering demand can be an opportunity to present pricing campaigns or do a
markdown pricing strategy to increase customer purchases.
2. Strategic pricing adjustments: Anticipating demand fluctuations enables timely pricing changes,
maximizing profitability without alienating customers.
3. Manage cash flow: Cash is king. Your capabilities to release cash or invest more in growth will
significantly improve when you know how your pricing affects the demand.
4. Enhance supply chain planning: Accurate forecasts help anticipate demand spikes, ensuring
sufficient inventory levels and avoiding rush charges and backorders.
5. Evaluate external factors: Integrating external data—such as macroeconomic trends—into forecasts
enhances agility, enabling businesses to adapt to changing market conditions.
6. Prepare for the future: Effective demand forecasting equips companies to face uncertainties, from
natural disasters to emerging competition, ensuring readiness for various scenarios.
7. Optimize marketing strategies: Understanding demand patterns allows for targeted marketing
campaigns, increasing their effectiveness.

Methods of forecasting:
Several methods are employed for forecasting demand. All these methods can be grouped under survey
method and statistical method. Survey methods and statistical methods are further subdivided in to different
categories.

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1. Survey Method: Under this method, information about the desires of the consumer and opinion of exports
are collected by interviewing them. Survey method can be divided into four type’s viz., Option survey method;
expert opinion; Delphi method and consumers interview methods.
a. Opinion survey method: This method is also known as sales-force composite method (or) collective
opinion method. Under this method, the company asks its salesman to submit estimate of future sales in their
respective territories. Since the forecasts of the salesmen are biased due to their optimistic or pessimistic
attitude ignorance about economic developments etc. these estimates are consolidated, reviewed and adjusted
by the top executives. In case of wide differences, an average is struck to make the forecasts realistic. This
method is more useful and appropriate because the salesmen are more knowledge.
b. Expert opinion method: Apart from salesmen and consumers, distributors or outside experts may also e
used for forecasting. In the United States of America, the automobile companies get sales estimates directly
from their dealers. Firms in advanced countries make use of outside experts for estimating future demand.
Various public and private agencies all periodic forecasts of short or long term business conditions.
c. Delphi Method: A variant of the survey method is Delphi method. It is a sophisticated method to arrive at
a consensus. Under this method, a panel is selected to give suggestions to solve the problems in hand. Both
internal and external experts can be the members of the panel. Panel members one kept apart from each other
and express their views in an anonymous manner. There is also a coordinator who acts as an intermediary
among the panelists. He prepares the questionnaire and sends it to the panelist. At the end of each round, he
prepares a summary report.
d. Consumers interview method: In this method the consumers are contacted personally to know about their
plans and preference regarding the consumption of the product. A list of all potential buyers would be drawn
and each buyer will be approached and asked how much he plans to buy the listed product in future. He would
be asked the proportion in which he intends to buy. This method seems to be the most ideal method for
forecasting demand.

2. Statistical Methods: Statistical method is used for long run forecasting. In this method, statistical and
mathematical techniques are used to forecast demand. This method relies on post data.
a. Time series analysis or trend projection methods: A well-established firm would have accumulated data.
These data are analyzed to determine the nature of existing trend. Then, this trend is projected in to the future
and the results are used as the basis for forecast. This is called as time series analysis. This data can be
presented either in a tabular form or a graph. In the time series post data of sales are used to forecast future.

b. Barometric Technique: Simple trend projections are not capable of forecasting turning paints. Under
Barometric method, present events are used to predict the directions of change in future. This is done with the
help of economics and statistical indicators. Those are
(1) Construction Contracts awarded for building materials (2) Personal income (3) Agricultural Income. (4)
Employment (5) Gross national income (6) Industrial Production (7) Bank Deposits etc.

c. Regression and correlation method: Regression and correlation are used for forecasting demand. Based
on post data the future data trend is forecasted. If the functional relationship is analyzed with the independent
variable it is simple correction. When there are several independent variables it is multiple correlation. In
correlation we analyze the nature of relation between the variables while in regression; the extent of relation
between the variables is analyzed. The results are expressed in mathematical form. Therefore, it is called as
econometric model building. The main advantage of this method is that it provides the values of the
independent variables from within the model itself.

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Factors effecting the demand forecasting:
Several factors affect customer demand, and understanding these influences is crucial for accurate forecasting.
1. Seasonality of product sales
Seasonality refers to a high variation of product demand throughout the year. A highly seasonal product may
serve only for a specific period or event, leading to a high sales volume during this peak period. Outside these
peak periods, sales will return to a regular state / steady or slow down.
Some demand forecasting examples based on seasonality are products sold:
During specific seasons: grilling equipment in the summer and snow sleds in the winter
During specific events: chocolates on Valentine ’s Day
During specific periods: school equipment in August before the start of a new school year
Thus, during the off-season, companies must reduce inventory for seasonal products but increase production
during peak seasons.
2. Competition
Competition has a direct impact on demand. As a result, customer demand can either drop or spike whenever
competition enters or exits the market. When a new player enters the scene, an existing player may suffer as
customers have more options. But when the opposite happens (when a business closes), existing players may
have greater demand from consumers.

3. Type of goods
Different products and services of different natures affect demand forecasting. For example, perishable goods
with a short product life cycle/expiration date must have an exact demand forecasting number. Otherwise, a
lot of stock is in risk of going to waste. On the other hand, demand forecasting for monthly magazine
subscriptions can be less exact.
4. Geography
The geographical location of your customers and where you manufacture, store and deliver orders can
significantly impact inventory forecasting, shipping cost, and delivery time. Shipping costs are one of the
driving forces that make e-commerce pricing more critical than ever.
So, it is essential to be strategic when choosing geographical locations for your retail supply chain. For
example, choosing a warehouse close to where most of your customers reside can help you fulfill your
customer orders faster. Also, this comes at a more affordable cost, as you don’t have to store products in a
faraway place.
5. Economy
When the economy falls into recession and fewer people work, the demand for luxury products will decline.
But, at the same time, demand for affordable products will likely increase.

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