Unit 2
Demand Analysis & Forecasting
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Unit Contents
Use of elasticities of demand in business decision-
making.
Concept and significance of demand forecasting.
Techniques of demand forecasting: Survey methods,
Market experiment, Time series analysis, Moving
average method, Regression analysis, Barometric
technique.
Limitations of forecasting.
Demand Analysis
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Demand Function
A mathematical relationship between demand and its determinants.
i.e., Qx = f(Px) : Specific demand function
Qx = f(Px, M, Pr, T, A, .....) : General demand function
Types of Demand Function
Linear demand function: A demand function with constant slope throughout the
demand curve.
Qx = a – bPx
where, a = intercept parameter
b = slope of the demand curve
Non-linear Demand Function: A demand function with different slopes on the
given demand curve.
Qx = [Link]-b
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Elasticity of Demand
Rate of change in quantity demanded of a commodity due to
change in its determinants like price, consumer’s income, price
of related goods, advertisement expenditure, etc.
Price Elasticity of Demand (ep)
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Two ways of calculation:
Point Method:
Arc Method:
Price Elasticity of Demand (ep)
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Two ways of calculation:
Point Method:
Arc Method:
Types of Price Elasticity of Demand
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ep = 0 : Demand remains same with any change in price
ep < 1 : % P > % Q (Demand is less sensitive to price)
ep = 1 : % P = % Q
ep > 1 : % P < % Q (Demand is more sensitive to price)
ep = : negligible change in price leads to substantial
change in demand
Uses of Price Elasticity of Demand in
Managerial Decision
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Product Pricing
Elastic demand (ep > 1) : P
Inelastic demand (ep < 1) : P
Factor/Input Pricing
Elastic factor : higher price
Example: skilled labor
Inelastic factor : lower price
Example: unskilled labor
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Monopoly Price
A monopoly has control over price but not demand.
Thus, elastic market : P
inelastic market : P
Price Discrimination
Total market (Airlines Company)
Inelastic sub-market
Elastic sub-market
(Business Class)
(Economy Class)
Higher Price
Lower Price
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Joint Product Pricing
elastic product : P (husk)
Inelastic product : P (rice)
International Trade
Competitive foreign market : P
Monopoly foreign market : P
Discount Decision
If ratio of rise in no. of consumers > the ratio of discount, it
is profitable to offer discount.
Income Elasticity of Demand (eY)
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Two Ways of Calculation:
Point Method
Arc Method
Types of Income Elasticity of Demand
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eY = 0 : Demand remains same with any change in income
eY < 1 : % Y > % Q
eY = 1 : % Y = % Q
eY > 1 : % Y < % Q
eY < 0 : inverse relationship between income and demand
for commodity
Uses of Income Elasticity in Managerial Decision
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To determine the effect of change in economic
activities
Marketing activity
To design marketing strategy
To classify goods into different categories
Cross Elasticity of Demand (eC)
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Two Ways of Calculation:
Point Method
eC
Arc Method
Types of Cross Elasticity of Demand (eC)
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Positive cross elasticity of demand (eC > 0)
If two goods are substitutes of each other, eC > 0.
Negative cross elasticity of demand (eC < 0)
If two goods are complements of each other, eC < 0.
Zero cross elasticity of demand (eC = 0)
If two goods are independent, eC = 0.
Uses of Cross Elasticity in Managerial Decision
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To establish the inter relationship between
goods
To classify industries
To establish the inter-relationship between
industries
Advertising Elasticity of Demand (eA)
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Two Ways of Calculation:
Point Method
Arc Method
Types of Advertising Elasticity of Demand
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EA > 1: % A < % Q
EA< 1: % A > % Q
EA = 1: % A = % Q
Uses of Advertising Elasticity in Managerial Decision
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Helps the management in deciding whether the outlay
on advertisement should be increased, decreased or
maintained at the present level.
Helps the management in studying the effect of
advertisement on sales-revenue.
Helps in evaluating the effectiveness of various media
of advertisement.
Helps to formulate marketing strategies in competitive
environment.
Relationship between Price, Price Elasticity and
Revenue
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Contd…
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Contd…
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Contd…
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Demand Forecasting
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Concept
Demand forecasting is the process of translating past experiences
of the firm regarding sales into future expectation.
Phillip Kotler: Company's sales forecast is an expected level of
company's sales based on a chosen marketing plan and assumed
environment conditions.
Reckie and Crook: Forecasting aims to reduce uncertainty about
tomorrow so that effective decisions can be made today by
providing predictions of future values of variables from past and
present information.
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Significance/Purposes of Forecasting
Short-term Objectives
i. Formulation of appropriate production policy
ii. Regular supply of raw materials
iii. Appropriate pricing policy
iv. Determination of sales
v. Short-term financial forecasting
vi. Regular supply of labour
vii. Maximum utilization of machines
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Long-term Objectives
i. Determination of production capacity
ii. Long-term financial forecasting
[Link] planning
iv. Planning of new product and the expansion of existing
product
v. Guide to related industries
vi. Guide to the government
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Steps in Demand Forecasting
i. Identification of forecasting objectives
ii. Ascertaining the determinants of demand
iii. Determination of relationship between demand and its
determinants
iv. Collection of relevant data
v. Selection of appropriate method of forecasting
vi. Presentation of results in readable form
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Techniques Forecasting
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A. Survey/Non-statistical Technique
Applicable for short-term forecasting.
Suitable in forecasting demand for new product
Also known as ‘subjective/Qualitative method’
In the absence of historical data, survey method is relevant.
Two Methods:
i. Consumer survey method
ii. Opinion poll method
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i. Consumer Survey Method
Also known as “Buyer’s Intention Survey”
Direct and short-run method of forecasting
Three Methods:
Complete Enumeration Method
All the targeted consumers are interviewed about how many units of
the good they think to consume.
In this method,
Probable demand = Sum of individual demands for the product.
i.e. Dp = X1 + X2 + X3 + ….. + Xn
or, Dp =
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Sample Survey Method
A representative number (Sample) from total population is considered.
After determining the sample size, the future demand is surveyed.
Formula:
Where
DP = Probable demand
H = Estimated number of households
HR = Number of households reporting demand
HS = Number of sample households
AD = Average expected consumption
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End Use Method
– Demand forecasting is prepared assuming the sales of good
as final use.
– Some goods may be final consumption goods and some may
be intermediate goods.
– Forecasting the demand for intermediate goods depends on
the survey of the production plan of industries.
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ii. Opinion poll method
Consists of collecting the opinions of scholars, experts,
sales representatives etc.
Three Techniques
Expert Opinion Method
– Collection of opinions of various experts who have sound
knowledge regarding the product.
– Such experts may be from inside or outside the business.
– Retailers, wholesalers, distributors, professional experts can
be considered while collecting opinions.
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Sales Force Method
– Since sales persons are closely associated with
customers, they are considered for collecting
opinions regarding the demand for the product.
– It is based on the preliminary knowledge and
experience of sales persons relating to sales.
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Market Studies and Experiment
Steps:
– Total market is classified into different categories.
– Then, a representative market is selected from total market
which is termed as ‘Test Market’.
– The product to be forecasted is kept in the test market for sale.
– Any one factor among various determinant of demand is
changed and the effect on demand is analyzed.
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B. Statistical Technique
– Applicable for long-term forecasting.
– It is used when historical data are available.
– Also known as “Quantitative Technique”.
Four Methods:
i. Time Series Analysis
ii. Moving Average Method
iii. Regression Analysis
iv. Barometric Method
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i. Time Series Analysis
– Series of data collected serially on the basis of given time period
is time series analysis.
– Also known as “Trend Projection Method”.
– It shows the trend of past sales of a product.
Steps:
Let Y = f(X)
Where,
Y = Sales/demand
X = Time period
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The Trend line/Time Series Equation is
Y = a + bx .....................(i)
where,
a = Constant parameter
b = Slope
Least square equations/Normal equation are
Y = na + bx ............. (ii)
xY = ax + bx2 ........... (iii)
– If x = 0,
– If x 0, we solve (ii) and (iii) to calculate a and b
Putting the values of a and b in equation (i), we get the trend line and sales (Y) can be
predicted if X (time period) is given.
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ii. Moving Average Method
– Moving average is predetermined average value derived from
observations.
– Depends on past sales data and no need of complex mathematical
calculation.
– Trend values as well as sales forecast can be determined by this
method.
Note:
For numerical illustration, please refer to mathematical examples in
the book.
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iii. Regression Analysis
– Regression is the trend of the result of any study approaching
towards the average.
– Least square method is employed while forecasting demand through
Regression Analysis.
Simple Regression Model
– Consists of a single independent variable.
Y = f(X)
Multiple Regression Model
Consists of two or more independent variables.
Y = f(X1, X2, .........., Xn)
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Steps in Regression Analysis
Development of a theoretical model
Data collection
Choice of the form of equation
Estimation and interpretation of results
Note:
Please refer to the book for mathematical examples.
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iv. Barometric Method
– Related to time series.
– Also known as ‘Economic Indicator Method’
– Time series method assumed future as an expanded form of the past
whereas barometric method assumes future as an expanded from of
present.
Three Basic Indicators
– Leading indicator: The indicator that changes before other indicators.
– Coincident indicator: Indicator that changes simultaneously with
leading indicator.
– Lagging Indicator: Indicator that changes after the changes in all
other indicators.
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Leading Indicator
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Limitations of Forecasting
i. Use of Technique
[Link] Errors
iii. Limitation of Measurability
iv. Statistical Errors
Note:
Please refer to the book for mathematical examples of
the Chapter.
End of Chapter 2
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Thank You!!!
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