UNIT-I

INTRODUCTION TO MANAGERIAL ECONOMICS

Managerial Economics

Introduction

Managerial Economics as a subject gained popularity in USA after the publication of the book
“Managerial Economics” by Joel Dean in 1951.

Managerial Economics refers to the firm’s decision making process. It could be also interpreted as
“Economics of Management” or “Economics of Management”. Managerial Economics is also called as
“Industrial Economics” or “Business Economics”.

As Joel Dean observes managerial economics shows how economic analysis can be used in
formulating polices

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”.

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”.

Nature of Managerial Economics

The 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’. One problem with normative statements is that they cannot to verify by looking at the facts,
because they mostly deal with the future.
(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, it also explains whether the concept can be applied in a given context on
not. 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. In managerial
economics, we also employ case study methods to conceptualize the problem, identify that
alternative and determine the best course of action.
(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 Managerial Economics:

The scope of managerial economics refers to its area of study. Managerial economics refers to its area of study.
Managerial economics, Provides management with a strategic planning tool that can be used to get a clear
perspective of the way the business world works and what can be done to maintain profitability in an ever-
changing environment. 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.

a. The selection of product or service to be produced.

b. The choice of production methods and resource combinations.
c. The determination of the best price and quantity combination
d. Promotional strategy and activities.
e. The selection of the location from which to produce and sell goods or service to consumer.
The production department, marketing and sales department and the finance department usually handle these
five types of decisions.

The scope of managerial economics covers two areas of decision making

a. Operational or Internal issues

b. Environmental or External issues
a. Operational issues:
Operational issues refer to those, which wise within the business organization and they are under the control of
the management. Those are:

1. Theory of demand and Demand Forecasting

2. Pricing and Competitive strategy
3. Production cost analysis
4. Resource allocation

Managerial economics relationship with other disciplines:

Many new subjects have evolved in recent years due to the interaction among basic disciplines. While
there are many such new subjects in natural and social sciences, managerial economics can be taken as the best
example of such a phenomenon among social sciences. Hence it is necessary to trace its roots and relation ship
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.

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.

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, hoe 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.
4. Managerial Economics and Statistics:

Managerial Economics needs the tools of statistics in more than one way. A successful businessman must
correctly estimate the demand for his product. He should be able to analyses the impact of variations in tastes.
Fashion and changes in income on demand only then he can adjust his output. Statistical methods provide and
sure base for decision-making. Thus statistical tools are used in collecting data and analyzing them to help in
the decision making process.

5. Managerial Economics and Operations Research

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.

QUESTIONS

1. What is managerial economics? Explain its focus are as

2. Point out the importance of managerial economics in decision making
3. What are the contributions and limitations of economic analysis in business decision making
4. Managerial Economics is the discipline which deals with the applications of economic theory to
business management discuss.
5. Explain the fundamental concepts of managerial economics
6. Discuss the nature & Scope of Managerial economics

DEMAND ANALYSIS

Introduction & Meaning:

Demand in common parlance means the desire for an object. But in economics demand is something
more than this. According to Stonier and Hague, “Demand in economics means demand backed up by enough
money to pay for the goods demanded”.

Thus demand in economics means the desire backed by the willingness to buy a commodity and the
purchasing power to pay. In the words of “Benham” “The demand for anything at a given price is the amount
of it which will be bought per unit of time at that Price”. (Thus demand is always at a price for a definite
quantity at a specified time.) Thus demand has three essentials – price, quantity demanded and time. Without
these, demand has to significance in economics.

Different types of economic demand

Companies and corporations put plenty of their budget into understanding the demand for their products. This
enables them to push their product to consumers or other businesses without losing money due to
overproduction or other factors. As an employee, understanding what type of demand your company falls
under is a good business practice. Here’s a glance at the different types of economic demand.

1. Market and individual demand: Individual demand is the economic demand for a product at a certain
price by one consumer. Customer tastes, perceived quality and brand loyalty all affect individual
demand. Market demand, also known as aggregate demand, is the total economic demand of all
individual demand in a particular market.

2. Company and industry demand: The demand for products at a certain price over a period of time
from a single entity is known as company demand. Industry demand is the total aggregate demand for
products in an industry. Company demand is often expressed as a percentage of industry demand in
order to measure market share. For example, the demand for Pepsi products is the company demand,
but it only makes up a percentage of the total industry demand for beverages.

3. Short-term and long-term demand: As the name implies, short-term demand for a product is the
economic demand over a shorter duration of time. Short-term demand is elastic, meaning that it reflects
price changes, fads and necessity more drastically than longer-term demand. For example, winter
clothing is only worn during the colder months, making the demand short-term in comparison to
clothes that are worn year-round. Price makes short-term demand fluctuate drastically.

Long-term demand refers to consumers’ demand for products over a lengthier stretch of time. This
demand doesn’t change nearly as much with respect to price. Instead, long-term demand changes based
on promotion and advertising by a company, the availability of substitutes and competition.

4. Market and market segment demand: Market demand is the aggregate demand of all consumers who
purchase the same type of product. Market segment demand, on the other hand, refers to a particular
subset of market demand, namely age, race, gender and a variety of other demographic factors.

5. Perishable and durable goods demand: Durable goods are any products that can be used more than
once in their life cycle. Perishable goods are items that only have a single use. While both types of
goods satisfy the demands of consumers, durable items have more perceived value over the long-term.
In addition, durable goods also need replacement over time (cars, shoes, clothing), so a market demand
still exists for them after an initial purchase.

6. Derived and autonomous demand: Autonomous demand, also known as direct demand, is when the
demand for a product is independent of all other goods in the market. Derived demand is an economic
demand that directly correlates with the demand for another product. For example, if the demand for
tires goes up, the demand for rubber will increase proportionately.

7. Income demand: Income is a determinant of economic demand, so it’s easy to understand why it has
it’s its own type of demand. Income demand is the willingness of a consumer to buy a certain product
at a given income level and price. If income goes down, demand goes down. If income goes up,
demand goes up.

8. Price demand: Price demand refers to the quantity of a certain good that a consumer will buy at a
certain price. Unlike income demand, price demand has an inverse relationship between price and
overall demand. As the price goes up, demand falls and vice-versa.

9. Cross demand: This type of economic demand centers on the number of substitutes and related
products in a particular market. When the price of a certain product goes up, cross demand dictates that
its substitute will see an increase in demand. An example of cross demand is if the price of cow’s milk
skyrockets, the demand for almond milk, soy milk and other milk substitutes will increase.

Types of demand vary by industry and company, but a vested knowledge and interest in the types of economic
demand will help you understand the mission and goals of your department, company or potential employer.
However, You don’t have to become an expert on all types of demands. Instead, focus your energy and study
on those that impact your industry.

Some companies only have to deal with a single type of demand while others fall under two or more them.
Once you’ve identified the types of economic demand of your company or prospective employer, you can
better comprehend the role of your job and how to increase your effectiveness and efficiency at your position.

Determinants of Demand

Some of the important determinants of demand are as follows,

1] Price of the Product

People use price as a parameter to make decisions if all other factors remain constant or equal. According to the
law of demand, this implies an increase in demand follows a reduction in price and a decrease in demand follows
an increase in the price of similar goods.

The demand curve and the demand schedule help determine the demand quantity at a price level. An elastic
demand implies a robust change quantity accompanied by a change in price. Similarly, an inelastic demand
implies that volume does not change much even when there is a change in price.

2] Income of the Consumers

Rising incomes lead to a rise in the number of goods demanded by consumers. Similarly, a drop in income is
accompanied by reduced consumption levels. This relationship between income and demand is not linear in nature.
Marginal utility determines the proportion of change in the demand levels.

3] Prices of related goods or services

• Complementary products – An increase in the price of one product will cause a decrease in the quantity
demanded of a complementary product. Example: Rise in the price of bread will reduce the demand for
butter. This arises because the products are complementary in nature.

• Substitute Product – An increase in the price of one product will cause an increase in the demand for a
substitute product. Example: Rise in price of tea will increase the demand for coffee and decrease the
demand for tea.

4] Consumer Expectations

Expectations of a higher income or expecting an increase in prices of goods will lead to an increase the quantity
demanded. Similarly, expectations of a reduced income or a lowering in prices of goods will decrease the quantity
demanded.

5] Number of Buyers in the Market

The number of buyers has a major effect on the total or net demand. As the number increases, the demand rises.
Furthermore, this is true irrespective of changes in the price of commodities.
LAW of Demand:

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 Appel (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.

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

Assumptions:

Law is demand is based on certain assumptions:

1. This is no change in consumers taste and preferences.

2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity
5. The commodity should not confer at any distinction
6. The demand for the commodity should be continuous
7. People should not expect any change in the price of the commodity
Exceptional demand curve:

Some times the demand curve slopes upwards from left to right. In this case the demand curve has a positive
slope.

Price
When price increases from OP to Op1 quantity demanded also increases from to OQ1 and vice versa. The
reasons for exceptional demand curve are as follows.

1. Giffen paradox:

The Giffen good or inferior good is an exception to the law of demand. When the price of an inferior good
falls, the poor will buy less and vice versa. For example, when the price of maize falls, the poor are willing to
spend more on superior goods than on maize if the price of maize increases, he has to increase the quantity of
money spent on it. Otherwise he will have to face starvation. Thus a fall in price is followed by reduction in
quantity demanded and vice versa. “Giffen” first explained this and therefore it is called as Giffen’s paradox.

2. Veblen or Demonstration effect:

‘Veblan’ has explained the exceptional demand curve through his doctrine of conspicuous consumption. Rich
people buy certain good because it gives social distinction or prestige for example diamonds are bought by the
richer class for the prestige it possess. It the price of diamonds falls poor also will buy is hence they will not
give prestige. Therefore, rich people may stop buying this commodity.

3. Ignorance:

Sometimes, the quality of the commodity is Judge by its price. Consumers think that the product is superior if
the price is high. As such they buy more at a higher price.

4.Speculative effect:

If the price of the commodity is increasing the consumers will buy more of it because of the fear that it
increase still further, Thus, an increase in price may not be accomplished by a decrease in demand.

5. Fear of shortage:

During the times of emergency of war People may expect shortage of a commodity. At that time, they may buy
more at a higher price to keep stocks for the future.
6.Necessaries:

In the case of necessaries like rice, vegetables etc. people buy more even at a higher price.

Factors Affecting Demand:

There are factors on which the demand for a commodity depends. These factors are economic, social as well as
political factors. The effect of all the factors on the amount demanded for the commodity is called Demand
Function.

These factors are as follows:

1. Price of the Commodity:

The most important factor-affecting amount demanded is the price of the commodity. The amount of a
commodity demanded at a particular price is more properly called price demand. The relation between price
and demand is called the Law of Demand. It is not only the existing price but also the expected changes in
price, which affect demand.

2. Income of the Consumer:

The second most important factor influencing demand is consumer income. In fact, we can establish a relation
between the consumer income and the demand at different levels of income, price and other things remaining
the same. The demand for a normal commodity goes up when income rises and falls down when income falls.
But in case of Giffen goods the relationship is the opposite.

3. Prices of related goods:

The demand for a commodity is also affected by the changes in prices of the related goods also. Related goods
can be of two types:

(i). Substitutes which can replace each other in use; for example, tea and coffee are
substitutes. The change in price of a substitute has effect on a commodity’s demand
in the same direction in which price changes. The rise in price of coffee shall raise
the demand for tea;

(ii). Complementary foods are those which are jointly demanded, such as pen and ink. In
such cases complementary goods have opposite relationship between price of one
commodity and the amount demanded for the other.

4. Tastes of the Consumers:

The amount demanded also depends on consumer’s taste. Tastes include fashion, habit, customs, etc. A
consumer’s taste is also affected by advertisement. If the taste for a commodity goes up, its amount demanded
is more even at the same price. This is called increase in demand. The opposite is called decrease in demand.

5. Wealth:
The amount demanded of commodity is also affected by the amount of wealth as well as its distribution. The
wealthier are the people; higher is the demand for normal commodities. If wealth is more equally distributed,
the demand for necessaries and comforts is more. On the other hand, if some people are rich, while the
majorities are poor, the demand for luxuries is generally higher.

6. Population:
Increase in population increases demand for necessaries of life. The composition of population also affects
demand. Composition of population means the proportion of young and old and children as well as the ratio of
men to women. A change in composition of population has an effect on the nature of demand for different
commodities.

7. Government Policy:

Government policy affects the demands for commodities through taxation. Taxing a commodity increases its
price and the demand goes down. Similarly, financial help from the government increases the demand for a
commodity while lowering its price.

8. Expectations regarding the future:

If consumers expect changes in price of commodity in future, they will change the demand at present even
when the present price remains the same. Similarly, if consumers expect their incomes to rise in the near future
they may increase the demand for a commodity just now.

9. Climate and weather:

The climate of an area and the weather prevailing there has a decisive effect on consumer’s demand. In cold
areas woolen cloth is demanded. During hot summer days, ice is very much in demand. On a rainy day, ice
cream is not so much demanded.

ELASTICITY OF DEMAND

Elasticity of demand explains the relationship between a change in price and consequent change in
amount demanded. “Marshall” introduced the concept of elasticity of demand. Elasticity of demand shows the
extent of change in quantity demanded to a change in price.
 In the words of “Marshall”, “The elasticity of demand in a market is great or small according as the
amount demanded increases much or little for a given fall in the price and diminishes much or little for a given
rise in Price”

Elastic demand: A small change in price may lead to a great change in quantity demanded. In this case,
demand is elastic.

In-elastic demand: If a big change in price is followed by a small change in demanded then the demand in
“inelastic”.

Types of Elasticity of Demand:

There are three types of elasticity of demand:

1. Price elasticity of demand

2. Income elasticity of demand
3. Cross elasticity of demand

1. Price elasticity of demand:

Marshall was the first economist to define price elasticity of demand. Price elasticity of demand measures
changes in quantity demand to a change in Price. It is the ratio of percentage change in quantity demanded to a
percentage change in price.

Proportionate change in the quantity demand of commodity

Price elasticity = ------------------------------------------------------------------

Proportionate change in the price of commodity

There are five cases of price elasticity of demand

A. Perfectly elastic demand:

When small change in price leads to an infinitely large change is quantity demand, it is called perfectly or
infinitely elastic demand. In this case E=∞
The demand curve DD1 is horizontal straight line. It shows the at “OP” price any amount is demand and if
price increases, the consumer will not purchase the commodity.

B. Perfectly Inelastic Demand

In this case, even a large change in price fails to bring about a change in quantity demanded.

When price increases from ‘OP’ to ‘OP’, the quantity demanded remains the same. In other words the response
of demand to a change in Price is nil. In this case ‘E’=0.
C. Relatively elastic demand:

Demand changes more than proportionately to a change in price. i.e. a small change in price loads to a very big
change in the quantity demanded. In this case

E > 1. This demand curve will be flatter.

When price falls from ‘OP’ to ‘OP’, amount demanded in crease from “OQ’ to “OQ1’ which is larger than the
change in price.

D. Relatively in-elastic demand.

Quantity demanded changes less than proportional to a change in price. A large change in price leads to small
change in amount demanded. Here E < 1. Demanded carve will be steeper.
When price falls from “OP’ to ‘OP1 amount demanded increases from OQ to OQ1, which is smaller than the
change in price.

E. Unit elasticity of demand:

The change in demand is exactly equal to the change in price. When both are equal E=1 and elasticity if said to
be unitary.
When price falls from ‘OP’ to ‘OP1’ quantity demanded increases from ‘OP’ to ‘OP1’, quantity demanded
increases from ‘OQ’ to ‘OQ1’. Thus a change in price has resulted in an equal change in quantity demanded so
price elasticity of demand is equal to unity.

2. Income elasticity of demand:

Income elasticity of demand shows the change in quantity demanded as a result of a change in income. Income
elasticity of demand may be slated in the form of a formula.

Proportionate change in the quantity demand of commodity

Income Elasticity = ------------------------------------------------------------------

Proportionate change in the income of the people

Income elasticity of demand can be classified in to five types.

A. Zero income elasticity:

Quantity demanded remains the same, even though money income increases. Symbolically, it can be expressed
as Ey=0. It can be depicted in the following way:
As income increases from OY to OY1, quantity demanded never changes.

B. Negative Income elasticity:

When income increases, quantity demanded falls. In this case, income elasticity of demand is negative. i.e., Ey
< 0.

When income increases from OY to OY1, demand falls from OQ to OQ1.

c. Unit income elasticity:

When an increase in income brings about a proportionate increase in quantity demanded, and then income
elasticity of demand is equal to one. Ey = 1
When income increases from OY to OY1, Quantity demanded also increases from OQ to OQ1.

d. Income elasticity greater than unity:

In this case, an increase in come brings about a more than proportionate increase in quantity demanded.
Symbolically it can be written as Ey > 1.

It shows high-income elasticity of demand. When income increases from OY

to OY1, Quantity demanded increases from OQ to OQ1.

E. Income elasticity leas than unity:

When income increases quantity demanded also increases but less than proportionately. In this case E < 1.

An increase in income from OY to OY, brings what an increase in quantity demanded from OQ to OQ1, But
the increase in quantity demanded is smaller than the increase in income. Hence, income elasticity of demand
is less than one.

3. Cross elasticity of Demand:

A change in the price of one commodity leads to a change in the quantity demanded of another commodity.
This is called a cross elasticity of demand. The formula for cross elasticity of demand is:

Proportionate change in the quantity demand of commodity “X”

Cross elasticity = -----------------------------------------------------------------------

Proportionate change in the price of commodity “Y”

a. In case of substitutes, cross elasticity of demand is positive. Eg: Coffee and Tea

When the price of coffee increases, Quantity demanded of tea increases. Both are substitutes.
 Price of Coffee

b. Incase of compliments, cross elasticity is negative. If increase in the price of one commodity leads to a
decrease in the quantity demanded of another and vice versa.

When price of car goes up from OP to OP!, the quantity demanded of petrol decreases from OQ to OQ!. The
cross-demanded curve has negative slope.
c. In case of unrelated commodities, cross elasticity of demanded is zero. A change in the price of one
commodity will not affect the quantity demanded of another.

Quantity demanded of commodity “b” remains unchanged due to a change in the price of ‘A’, as both are
unrelated goods.

Factors influencing the elasticity of demand

Elasticity of demand depends on many factors.

1. Nature of 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. Availability of 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.

3. Variety of 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.
4. Postponement of demand:

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.

5. Amount of money spent:

Elasticity of demand depends on the amount of money spent on the commodity. If the consumer spends a
smaller for example a consumer spends a little amount on salt and matchboxes. Even when price of salt or
matchbox goes up, demanded will not fall. Therefore, demand is in case of clothing a consumer spends a large
proportion of his income and an increase in price will reduce his demand for clothing. So the demand is elastic.

6. Time:

Elasticity of demand varies with time. Generally, demand is inelastic during short period and elastic during the
long period. Demand is inelastic during short period because the consumers do not have enough time to know
about the change is price. Even if they are aware of the price change, they may not immediately switch over to
a new commodity, as they are accustomed to the old commodity.

7. Range of Prices:

Range of prices exerts an important influence on elasticity of demand. At a very high price, demand is inelastic
because a slight fall in price will not induce the people buy more. Similarly at a low price also demand is
inelastic. This is because at a low price all those who want to buy the commodity would have bought it and a
further fall in price will not increase the demand. Therefore, elasticity is low at very him and very low prices.

Importance of Elasticity of Demand:

The concept of elasticity of demand is of much practical importance.

1. Price fixation:

Each seller under monopoly and imperfect competition has to take into account elasticity of demand while
fixing the price for his product. If the demand for the product is inelastic, he can fix a higher price.

2. Production:

Producers generally decide their production level on the basis of demand for the product. Hence elasticity of
demand helps the producers to take correct decision regarding the level of cut put to be produced.
3. Distribution:

Elasticity of demand also helps in the determination of rewards for factors of production. For example, if the
demand for labour is inelastic, trade unions will be successful in raising wages. It is applicable to other factors
of production.

4. International Trade:

Elasticity of demand helps in finding out the terms of trade between two countries. Terms of trade refers to the
rate at which domestic commodity is exchanged for foreign commodities. Terms of trade depends upon the
elasticity of demand of the two countries for each other goods.

5. Public Finance:

Elasticity of demand helps the government in formulating tax policies. For example, for imposing tax on a
commodity, the Finance Minister has to take into account the elasticity of demand.

6. Nationalization:

The concept of elasticity of demand enables the government to decide about nationalization of industries.

Demand Forecasting

Introduction:

The information about the future is essential for both new firms and those planning to expand the scale of their
production. Demand forecasting refers to an estimate of future demand for the product.

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.

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.

Methods of forecasting:

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

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.

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. On the basis of the summary report the panel members have to give suggestions. This method has been
used in the area of technological forecasting. It has proved more popular in forecasting. It has provided more
popular in forecasting non-economic rather than economic variables.

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.

QUESTIONS

1. What is meant by elasticity of demand? How do you measure it? What are determinates of elasticity of
demand?
2. What is the utility of demand forecasting? What are the criteria for a good forecasting method?
Forecasting of demand for a new product? ‘ Economic indicators’
3. What is promotional elasticity of demand? How does if differ from cross elasticity of demand.