DEPARTMENT OF AERONOUTICAL ENGINEERING

ENGINEERING ECONOMICS UNIT- 2 NOTES

2024-25

What Is Supply?

Supply is a fundamental economic concept that describes the total amount of a specific good
or service that is available to consumers. Supply can relate to the amount available at a specific
price or the amount available across a range of prices if displayed on a graph. This relates
closely to the demand for a good or service at a specific price; all else being equal, the supply
provided by producers will rise if the price rises because all firms look to maximize profits.

Understanding Supply

The concept of supply in economics is complex with many mathematical formulas, practical
applications, and contributing factors. While supply can refer to anything in demand that is
sold in a competitive marketplace, supply is most used to refer to goods, services, or labor.

One of the most important factors that affect supply is the good’s price. Generally, if a good’s
price increases, so will the supply. There is often an inverse relationship between the price
consumers are willing to pay and the price manufacturers or retailers are wanting to charge.

The conditions of the production of the item in supply is also significant when a technological
advancement increases the quality of a good being supplied, or if there is a disruptive
innovation, such as when a technological advancement renders a good obsolete or less in
demand. Government regulations can also affect supply; consider environmental laws
regarding the extraction of oil affect the supply of such oil.

Supply is represented in microeconomics by a number of mathematical formulas. The supply

function and equation express the relationship between supply and the affecting factors. A
wealth of information can be gleaned from a supply curve, such as movements (caused by a
change in price), shifts (caused by a change that is not related to the price of the good) and
price elasticity.

What Is the Law of Supply?

The law of supply is a microeconomic law. It states that, all other factors being equal, as the
price of a good or service increases, the quantity of that good or service that suppliers offer will
increase, and vice versa.

In plain terms, this law means that as the price of an item goes up, suppliers will attempt to
maximize their profits by increasing the number of that item that they sell.

What Is Price Elasticity of Supply?

Price elasticity of supply is the responsiveness of a supply of a good or service after a change
in its market price. According to basic economic theory, the supply of a good will increase
when its price rises. Conversely, the supply of a good will decrease when its price decreases.
This happens because producers want to take advantage of a rise in price, so they increase
production of their goods and services until demand is exceeded—at which time prices begin
to fall. Producers then decrease output to match the price decline.

Goods and services can be either elastic or inelastic. Elastic means the product is considered
sensitive to price changes—luxury goods and non-necessary items fall into this category.
Inelastic means the product is not sensitive to price movements—food and gas are examples
of inelastic supply goods.

What Is Demand Forecasting?

The answer to, 'What is demand forecasting?' is that it is a process that businesses utilise to
understand and predict customer demand over a period. This helps them make informed
decisions about supply chain operations, inventory stocking, capacity planning, cash flow and
profit margins. They use various demand forecasting methods, such as:

 Trend projection: Trend projection uses historical data to project future sales. It is
important to remove outliers, such as sudden spikes in sales and historical anomalies,
before opting for this method.
  Market research: Market research uses data from customer surveys to provide
businesses with valuable information. It helps cluster customers based on their
purchasing habits, demographic, geographic and psychographic variables.

 Delphi method: It involves sending several questionnaires to an expert panel over

several rounds to generate forecasts. The primary objective of this technique is to arrive
at a group consensus which can provide unified expert opinion.

 Sales force composite: This method uses data from the sales groups to predict future
demand for a product or a service. The sales team provides data such as customer
behaviour, product trends, competitors' products and pricing strategies and customer
feedback.

 Econometric technique: This technique combines sales data with external economic
factors to build a mathematical model that can accurately predict future customer
demand. The external factors can include regulations and policies, technology,
macroeconomic conditions and geopolitical scenarios.

Methods of Demand Forecasting

Demand forecasting is the art as well as the science of predicting the likely demand for a
product or service in the future. This prediction is based on past behavior patterns and the
continuing trends in the present. Hence, it is not simply guessing the future demand but is
estimating the demand scientifically and objectively. Thus, there are various methods of
demand forecasting which we will discuss here.

Methods of Demand Forecasting

There is no easy or simple formula to forecast the demand. Proper judgment along with the
scientific formula is needed to correctly predict the future demand for a product or service.
Some methods of demand forecasting are discussed below:

1] Survey of Buyer’s Choice

When the demand needs to be forecasted in the short run, say a year, then the most feasible
method is to ask the customers directly that what are they intending to buy in the forthcoming
time period. Thus, under this method, potential customers are directly interviewed.
This survey can be done in any of the following ways:
 a. Complete Enumeration Method: Under this method, nearly all the potential buyers are
asked about their future purchase plans.

b. Sample Survey Method: Under this method, a sample of potential buyers are chosen
scientifically and only those chosen are interviewed.

c. End-use Method: It is especially used for forecasting the demand of the inputs. Under
this method, the final users i.e. the consuming industries and other sectors are identified.
The desirable norms of consumption of the product are fixed, the targeted output levels
are estimated and these norms are applied to forecast the future demand of the inputs.

Hence, it can be said that under this method the burden of demand forecasting is on the buyer.
However, the judgments of the buyers are not completely reliable and so the seller should take
decisions in the light of his judgment also.

The customer may misjudge their demands and may also change their decisions in the future
which in turn may mislead the survey. This method is suitable when goods are supplied in bulk
to industries but not in the case of household customers.

2] Collective Opinion Method

Under this method, the salesperson of a firm predicts the estimated future sales in their region.
The individual estimates are aggregated to calculate the total estimated future sales. These
estimates are reviewed in the light of factors like future changes in the selling price, product
designs, changes in competition, advertisement campaigns, the purchasing power of the
consumers, employment opportunities, population, etc.

The principle underlying this method is that as the salesmen are closest to the consumers they
are more likely to understand the changes in their needs and demands. They can also easily
find out the reasons behind the change in their tastes.

Therefore, a firm having good sales personnel can utilize their experience to predict the
demands. Hence, this method is also known as Salesforce opinion or Grassroots approach
method. However, this method depends on the personal opinions of the sales personnel and is
not purely scientific.

3] Barometric Method
This method is based on the past demands of the product and tries to project the past into the
future. The economic indicators are used to predict the future trends of the business. Based on
future trends, the demand for the product is forecasted. An index of economic indicators is
formed. There are three types of economic indicators, viz. leading indicators, lagging
indicators, and coincidental indicators.

The leading indicators are those that move up or down ahead of some other series. The lagging
indicators are those that follow a change after some time lag. The coincidental indicators are
those that move up and down simultaneously with the level of economic activities.

4] Market Experiment Method

Another one of the methods of demand forecasting is the market experiment method. Under
this method, the demand is forecasted by conducting market studies and experiments on
consumer behavior under actual but controlled, market conditions.

Certain determinants of demand that can be varied are changed and the experiments are done
keeping other factors constant. However, this method is very expensive and time-consuming.

5] Expert Opinion Method

Usually, market experts have explicit knowledge about the factors affecting demand. Their
opinion can help in demand forecasting. The Delphi technique, developed by Olaf Helmer is
one such method.

Under this method, experts are given a series of carefully designed questionnaires and are asked
to forecast the demand. They are also required to give the suitable reasons. The opinions are
shared with the experts to arrive at a conclusion. This is a fast and cheap technique

Demand Forecasting Techniques

There are two methods in which demand forecasting can be done i.e (A) Survey Methods and
(B) Statistical Methods.

 Advanced Analytics:

 Passive Demand Forecasting: Passive demand forecasting is the simplest way to make
predictions using historical data. This type of forecasting is mainly used by well-
 established organizations with an ample amount of historical data and market
experience.

 Short Term Demand Forecasting 2: Short-term demand forecasting will make

predictions for the next three to twelve months of time period. It is used to act quickly
to changes in customer demand and market behavior. In this type of forecasting, real-
time sales data is used to manage just in time inventory.

 Long Term Demand Forecasting: Data security is non-negotiable in today’s world.

Snowflake takes this seriously, offering robust security features to protect your precious
data. From encryption to access controls, your data is in safe hands.

 External Macro Forecasting: External macro forecasting helps to overlook trends in the
broader economy. This projection looks at how those trends will affect your goals. An
external macro demand forecast also can offer you direction for a way to satisfy those
goals.

 Internal Business Forecasting: Internal Business Forecasting deals with internal

business operations such as business financing, supply-chain management, cash on
hand, and personnel. It basically points towards the areas where the organizations need
to increase the capacity in order to meet the expansion goals.

 Advanced Analytics:

 Market Research
In the market research technique, consumer-specific survey forms are sent out in
tabular format to get insights that an organization can’t get from internal sales. It
gives better information about the type of customers and demographic data which will
help to target future markets. Market Research helps young companies to know their
customer base better.

 Sale Force Opinion

SalesForce Opinion method use data from sales groups to forecast demand.
Salespeople of an organization are closest to their customer base, hence can generate
valuable information on customer needs, behavior, and feedback and can even give
information about the competition in the markets.
  Delphi Method
In Delphi Method, an organization hires a group of external experts. Each Expert
generates a forecast based on their market knowledge. After this process forecasts are
shared among the experts anonymously, hence experts get influenced by each other’s
forecasts. Now the experts are asked again to generate a forecast and this process is
repeated until all experts reach a near consensus scenario. The process is intended to
permit the experts to expand on one another’s information and assessments.

Criteria for Good Demand Forecasting

1. Accuracy: The primary goal of any forecasting method is to accurately predict future
outcomes. Therefore, the accuracy of the forecast is the most important criterion to
evaluate the quality of a forecasting method. The accuracy is typically measured by
comparing the predicted values to the actual values. A good forecasting method should
have a high level of accuracy and a low margin of error.

2. Consistency: A good forecasting method should produce consistent results over time.
This means that the method should consistently predict future outcomes with the same
level of accuracy, regardless of the period being forecasted. A forecasting method that
produces inconsistent results is not reliable and can lead to incorrect decision-making.

3. Timeliness: A good forecasting method should provide predictions in a timely manner.

This means that the method should be able to provide accurate forecasts within a
reasonable time frame, depending on the needs of the user. For example, a method that
takes too long to provide a forecast may not be suitable for real-time decision-making.

4. Relevance: A good forecasting method should be relevant to the problem being solved.
This means that the method should be tailored to the specific needs of the user and the
context in which it will be used. For example, a forecasting method that works well for
predicting sales in one industry may not be suitable for predicting sales in a different
industry.

5. Ease of Use: A good forecasting method should be easy to use and interpret. This means
that the method should be user-friendly and not require extensive training or expertise
 to use. A method that is difficult to use or requires specialized knowledge may not be
practical for many users.

6. Flexibility: A good forecasting method should be flexible and adaptable to changing

circumstances. This means that the method should be able to incorporate new data and
adjust predictions as new information becomes available. A rigid method that cannot
adapt to changing conditions may quickly become obsolete.

7. Cost: A good forecasting method should be cost-effective. This means that the benefits
of using the method should outweigh the costs of implementing and maintaining it. A
method that is too expensive or requires too many resources may not be practical for
many users.

Why Is Demand Forecasting for New Products Important?

Money is an important asset whose even slight improper spending can hamper a company’s
cost sheet. And when it comes to supply chain verticals, these expenses need more
accountability. Demand forecasting becomes an indispensable aspect from an organization's
planning point of view for a production process to be efficient & intelligible.

Preparing the budget

A new product forecasting process needs its budget sorted out as it helps reduce risk during a
good's life cycle. It benefits efficient financial decision-making that drives cash flow, allocation
of resources, profit margins, expansion opportunities, inventory accounting, operational costs
& overall expenses.

Better Inventory Control

The critical aspect that new product demand forecasting models drive is it lets your business
know which product your customer base is looking out for and when they are looking to acquire
it. Thus, helping your inventory operations complete the order fulfilment targets by having
better inventory & warehousing control. This also saves your partners & stakeholders the
shortage of supplies during sudden customer demands during peak season, while upping the
credentials of your brand value.

Tapping into Market Potential

Dynamic Pricing is a well-known concept in today’s ecommerce driven business. To create a
sudden splurge in demands, companies employ flash sales with reduced prices to attract higher
conversion rates. This is a strategical business action which is a byproduct of smart demand
forecasting process. A company’s understanding of market opportunities based on demand
forecasting gives them foresight to house inventory beforehand and cash-in with a promotional
sale at a later stage to edge out its competition. Not only does it improve an organization’s
digital footprint but also keeps you trending considering your marketing plan has made you the
sole player providing the most sought-after product in the market.

Better Profit Margins

Every business thrives on good profits at the end of each quarter. With demand forecasting
providing you with accurate marketing insight which later translates into intelligent sales
decision bringing in attractive numbers – a business model more often than not will end up
returning profit on its investments. Any industry which proactively invests in demand planning
based on relevant sales data, market trends & the current economic situation will have a thriving
commerce statement.

What Are the Methods of Demand Forecasting for New Products?

Demand forecasting is inclusive of various analytically borne methods whose end-goal is to

help organizations come up with a new product which is relevant to current consumption
behaviour of its targeted user base. Here are a few coined processes inclusive of fruitful demand
planning.

o Substitute Approach

This method runs on the assumption that the introduction of a new product in place of an
existing one will give the organization some workable marketing insights. It generally is
inclusive of opinion analysis/survey which helps the production vertical with some
constructive feedback.

o Evolutionary Approach

This course of action assumes that the new product will be a default improvement over the one
it is replacing. This demand forecasting technique allows the new product to follow the same
life cycle as the existing products. Hence, the sales figures of the existing products acts as
default baseline targets for the newly launched product.

o Buyers or Consumers view

This action plan accounts for an organization’s loyal user base as its early bird consumers for
the new product and relies on their first-impression view. A company runs predictive analysis
on these first reviews to set demand forecasts for a fully-fledged market launch.

o Expert’s View

The approach accounts for the expert’s view of the marketing field who are well-equipped with
the ever-changing trends of a retailing filled with capable competitors. An expert’s opinion is
treated as a gospel helping an organization find its footing for a new product launch.

o Trial Run

As the name suggests, this method applies a trial run for the new product in certain selected
retail areas for a specified period. Its response sets the base for forecasting the sales of the latest
development.

What Is Market Structure?

Market structure refers to the way that various industries are classified and differentiated in
accordance with their degree and nature of competition for products and services. It consists of
four types: perfect competition, oligopolistic markets, monopolistic markets, and monopolistic
competition.

Types of Market Structures

According to economic theory, market structure describes how firms are differentiated and
categorized by the types of products they sell and how those items influence their operations.
A market structure helps us to understand what differentiates markets from one another.

In economics, market structure is the number of firms producing identical products which are
homogeneous. The types of market structures include the following:

1. Monopolistic competition, also called competitive market, where there is a large

number of firms, each having a small proportion of the market share and slightly
differentiated products.
 2. Oligopoly, in which a market is by a small number of firms that together control the
majority of the market share.

3. Duopoly, a special case of an oligopoly with two firms.

4. Monopsony, when there is only one buyer in a market.

5. Oligopsony, a market in which many sellers can be present but meet only a few buyers.

6. Monopoly, in which there is only one provider of a product or service.

7. Natural monopoly, a monopoly in which economies of scale cause efficiency to increase

continuously with the size of the firm. A firm is a natural monopoly if it is able to serve
the entire market demand at a lower cost than any combination of two or more smaller,
more specialized firms.

8. Perfect competition, a theoretical market structure that features no barriers to entry, an

unlimited number of producers and consumers, and a perfectly elastic demand curve.

Perfect Competition: Definition

In a market with perfect competition, the resources are divided equally and evenly among the
market participants. There is no monopoly and every player gets an equal share of sales in such
markets. Each company in a market of perfect competition would have the same and equal
market knowledge and they would sell the same products. There will be no dearth of consumers
for any participant in the market and demand would also be equally shared by the players in
the market.

For perfect competition in a market, the sellers should sell identical products. Moreover,
companies cannot decide the market prices of the products and prices will be set all by market
forces. The market share of companies in a perfectly competitive market will be the same. All
buyers in a perfectly competitive market would have all and equal knowledge of the products
and their attributes. The perfectly competitive market will also have no barriers to entry or exit.

In a perfectly competitive market, the companies would manage to make just enough profits to
stay in the business and all players would make equal amounts of profit. The market dynamics
would let the companies have an equal playing field and no company can make substantial
profits larger than the average profit of the market players.

Perfect competition is just a theory. It is impossible to find perfectly competitive markets in

the real world. Therefore, examples of perfect competition are impossible to find although
environments that are similar to perfect competition can be found sometimes in imperfect
competitions.

Imperfect Competition: Definition

Imperfect competition may exist in market structures that are monopolies, oligopolies,
monopolistic competition, monopsonies, and oligopolies.

In monopolies, there is only one market player that is the leader in the market. It can control
the market as and if required. Moreover, it can also control the price of products in the market
where a monopoly exists. In other words, in monopolies, the company in the position of the
leader, can decide the price of the products, and supply and demand forces can be ignored by
the leader.

In the case of oligopolies, there are a few market leaders who may collectively control the
market. Technology companies, such as mobile phone manufacturers are a good example of
oligopolies. In oligopolies, the players of the market can bar the entry of other players. The
players in the market may collectively set the prices of the product or the chosen leader among
them may take the price-setting decision.

In monopolistic competition, there are many sellers of the same product that may not be
substituted. The barriers of entry may be low in case of monopolistic competition and the
companies may set the prices, but the decision of one player does not affect the conditions of
the market.

Monopsonies are counterpoints of monopolies. Here only one buyer has many sellers. The
government-controlled agencies, such as defense are a good example of monopsony. The buyer
in monopsony can set the prices due to the competition among sellers who vie to sell their
products to the buyer.
In the case of oligopsony, there are a few buyers but many sellers. The tobacco industry in
which less than five companies buy all the tobacco grown in the world is a good example of an
oligopsony. Here, the buyers can determine the prices after collective bargaining.