Business Forecasting - 4th Sem MBA Notes

Prof. Chitranka K, ch.E, chart PR, ChartMktr

Module 2 - Demand Analysis

An Overview:

Demand analysis is a fundamental concept in economics that focuses on

understanding consumer behavior regarding the purchase of goods and services.
Demand refers to the quantity of a good or service that consumers are willing and able
to purchase at various price levels over a specific time period. Central to this concept is
the Law of Demand, which states that, all else being equal, an increase in the price of a
good will lead to a decrease in the quantity demanded, and conversely, a decrease in
price will typically result in an increase in quantity demanded.

To visualize this relationship, economists use the demand curve, which is a graphical
representation of the relationship between price and quantity demanded. This curve
generally slopes downward from left to right, indicating an inverse relationship between
price and demand. Demand can be categorized into two types: individual demand,
which reflects the purchasing behavior of a single consumer, and market demand, which
aggregates the demand from all consumers in a given market for a specific good or
service.

The analysis of demand also distinguishes between movement along the demand curve
and shifts of the entire curve. A movement occurs along the demand curve as a result
of a change in the product's price, while a shift signifies a change in demand due to
factors other than price, such as consumer preferences or income levels. A demand
schedule is often used to illustrate these relationships, presenting a table that shows
the quantity demanded at various price points, which helps in constructing the demand
curve.

In demand analysis, the ceteris paribus assumption is crucial; it means "all other things
being equal," allowing economists to isolate the effect of price changes on demand
without the influence of other variables. Additionally, demand can be analyzed in both
the short run and the long run. Short-run demand tends to react quickly to price
changes, while long-run demand takes into account changes in consumer habits and
preferences over time.
The market structure also plays a significant role in shaping the demand curve. The
demand characteristics can vary based on whether the market is perfectly competitive,
monopolistic, or oligopolistic. Lastly, demand analysis has broad applications across
various fields, including marketing, finance, and public policy, providing valuable insights
that inform strategic decision-making. Understanding demand is essential for
businesses to effectively meet consumer needs and optimize their offerings in the
marketplace.

Significance of Demand Analysis and Forecasting

1. Informed Decision-Making: Provides businesses with critical insights into

consumer preferences, helping to shape product development and marketing
strategies.
2. Pricing Strategies: Understanding demand allows firms to set optimal prices to
maximize revenue and market penetration depending on elasticity responses.
3. Comprehensive Market Evaluations: Helps firms assess overall market potential,
including identifying target consumer segments and untapped markets.
4. Inventory Management: Accurate forecasts minimize stockouts and overstock
situations, improving operational efficiency and reducing costs.
5. Resource Allocation: Demand forecasts aid in distributing resources effectively
to maximize output, leading to optimal production levels.
6. Risk Management: Understanding demand fluctuations helps businesses prepare
for market volatility, enabling more robust contingency plans.
7. Strategic Planning: Demand forecasting informs long-term business strategies,
including expansions, mergers, or product launches.
8. Performance Measurement: Firms can compare actual sales against forecasts to
evaluate marketing effectiveness and demand prediction accuracy.
9. Competitive Advantage: Businesses that accurately forecast demand can
respond to market changes faster than competitors, gaining a strategic edge.
10. Policy Formulation: Demand analysis supports government and NGOs in making
effective policy decisions, such as taxation and subsidy allocations.

Determinants of Demand

1. Price of the Good: The primary determinant; changes in the product's price
directly affect the quantity demanded.
2. Consumer Income: The purchasing power of consumers influences demand; as
income rises, demand for normal goods increases, while demand for inferior
goods may decrease.
3. Prices of Related Goods:
○ Substitutes: An increase in the price of one may lead to an increase in
demand for the other (e.g., price rise of butter may increase demand for
margarine).
○ Complements: An increase in the price of one may decrease demand for
the other (e.g., price increase of printers may decrease demand for ink
cartridges).
4. Consumer Preferences: Changes in tastes and fashions can significantly affect
demand; firms must stay attuned to these shifts to remain relevant.
5. Consumer Expectations: Anticipated future price changes can lead consumers to
buy more now if they expect prices to rise in the future.
6. Population and Demographic Changes: The size and structure of the population,
including age, gender, and income distribution, can impact overall demand
patterns.
7. Advertising and Marketing Efforts: Effective advertising can shift demand curves
by enhancing consumer awareness and changing preferences.
8. Seasonality: Many goods experience seasonal demand fluctuations (e.g., winter
clothing demand spikes in colder months).
9. Economic Conditions: Broader economic factors like inflation, employment rates,
and overall economic growth affect disposable income and thus demand.
10. Cultural and Social Influences: Societal trends and cultural factors can shape
consumer preferences and demand for products and services.

Elasticity of Demand

1. Definition of Elasticity: Elasticity of demand measures how responsive the

quantity demanded of a good is to changes in price, income, or related goods.
2. Price Elasticity of Demand (PED): Most common form, showing the
responsiveness of demand to price changes calculated using the formula:
○ PED = (% Change in Quantity Demanded) / (% Change in Price)
3. Types of PED:
○ Elastic Demand (>1): Quantity demanded changes significantly with price
changes (e.g., luxury items).
 ○ Inelastic Demand (<1): Quantity demanded changes little with price
changes (e.g., essential goods).
○ Unitary Elastic (1): Quantity demanded changes proportionally to price
change.
4. Determinants of Price Elasticity:
○ Availability of Substitutes: The more substitutes available, the more elastic
the demand.
○ Necessity vs. Luxury: Necessities often have inelastic demand, while
luxuries have elastic demand.
○ Time Horizon: Demand elasticity can vary over time; it may be more elastic
in the long run as consumers adjust habits.
5. Cross Elasticity of Demand: Measures the responsiveness of the quantity
demanded of one good to a price change in another good.
○ Positive Cross Elasticity: Indicates substitutes (e.g., coffee and tea).
○ Negative Cross Elasticity: Indicates complements (e.g., peanut butter and
jelly).
6. Income Elasticity of Demand: Measures how the quantity demanded changes as
consumer income changes.
○ Normal Goods: Positive income elasticity (>0).
○ Inferior Goods: Negative income elasticity (<0).
7. Revenue Implications: Understanding elasticity helps businesses predict how
price changes will affect total revenue.
○ Increasing Price on Elastic Demand: May decrease total revenue.
○ Increasing Price on Inelastic Demand: May increase total revenue.
8. Elasticity and Market Dynamics: Elasticity of demand can dictate market
strategies, such as pricing models and promotional efforts.
9. Measurement Challenges: Accurately determining elasticity can be complicated
due to external factors affecting demand.
10. Application in Business Strategy: Companies use elasticity analysis to guide
pricing strategies, product launches, and market entry decisions.

Revenue and Profit of a Firm

1. Total Revenue (TR): Calculated by multiplying the price of a product by the

quantity sold (TR = Price × Quantity). It's crucial for assessing business
performance.
2. Marginal Revenue (MR): The additional revenue gained from selling one more
unit of a good; crucial for optimizing production levels.
○ MR Calculation: MR = Change in TR / Change in Quantity.
3. Relation Between Price and TR:
○ Elastic Demand: Increasing prices leads to a decrease in TR.
○ Inelastic Demand: Increasing prices can lead to a rise in TR.
4. Cost Consideration: To determine profit, firms also consider total costs, where
Profit = Total Revenue - Total Costs.
5. Types of Costs:
○ Fixed Costs: Costs that do not vary with production levels (e.g., rent).
○ Variable Costs: Costs that vary directly with production levels (e.g., raw
materials).
6. Break-even Analysis: Helps businesses understand how many units they need to
sell to cover costs, calculating the break-even point where TR = TC.
7. Profit Maximization: Firms aim to operate at a level where marginal cost (MC)
equals marginal revenue (MR) to maximize profits.
8. Market Structure Influence: Profit margins can vary significantly depending on
market structure (perfect competition, monopoly, oligopoly), influencing pricing
strategies.
9. Long-term Profit Outlook: While some firms may experience short-term profit
fluctuations, long-term sustainability depends on brand loyalty, innovation, and
market positioning.
10. Role of Demand Forecasting: Accurate demand forecasting is critical for revenue
management, allowing firms to adjust supply in anticipation of demand changes.

Estimation of Demand

1. Objective of Demand Estimation: To predict future demand for a product to guide

production, inventory management, and marketing strategies.
2. Qualitative Approaches: Involves gathering opinions and insights through
methods like focus groups, expert interviews, and market research surveys.
3. Quantitative Approaches: Use historical data and statistical techniques to model
demand using numerical methods such as time series analysis and regression.
4. Time Series Analysis: Analyzes historical sales data to identify patterns and
trends over time, useful for forecasting future demand.
5. Regression Analysis: A statistical technique to explore relationships between
demand and various factors (e.g., price, income, advertising).
6. Market Experiments: Testing new products or marketing strategies in controlled
settings (e.g., A/B testing) to gauge potential market response.
7. Seasonal Trends: Incorporating seasonal factors into demand forecasts is
essential for products with fluctuating demand patterns (e.g., holiday
decorations).
8. Consumer Surveys: Collecting direct feedback from consumers about their
purchasing intentions and preferences to inform demand estimates.
9. Adjustment for External Factors: Acknowledging and adjusting for economic
conditions, consumer trends, and competitive actions that may impact demand.
10. Performance Evaluation: Regularly comparing forecasted demand with actual
sales to refine estimation techniques and improve accuracy over time.

Forecasting Demand

1. Definition: Forecasting demand involves predicting future consumer demand for

a product or service using historical data and market analysis.
2. Importance: Accurate demand forecasts enable businesses to make informed
decisions about production, inventory management, and resource allocation,
thereby improving operational efficiency.
3. Historical Data: Using past sales data and trends helps develop a baseline for
making future predictions, identifying patterns that may repeat over time.
4. Market Research: Conducting surveys and studies to gather insights from
consumers about their preferences and purchasing intentions can improve
forecasting accuracy.
5. Economic Indicators: Analysts often incorporate economic indicators, such as
consumer confidence and employment rates, to assess potential demand
fluctuations.
6. Seasonal Variations: Understanding how seasonal factors influence demand is
critical, especially for products that have cyclical sales patterns (e.g., holiday
decorations).
7. Competitive Analysis: Monitoring competitors’ sales and market strategies
provides context that can affect demand forecasts, helping to anticipate changes
in the competitive landscape.
8. Quantitative vs. Qualitative: Forecasting can be approached through quantitative
methods (relying on numerical data) or qualitative methods (based on subjective
insights), with different techniques suited to different contexts.
9. Time Horizon: Forecasts can be short-term (days to months), medium-term
(months to a year), or long-term (beyond one year), depending on the business
needs and market dynamics.
10. Continuous Learning: Demand forecasting is an ongoing process; businesses
must continuously refine their models based on actual sales data and changing
market conditions.

Selecting a Forecasting Technique

1. Define Objectives: Clearly establish the objectives of the forecast (e.g., accuracy,
time frame) to guide the selection of appropriate techniques.
2. Data Availability: Assess the availability and quality of historical data, as some
techniques require extensive data for accurate predictions.
3. Statistical Methods: Quantitative techniques such as time series analysis,
moving averages, and regression analysis are suitable for data-rich environments
and long historical datasets.
4. Qualitative Techniques: Use qualitative methods like expert judgment, Delphi
method, or consumer surveys when historical data is limited or when predicting
new products.
5. Adjust for Seasonality: If demand is influenced by seasonal factors, techniques
like seasonal decomposition or seasonal indexes should be incorporated into the
forecasting model.
6. Model Complexity: Balance the complexity of the forecasting model with its
interpretability; complex models may offer accuracy but can be harder to explain
and implement.
7. Accuracy Measurement: Choose techniques that allow for easy measurement of
forecasting accuracy, such as Mean Absolute Error (MAE) or Root Mean Square
Error (RMSE).
8. Scenario Analysis: Consider using multiple forecasting methods to produce a
range of forecasts, allowing for scenario planning and risk assessment.
9. Technology Utilization: Implement forecasting software and tools that can
automate data analysis and model application, enhancing efficiency and
accuracy.
10. Continuous Review: Regularly reassess the chosen forecasting technique to
ensure it remains relevant and accurate against changing market conditions and
consumer behaviors.
 Purpose of Forecast

1. Informed Decision-Making: The primary purpose of forecasting is to provide

businesses with the information necessary to make informed strategic decisions.
2. Inventory Management: Forecasting helps businesses manage inventory levels
effectively, ensuring that they have sufficient stock to meet demand without
overstocking.
3. Production Planning: Accurate forecasts facilitate effective production
scheduling, helping businesses to optimize resources and minimize waste.
4. Financial Planning: Businesses use demand forecasts for budgeting and financial
projections, ensuring that resources are allocated appropriately to support
anticipated sales levels.
5. Market Entry Strategies: Forecasting allows companies to identify optimal timing
and strategies for entering new markets or introducing new products.
6. Risk Management: By anticipating demand fluctuations, businesses can develop
contingency plans and mitigate risks associated with supply and demand
imbalances.
7. Sales and Marketing Alignment: Forecasts guide sales and marketing strategies,
ensuring that promotions and campaigns align with expected demand.
8. Capacity Planning: Forecasting helps businesses understand future capacity
needs, allowing them to invest in infrastructure, equipment, and labor to meet
anticipated demand.
9. Competitive Advantage: Companies that effectively forecast demand can
respond quickly to market changes, gaining a competitive edge over rivals.
10. Evaluating Business Performance: Demand forecasts provide benchmarks
against which actual sales performance can be measured, helping businesses
evaluate effectiveness and adjust strategies accordingly.

Type of Users

1. Manufacturers: Rely on demand forecasts to plan production schedules, manage

inventory, and ensure timely delivery of products.
2. Retailers: Use forecasts to determine stock levels, manage inventory turnover,
plan sales promotions, and optimize store space allocation.
3. Supply Chain Managers: Employ demand forecasting to coordinate logistics,
manage suppliers, and ensure the efficient flow of goods from production to
retail.
4. Marketing Professionals: Utilize forecasts to develop targeted marketing
strategies and campaigns that align with anticipated consumer demand.
5. Financial Analysts: Use demand projections for financial modeling, budgeting,
and capital investment planning.
6. Sales Teams: Depend on accurate forecasts to set realistic sales targets, improve
resource allocation, and motivate sales personnel.
7. Product Development Teams: Employ demand insights to prioritize product
development initiatives based on projected market needs.
8. Economists and Researchers: Analyze demand forecasts to study market trends,
consumer behavior, and economic indicators for policy formulation.
9. Executives and Managers: Utilize demand forecasts for high-level strategic
planning, resource allocation, and long-term business growth initiatives.
10. Policy Makers: Governments and organizations use demand forecasts to assess
economic conditions, plan public services, and make decisions about
infrastructure and resource allocation.

Possible Questions

Questions on Demand Analysis

1. Law of Demand:
○ How does an increase in the price of a good, say from ₹500 to ₹600, affect
the quantity demanded? Provide an example using a demand curve.
2. Demand Curve:
○ Draw a demand curve for a product priced at ₹300. Explain what a
movement along the curve versus a shift of the curve represents.
3. Determinants of Demand:
○ How would an increase in consumer income from ₹30,000 to ₹40,000
affect the demand for luxury cars priced at ₹5,00,000? Provide specific
examples of normal and inferior goods.
4. Elasticity of Demand:
○ Calculate the price elasticity of demand if the quantity demanded of a
product decreases from 100 to 80 units when the price increases from
₹1,000 to ₹1,200.
 ○ What type of elasticity does a product with a PED of 0.5 represent?
Discuss its implications for pricing strategy.
5. Cross Elasticity of Demand:
○ If the price of a packet of biscuits increases by ₹10 (from ₹100 to ₹110)
and the quantity demanded for cookies increases from 50 to 70 packets,
what is the cross elasticity of demand? What does this indicate about the
relationship between the two goods?
6. Income Elasticity of Demand:
○ If a consumer's income increases by ₹10,000 and their demand for
vacations increases from 2 to 3 trips a year, what is the income elasticity
of demand? Classify the good based on this elasticity.

Questions on Revenue and Profit

1. Total Revenue Calculation:

○ If a company sells 200 units of a product at ₹1,200 each, what is the total
revenue? How would a price increase to ₹1,500 affect total revenue if
demand is elastic?
2. Marginal Revenue:
○ A firm notices that increasing production from 100 to 101 units increases
total revenue from ₹80,000 to ₹81,500. What is the marginal revenue of the
101st unit?
3. Break-even Analysis:
○ If a company has fixed costs of ₹5,00,000 and variable costs of ₹200 per
unit, how many units must it sell at a price of ₹800 to break even?

Questions on Demand Estimation and Forecasting

1. Qualitative vs. Quantitative Approaches:

○ What are the advantages and disadvantages of using qualitative methods
(like consumer surveys) versus quantitative methods (like regression
analysis) for demand forecasting?
2. Time Series Analysis:
○ Given historical sales data showing a seasonal pattern with peak sales of
₹3,00,000 in December and low sales of ₹1,00,000 in July, how would you
identify seasonal trends? What statistical methods would you use?
3. Scenario Analysis:
 ○ How can scenario analysis help a company prepare for potential
fluctuations in demand for a product priced at ₹1,000? Provide an example
of strategy adjustments based on different demand scenarios.
4. Forecasting Techniques:
○ What factors should be considered when selecting a forecasting
technique for a new product with no historical data, such as an innovative
health drink priced at ₹150?
5. Performance Evaluation:
○ How can a company measure the accuracy of its demand forecasts? What
metrics would be useful (e.g., Mean Absolute Percentage Error) for
products priced at various ranges?

Problems Using Formulas

1. Price Elasticity of Demand:

calculate the PED if the quantity demanded of a product increases from 150 to
180 units when the price decreases from ₹500 to ₹400.

2. Total Revenue and Price Changes:

○ If a product has an elastic demand (PED > 1) and the price is increased
from ₹600 to ₹700, calculate the expected change in total revenue if the
quantity demanded decreases from 300 to 240 units.
3. Income Elasticity of Demand:
○ calculate the income elasticity if the quantity demanded for a product
increases from 200 units to 250 units when income rises from ₹50,000 to
₹60,000.
4. Break-even Point Calculation:
○ If fixed costs are ₹3,00,000 and variable costs are ₹250 per unit, calculate
the break-even point in units if the selling price is ₹1,000 per unit.