Unit 2

DEMAND ANALYSIS
Unit II: Demand Analysis

1. Demand Function
2. Elasticity of Demand: Measurement,
Determinants and Uses
3. Demand Estimation: Marketing Research
Approaches and Regression Analysis
4. Demand Forecasting

a. Qualitative Forecasts
b. Quantitative Forecasts: Time Series
Analysis, Smoothing Techniques, Barometric
Methods, Econometric Models, input –
output Model
DEMAND FUNCTION:
 Demand function refers to the functional or
technical or mathematical relationship
between quantity of demand and factors
determinant of demand.
Qx= f ( Px, Py, Y, ………….)
 Demand function establishes a functional

relationship between price of a commodity

(as an independent variable) and demand
for same commodity (as a dependent
variable).
Qx = f (Px)
Determinants of demand
1. Price Of The Goods
2. Income Of The Consumer
3. Prices Of The Other Commodities
Complimentary Goods
Substitutable Goods
4. Taste And Preferences
5. Future Expectation
6. Advertisement
7. Population (number of consumers)
8. Time And Place
9. Climate (weather)
10. Government Policies (money supply, tax etc.)
11. Customs, fashion
TYPES OF DEMAND FUNCTION

1. Linear demand function:

A demand curve is said to be linear when the
slope of the demand curve remains constant
through out its length.
Dx = a – bPx Qx= 20-2Px PX: 0 1 2 3
Where QX:20 18 16 14
Dx = quantity demand of goods x
Px = price of x
a = intercept ( demand at zero price)
b = slope of demand curve ( b shows the relationship
between Dx and Px
CONTD…

2. Non linear demand function:

A demand curve is said to be non linear curvilinear
when the slope of demand curve changes all along the
demand curve. Non linear demand function gives a
demand curve instead of a demand line. A non-linear
demand function is generally expressed in power
function as
Qx = 20Px-.5 Px: 0 1 2 3
Dx = quantity demand of goodsQx: 20 19 17 14
Px = price of x
a = intercept ( demand at zero price)
b = slope of demand curve ( b shows the relationship
between Dx and Px
ELASTICITY OF DEMAND
 Elasticity of demand is the rate of change in
quantity demanded of a commodity as a
result of change in its determinants like
price, consumer’s income, price of related
commodity, advertisement expenditure etc.
Types of elasticity of demand
a) Price elasticity of demand (ep)
b) Income elasticity of demand (ey)
c) Cross elasticity of demand (ec)
d) Advertisement elasticity of demand (ea)
PRICE ELASTICITY OF DEMAND:
 It is the proportionate change in quantity
demanded of a goods due to proportionate
change in its price.
(ep) =
 (ep) = = lower segment / upper
segment
 (ep) =
TYPES (DEGREE) OF PRICE ELASTICITY OF DEMAND:

1. Perfectly inelastic demand (ep = 0)

2. Relatively inelastic demand (ep < 1)
3. Unitary elastic demand (ep = 1)
4. Relatively elastic demand (ep > 1)
5. Perfectly elastic demand (ep = ∞ )
Price

(ep =
∞)
(ep > 1)

(e < 1) (e = 1)
(ep = 0) p p

0
quantity
MEASUREMENT METHODS OF PRICE ELASTICITY OF
DEMAND

 Total outlay method

 Percentage Method
 Arc (Mid way or Average) Method
 Point Method
USES OF PRICE ELASTICITY IN MANAGERIAL
DECISION
I. Product pricing
II. Factor pricing/pricing of inputs

III. Monopoly price

IV. Price discrimination

V. Joint product pricing

VI. International trade
VII. Discount decision
DETERMINANTS OF ELASTICITY OF DEMAND

 Nature of commodity
 Availability of substitutes
 Define market
 Time
Relationship between price
elasticity and revenue:
ep =
TR = P*Q
MR = MR=, = P + Q=P+Q
MR=P(1+Q/p*dP/dQ) ep=dQ/dP*P/Q
MR = P(1 - )
MR = P( )

e = 1, MR = 0, TR = Maximum
e >1 MR >0, TR increasing
e<1 MR <0, TR decreasing
 TR

TR maximum
a

Output
0 Q
TR
AR,MA
ep.>1
Ep=1
ep<1

MR>0 AR= D
0
Q Output
MR=0
MR<0

MR
Price elasticity of demand and
revenue curve

Outp Price TR= AR MR= Ep Ep Ep Ep (total

ut P*Q dTR/ (poi (percentag (arc) outlay)
dQ nt ) e)
A 0 18 0 0 0 ∞ -
B 1 16 16 16 16 Ep>1
C 2 14 28 14 12 Ep>
D 3 12 36 12 8 ep>1
E 4 10 40 10 4
F 5 8 40 8 0 1 Ep=1
G 6 6 36 6 -4
H 7 4 28 4 -8 Ep<1
I 8 2 16 2 -12
J 9 0 0 0 -16 0
INCOME ELASTICITY OF DEMAND (EY):
 Types of income elasticity of demand
1. Zero income elasticity
2. negative income elasticity
3. Positive Unitary income elasticity
4. Positive greater than unitary income elasticity
5. Positive less than unitary income elasticity
Uses of income elasticity in
managerial decision
6. To design marketing strategy
7. To classify goods into different
categories
DETERMINANTS OF INCOME ELASTICITY OF DEMAND

 Proportion of income spent

 Level of income
 Time period
CROSS ELASTICITY OF DEMAND

 Types of cross elasticity of demand

1. Negative cross elasticity of demand
2. Positive cross elasticity of demand
3. Zero cross elasticity of demand
Uses of cross elasticity of demand in
managerial decision
4. To formulate business policies
5. To classify goods and industries
6. Pricing strategies
ADVERTISING ELASTICITY OF DEMAND
 Types of advertising elasticity of demand
1. Greater than 1

2. Less than 1
3. Equal to 1
Uses of advertising elasticity in managerial
decision
I. It helps the management in deciding whether the
outlay on advertisement should be increased,
decreased, or maintained at the present level.
II. It helps the management in studying the effect of
advertisement on sales-revenue.
III. It helps in evaluating the effectiveness of various
media of advertisement,
IV. It helps to formulate marketing strategies in
competitive environment
DEMAND FORECASTING:
 Forecasting is an estimate of a future situation.
 It is a prediction of situation under given condition.
 Forecasting is done under certain assumptions of
establishing theoretical relationship between the value of
the variables (dependent) to be predicted and likely
affecting factors (independent variables) which are traded
on the basis of past and present information on their
behavior.
 The reliability of forecast depends upon reliability of the
assumption.
 “Forecasting aims to reduce uncertainty about tomorrow,
so that effective decision can be made today by providing
predictions of future values of variables from past and
present information” ---- Reekie and Crook
 under given circumstance Objective of forecasting is to
predict demand. It means as estimation of the level of
demand that might be realized in future
SIGNIFICANCE OF FORECASTING:
1. Production planning
2. Sales planning
3. Inventory planning
4. Profit planning
5. Stability
6. Growth and long-term investment
programmers
7. Economic planning and policy
making
PURPOSE OF DEMAND FORECASTING:
Level of forecasting
1. Micro level
2. Industry level
3. Macro level
Short-term forecasting
I. for a suitable production and sales policy
II. Helping purchase planning to reduce the cost of
production
III. Determining short-term financial requirements

IV. Determining appropriate pricing policies

V. Fixing the sales target
Medium-term forecasting
Long-term forecasting
i. Planning the establishment of new unit
ii. Long-term financing planning
iii. Human resources planning
STEPS IN DEMAND
FORECASTING
1. Identify and clearly state the objective
of the forecasting
2. Select appropriate methods of
forecasting
3. Ascertain the determinants of demand
for the particular product of product
group
4. Collection of data
5. Presentation and analysis of data
 CRITERIA FOR GOOD FORECASTING:

1. Accuracy
2. Simplicity
3. Durability
4. Flexibility
5. Economy
6. Availability
FORECASTING TECHNIQUES:
SURVEY METHODS AND STATISTICAL METHODS
Survey methods (Non-statistical Technique)
1) Consumer’s survey method
 Complete enumeration method

 Sample survey method

 End-use method

2) Opinion Poll
 Expert opinion

 Delphi method

3) Market experiment
 Market test

 Laboratory test or consumer clinic

SURVEY METHOD:
 This methods are often used to make short-term
forecasts. Under this method, information is collected
about consumers’ intensions and their future purchase
plan. Basically, new products require the use of survey
method only because of absence of any historical data.
Consumer’s survey method:
 This method of forecasting involves direct interview of

the potential consumers. Potential consumers or users

are asked about quantity of the product they would be
willing to buy at different prices over a given period of
time. Direct interview involves questioning consumers
about how they would respond to particular changes in
the price, income and other factors determinant of
demand. This method may be i) complete enumeration
method, ii) sample survey method and iii) end used
method
OPINION POLL/ SURVEY OF MARKET EXPERTS:

Opinion survey method aims at collecting

opinions of those who are supposed to possess
knowledge of the market. Sales
representatives, sales executives, professional
marketing experts and consultants may be the
experts. This method may be
i) expert-opinion method and
ii) Delphi method
MARKET EXPERIMENT METHOD:

In this method demand of a product is

forecasted by experimenting consumer’s
behavior in market. This method is
helpful to determining its best pricing
strategy, promotional campaigns, and
product qualities.
i) Market testing
ii) Laboratory experiment
STATISTICAL TECHNIQUE/QUANTITATIVE
TECHNIQUE

 Time series analysis

 Moving Average method
 Regression Technique
 Barometric Technique
TIME SERIES ANALYSIS:

 classical method of business demand forecasting.

 An arrangement of statistical data in chronological order is

called time series.

 Data representing a change over a period of time are known as

time series,
 time is most important factor

Mathematically Y=f(X)
Components of time series i)secular trend (s) ii) sesonal variation
(v) iii)cyclical fluctuation (c) iv) random or irregular fluctuation (R)
Lest square equation Y= a+bX
∑Y=an +b∑X 20= 5a +b 10
∑YX=a∑X +b∑X2 45= 10a +b28

a= ∑Y/n ∑X = 0
b = ∑XY/∑X2
MOVING AVERAGE METHOD:
 Under this method, the forecasted
value of a time series in a period is
equal to the average value of the time
series in a number of previous periods.
Three years moving average
Five years moving average
 Regression
 Y=a+bX ……(i)
 ƩY = na + ƩX
 ƩXY= ƩX+ƩX2
 a =- b

OR
OR and y = Y -
BAROMETRIC METHOD
 Economists used economic indicators as
barometer to forecast trends in business
activities.
1. Leading indicators: money supply, average
work week, new order of capital goods,
new building permits
2. Coincidental indicators: increase in income
and consumption, interest rate charge by
commercial bank and market interest and
3. Lagging indicators: interest rate charge by
money lenders
 Indicators

Leading
indicators
lagging
indicato
rs
COMPOSITE AND DIFFUSION INDEX
 Composite indices: is consist of a
weighted average of several leading
indicators. It is interpreted in terms of
percentage changes from the period to
period.
 Diffusion indices: it is calculated as the
proportion of indicators that increases
from one period to the next.
Month Leading Leading Leading
indicator I indicator II indicator III

1 400 30 100

2 425 29 110

3 460 33 135

Month diffusion Composite

1 - 100
2 66.7 104.31
3 100 120
LIMITATIONS OF
FORECASTING:
 Choice of Technique
 Accuracy
 Availability of data
 Statistical error
 Change in determinants
 Study of consumer’s psychology
 Lack of experienced experts for
forecasting
 Calculation of least possible cost
 Determination of relationship among the
determinants of demand