Managerial Economics

Definition and Meaning of Managerial Economics:

Managerial economics, used synonymously with business economics. It is a branch of economics that deals with the application of microeconomic analysis to decision-making techniques of businesses and management units. It acts as the via media between economic theory and pragmatic economics. Managerial economics bridges the gap between "theory and practice". Managerial economics can be defines as:

According to Spencer and Siegelman:

“The integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management”.

According to McGutgan and Moyer:

“Managerial economics is the application of economic theory and methodology to decision-making problems faced by both public and private institutions”.

Managerial economics studies the application of the principles, techniques and concepts of economics to managerial problems of business and industrial enterprises. The

term is used interchangeably with micro economics, macro economics, monetary economics.

Characteristics of Managerial Economics:

(i) It studies the problems and principles of an individual business firm or an individual industry. It aids the management in forecasting and evaluating the trends of the market.

(ii) It is concerned with varied corrective measures that a management undertakes under various circumstances. It deals with goal determination, goal development and achievement of these goals. Future planning, policy making, decision making and optimal utilization of available resources, come under the banner of managerial economics.

(iii)  Managerial economics is pragmatic. In pure microeconomic theory, analysis is performed, based on certain exceptions, which are far from reality. However, in managerial economics, managerial issues are resolved daily and difficult issues of economic theory are kept at bay.

(iv) Managerial economics employs economic concepts and principles, which are known as the theory of Firm or 'Economics of the Firm'. Thus, its scope is narrower than that of pure economic theory.

(v) Managerial economics incorporates certain aspects of macroeconomic theory. These are essential to comprehending the circumstances and environments that envelop the working conditions of an individual firm or an industry. Knowledge of macroeconomic issues such as business cycles, taxation policies, industrial policy of the government, price and distribution policies, wage policies and antimonopoly policies and so on, is integral to the successful functioning of a business enterprise.

(vi) Managerial economics aims at supporting the management in taking corrective decisions and charting plans and policies for future.

(vii) Science is a system of rules and principles engendered for attaining given ends. Scientific methods have been credited as the optimal path to achieving one's goals. Managerial economics has been is also called a scientific art because it helps the management in the best and efficient utilization of scarce economic resources. It considers production costs, demand, price, profit, risk etc. It assists the management in singling out the most feasible alternative. Managerial economics facilitates good and result oriented decisions under conditions of uncertainty.

(viii) Managerial economics is a normative and applied discipline. It suggests the application of economic principles with regard to policy formulation, decision-making and future planning. It not only describes the goals of an organization but also prescribes the means of achieving these goals.

Importance of Managerial Economics:

Business and industrial enterprises aim at earning maximum proceeds. In order to achieve this objective, a managerial executive has to take recourse in decision making, which is the process of selecting a specified course of action from a number of alternatives. A sound decision requires fair knowledge of the aspects of economic theory and the tools of economic analysis, which are directly involved in the process of decision-making. Since managerial economics is concerned with such aspects and tools of analysis, it is pertinent to the decision making process.

 (i) Accommodating traditional theoretical concepts to the actual business behavior and conditions:Managerial economics amalgamates tools, techniques, models and theories of traditional economics with actual business practices and with the environment in which a firm has to operate. According to Edwin Mansfield, “Managerial Economics attempts to bridge the gap between purely analytical problems that intrigue many economic theories and the problems of policies that management must face”.

(ii) Estimating economic relationships: Managerial economics estimates economic relationships between different business factors such as income, elasticity of demand, cost volume, profit analysis etc.

(iii) Predicting relevant economic quantities: Managerial economics assists the management in predicting various economic quantities such as cost, profit, demand,

capital, production, price etc. As a business manager has to function in an environment of uncertainty, it is imperative to anticipate the future working environment in terms of the said quantities.

(iv) Understanding significant external forces: The management has to identify all the important factors that influence a firm. These factors can broadly be divided into two categories. Managerial economics plays an important role by assisting management in understanding these factors.

(a) External factors: A firm cannot exercise any control over these factors. The plans, policies and programs of the firm should be formulated in the light of these factors. Significant external factors impinging on the decision making process of a firm are economic system of the country, business cycles, fluctuations in national income and national production, industrial policy of the government, trade and fiscal policy of the government, taxation policy, licensing policy, trends in foreign trade of the country, general industrial relation in the country and so on.

(b) Internal factors: These factors fall under the control of a firm. These factors are associated with business operation. Knowledge of these factors aids the management in making sound business decisions.

(v) Basis of business policies: Managerial economics is the founding principle of business policies. Business policies are prepared based on studies and findings of managerial economics, which cautions the management against potential upheavals in national as well as international economy. Thus, managerial economics is helpful to the management in its decision-making process.

Nature of Managerial Economics:

·                     The primary function of management executive in a business organisation is decision making and forward planning.

·                     Decision making and forward planning go hand in hand with each other. Decision making means the process of selecting one action from two or more alternative courses of action. Forward planning means establishing plans for the future to carry out the decision so taken.

·                     The problem of choice arises because resources at the disposal of a business unit (land, labour, capital, and managerial capacity) are limited and the firm has to make the most profitable use of these resources.

·                     The decision making function is that of the business executive, he takes the decision which will ensure the most efficient means of attaining a desired objective, say profit maximisation. After taking the decision about the particular output, pricing, capital, raw-materials and power etc., are prepared. Forward planning and decision-making thus go on at the same time.

·                      A business manager’s task is made difficult by the uncertainty which surrounds business decision-making. Nobody can predict the future course of business conditions. He prepares the best possible plans for the future depending on past experience and future outlook and yet he has to go on revising his plans in the light of new experience to minimise the failure. Managers are thus engaged in a continuous process of decision-making through an uncertain future and the overall problem confronting them is one of adjusting to uncertainty.

·                      In fulfilling the function of decision-making in an uncertainty framework, economic theory can be, pressed into service with considerable advantage as it deals with a number of concepts and principles which can be used to solve or at least throw some light upon the problems of business management. E.g are profit, demand, cost, pricing, production, competition, business cycles, national income etc. The way economic analysis can be used towards solving business problems, constitutes the subject-matter of Managerial Economics.

·                     Thus in brief we can say that Managerial Economics is both a science and an art.

Scope of Managerial Economics:

The scope of managerial economics is not yet clearly laid out because it is a developing       science. Even then the following fields may be said to generally fall under Managerial Economics:

    1.  Demand Analysis and Forecasting

    2.  Cost and Production Analysis

    3.  Pricing Decisions, Policies and Practices

    4.  Profit Management

    5.  Capital Management

These divisions of business economics constitute its subject matter.

Recently, managerial economists have started making increased use of Operation Research methods like Linear programming, inventory models, Games theory, queuing up theory etc., have also come to be regarded as part of Managerial Economics.

   1.Demand Analysis and Forecasting: A business firm is an economic organisation which is engaged in transforming productive resources into goods that are to be sold in the market. A major part of managerial decision making depends on accurate estimates of demand. A forecast of future sales serves as a guide to management for preparing production schedules and employing resources. It will help management to maintain or strengthen its market position and profit base. Demand analysis also identifies a number of other factors influencing the demand for a product. Demand analysis and forecasting occupies a strategic place in Managerial Economics.

  2.Cost and production analysis: A firm’s profitability depends much on its cost of production. A wise manager would prepare cost estimates of a range of output, identify the factors causing are cause variations in cost estimates and choose the cost-minimising output level, taking also into consideration the degree of  uncertainty in production and cost calculations. Production processes are under the charge of engineers but the business manager is supposed to carry out the production function analysis in order to avoid wastages of materials and time. Sound pricing practices depend much on cost control. The main topics discussed under cost and production analysis are: Cost concepts, cost-output relationships, Economics and Diseconomies of scale and cost control.

  3.Pricing decisions, policies and practices: Pricing is a very important area of Managerial Economics. In fact, price is the genesis of the revenue of a firm ad as such the success of a business firm largely depends on the correctness of the price decisions taken by it. The important aspects dealt with this area are: Price determination in various market forms, pricing methods, differential pricing, product-line pricing and price forecasting.

    4.Profit management: Business firms are generally organized for earning profit and in the long period, it is profit which provides the chief measure of success of a firm. Economics tells us that profits are the reward for uncertainty bearing and risk taking. A successful business manager is one who can form more or less correct estimates of costs and revenues likely to accrue to the firm at different levels of output. The more successful a manager is in reducing uncertainty, the higher are the profits earned by him. In fact, profit-planning and profit measurement constitute the most challenging area of Managerial Economics.

   5.Capital management: The problems relating to firm’s capital investments are perhaps the most complex and troublesome. Capital management implies planning and control of capital expenditure because it involves a large sum and moreover the problems in disposing the capital assets off are so complex that they require considerable time and labour. The main topics dealt with under capital management are cost of capital, rate of return and selection of projects.

Economic objectives of firms

The main objectives of firms are:

1.      Profit maximisation

2.      Sales maximisation

3.      Increased market share/market dominance

4.      Social/environmental concerns

5.      Profit satisficing

6.      Co-operatives/

Sometimes there is an overlap of objectives. For example, seeking to increase market share, may lead to lower profits in the short-term, but enable profit maximisation in the long run.

Profit maximisation

Usually, in economics, we assume firms are concerned with maximising profit. Higher profit means:

·         Higher dividends for shareholders.

·         More profit can be used to finance research and development.

·         Higher profit makes the firm less vulnerable to takeover.

·         Higher profit enables higher salaries for workers

1. Profit Satisficing

·         In many firms, there is a separation of ownership and control. Those who own the company (shareholders) often do not get involved in the day to day running of the company.

·         This is a problem because although the owners may want to maximise profits, the managers have much less incentive to maximise profits because they do not get the same rewards, (share dividends)

·         Therefore managers may create a minimum level of profit to keep the shareholders happy, but then maximise other objectives, such as enjoying work, getting on with other workers. (e.g. not sacking them) This is the problem of separation between owners and managers.

·         This ‘principal-agent‘ problem can be overcome, to some extent, by giving managers share options and performance related pay although in some industries it is difficult to measure performance.

·         More on profit-satisficing.

2. Sales maximisation

Firms often seek to increase their market share – even if it means less profit. This could occur for various reasons:

·         Increased market share increases monopoly power and may enable the firm to put up prices and make more profit in the long run.

·         Managers prefer to work for bigger companies as it leads to greater prestige and higher salaries.

·         Increasing market share may force rivals out of business. E.g. the growth of supermarkets have lead to the demise of many local shops. Some firms may actually engage in predatory pricing which involves making a loss to force a rival out of business.

3. Growth maximisation

This is similar to sales maximisation and may involve mergers and takeovers. With this objective, the firm may be willing to make lower levels of profit in order to increase in size and gain more market share. More market share increases their monopoly power and ability to be a price setter.

4. Long run profit maximisation

In some cases, firms may sacrifice profits in the short term to increase profits in the long run. For example, by investing heavily in new capacity, firms may make a loss in the short run but enable higher profits in the future.

5. Social/environmental concerns

A firm may incur extra expense to choose products which don’t harm the environment or products not tested on animals. Alternatively, firms may be concerned about local community / charitable concerns.

·         Some firms may adopt social/environmental concerns as part of its branding. This can ultimately help profitability as the brand becomes more attractive to consumers.

·         Some firms may adopt social/environmental concerns on principal alone – even if it does little to improve sales/brand image.

6. Co-operatives

Co-operatives may have completely different objectives to a typical PLC. A co-operative is run to maximise the welfare of all stakeholders – especially workers. Any profit the co-operative makes will be shared amongst all members.

Definition of Micro Economics

Microeconomics is the branch of economics that concentrates on the behaviour and performance of the individual units, i.e. consumers, family, industry, firms. Here, the demand plays a key role in determining the quantity and the price of a product along with the price and quantity of related goods (complementary goods) and substitute products, so as to make a judicious decision regarding the allocation of scarce resources, concerning their alternative uses.

Examples: Individual Demand, Price of a product, etc.

Definition of Macro Economics

Macroeconomics is the branch of economics that concentrates on the behaviour and performance of aggregate variables and those issues which affect the whole economy. It includes regional, national and international economies and covers the major areas of the economy like unemployment, poverty, general price level, GDP (Gross Domestic Product), imports and exports, economic growth, globalisation, monetary/ fiscal policy, etc. It helps in resolving the various problems of the economy, thereby enabling it to function efficiently.

Examples: Aggregate Demand, National Income, etc.

Key Differences between Micro and Macro Economics

The points given below explains the difference between micro and macro economics in detail:

1. Microeconomics studies the particular market segment of the economy, whereas Macroeconomics studies the whole economy, that covers several market segments.
2. Micro economics stresses on individual economic units. As against this, the focus of macro economics is on aggregate economic variables.
3. While microeconomics is applied to operational or internal issues, environmental and external issues are the concern of macro economics.
4. Microeconomics deals with an individual product, firm, household, industry, wages, prices, etc., while Macroeconomics deals with aggregates like national income, national output, price level, etc.
5. Microeconomics covers issues like how the price of a particular commodity will affect its quantity demanded and quantity supplied and vice versa while Macroeconomics covers major issues of an economy like unemployment, monetary/ fiscal policies, poverty, international trade, etc.
6. Microeconomics determine the price of a particular commodity along with the prices of complementary and the substitute goods, whereas the Macroeconomics is helpful in maintaining the general price level.
7. While analysing any economy, micro economics takes a bottom-up approach, whereas the macroeconomics takes a top-down approach into consideration.

Micro Economics

Pros:

• It helps in the determination of prices of a particular product and also the prices of various factors of production, i.e. land, labour, capital, organisation and entrepreneur.
• It is based on a free enterprise economy, which means the enterprise is independent to take decisions.

Cons:

• The assumption of full employment is completely unrealistic.
• It only analyses a small part of an economy while a bigger part is left untouched.

Macro Economics

Pros:

• It is helpful in determining the balance of payments along with the causes of deficit and surplus of it.
• It makes the decision regarding economic and fiscal policies and solves the issues of public finance.

Cons:

• Its analysis says that the aggregates are homogeneous, but it is not so because sometimes they are heterogeneous.
• It covers only the aggregate variables which avoid the welfare of the individual.

Similarities

As microeconomics focuses on the allocation of limited resources among the individuals, the macro economics examines that how the distribution of limited resources is to be done among many people, so that it will make the best possible use of the scarce resources. As micro economics studies about the individual units, at the same time, macro economics studies about the aggregate variables. In this way, we can say that they are interdependent.

Conclusion

Micro and Macro Economics are not contradictory in nature, in fact, they are complementary. As every coin has two aspects- micro and macroeconomics are also the two aspects of the same coin, where one’s demerit is others merit and in this way they cover the whole economy. The only important thing which makes them different is the area of application.

BASIC ECONOMIC PROBLEM

The economic problem – sometimes called the basic or central economic problem – asserts that an economy's finite resources are insufficient to satisfy all human wants and needs. It assumes that human wants are unlimited, but the means to satisfy human wants are limited. Economy problem is the problem of rational management of resources or the problem of optimum utilisation of resources.it arises because 1 resources are scarce and 2

The economic problem – sometimes called the basic or central economic problem – asserts that an economy's finite resources are insufficient to satisfy all human wants and needs. It assumes that human wants are unlimited, but the means to satisfy human wants are limited. Economy problem is the problem of rational management of resources or the problem of optimum utilisation of resources.it arises because 1 resources are scarce and 2 resources have alternative uses

Three questions arise from this:

• What to produce?

• How to produce? &

• For whom to produce?

·         What to produce?

'What and how much will you produce?' This question lies with selecting the type of supply and the quantity of the supply, focusing on efficiency.

e.g. "What should I produce more; laptops or tablets?"

·         How to produce? Capital goods or consumer goods

'How do you produce this?' This question deals with the assets and procedures used while making the product, also focusing on efficiency.

e.g. "Should I hire more workers, or do I invest in more machinery?"

·         For whom to produce?

'To whom and how will you distribute the goods?' and 'For whom will you produce this for?' arises from this question. This question deals with distributing goods that have been produced, focusing on efficiency and equity.

e.g. "Do I give more dividends to stock holders, or do I increase worker wages?"

Economics revolve around these fundamental economic problems.

Overview

The economic problem is most simply explained by the question: "How do we satisfy unlimited wants with limited resources?" The premise of the economic problem model is that wants are constant and infinite due to constantly changing demands (often closely related to changing demographics of the population), but resources in the world to satisfy human wants are always limited to the amount of natural or human resources available. The economic problem and methods to curb it—revolve around the idea of choice in prioritizing which wants can be fulfilled and what to produce for the economy.

Opportunity cost is the loss in terms of potential benefit had another action been taken. We make choices every day. We have to, as we have limited resources but so many wants. We therefore must decide which wants to satisfy and which not to. All choices involve giving something up. This leads to opportunity cost. This issue of 'what to give up' exists not only for consumers like us but for governments and businesses too...........................

Needs and wants

Needs are things or material items of peoples need for survival, such as food, clothing, housing, and water. Everyone has a different needs and wants. Until the Industrial Revolution, the vast majority of the world's population struggled for access to basic human needs.

Wants are effective desires for a particular product, or for something that can only be obtained by working for it. While the fundamental needs of survival are key in the function of the economy, wants are the driving force that stimulates demand for goods and services. To curb the economic problem, economists must classify the nature and different wants of consumers, as well as prioritize wants and organize production to satisfy as many wants as possible.

An assumption often made in mainstream neoclassical economics (and methods that try to solve the economic problem) is that humans inherently pursue their self-interest, and that the market mechanism best satisfies the various wants different individuals might have. These wants are often divided into individual wants (which depend on the individual's preferences and purchasing power parity) and collective wants (which are the wants of entire groups of people). Things such as food and clothing can be classified as either wants or needs, depending on what type and how often a good is requested.

Four parts of the problem]

The economic problem can be divided into different parts, which are given below.

Problem of allocation of resources

The problem of allocation of resources arises due to the scarcity of resources, and refers to the question of which wants should be satisfied and which should be left unsatisfied. In other words, what to produce and how much to produce. More production of a good implies more resources required for the production of that good, and resources are scarce. These two facts together mean that, if a society decides to increase production of some good, it has to withdraw some resources from the production of other goods. In other words, more production of a desired commodity can be made possible only by reducing the quantity of resources used in the production of other goods.

The problem of allocation deals with the question of whether to produce capital goods or consumer goods. If the community decides to produce capital goods, resources must be withdrawn from the production of consumer goods. In the long run, however, investment in capital goods augments the production of consumer goods. Thus, both capital and consumer goods are important. The problem is determining the optimal production ratio between the two.

The problem of all economic efficiency

Resources are scarce and it is important to use them as efficiently as possible. Thus, it is essential to know if the production and distribution of national product made by an economy is maximally efficient. The production becomes efficient only if the productive resources are utilized in such a way that any reallocation does not produce more of one good without reducing the output of any other good. In other words, efficient distribution means that redistributing goods cannot make anyone better off without making someone else worse off. (See Pareto efficiency.)

The inefficiencies of production and distribution exist in all types of economies. The welfare of the people can be increased if these inefficiencies are ruled out. Some cost must be incurred to remove these inefficiencies. If the cost of removing these inefficiencies of production and distribution is more than the gain, then it is not worthwhile to remove them.

The problem of full-employment of resources

In view of the scarce resources, the question of whether all available resources are fully utilized is an important one. A community should achieve maximum satisfaction by using the scarce resources in the best possible manner—not wasting resources or using them inefficiently. There are two types of employment of resources:

·         Labour-intensive

·         Capital-intensive

In capitalist economies, however, available resources are not fully used. In times of depression, many people want to work but can't find employment. It supposes that the scarce resources are not fully utilized in a capitalistic economy.

The problem of economic growth

If productive capacity grows, an economy can produce progressively more goods, which raises the standard of living. The increase in productive capacity of an economy is called economic growth. There are various factors affecting economic growth.

                                                            

UNIT-II

Theory of Consumer Behavior:

There are two main approaches to the of consumer behavior of demand. The first approach is the Marginal Utility or Cardinalist Approach. The second is the Ordinalist Approach. We discuss these two approaches separately.

Cardinal Utility Analysis:

Human wants are unlimited and they are of different intensity. The means at the disposal of a man are not only scarce but they have alternative uses. As a result of scarcity of recourses, the consumer cannot satisfy all his wants. Continue reading.

Total Utility and Marginal Utility:

People buy goods because they get satisfaction from them. This satisfaction which the consumer experiences when he consumes a good, when measured as number of utils is called utility. Continue reading.

Law of Diminishing Marginal Utility:

The law of diminishing marginal utility describes a familiar and fundamental tendency of human behavior. The law of diminishing marginal utility states that, “as a consumer consumes more and more units of a specific commodity, the utility from the successive units goes on diminishing”. Continue reading.Law of Equi Marginal Utility:

In the cardinal utility analysis, the principle of equal marginal utility occupies an important place. We state the assumptions of the law first and then proceed to explain it. Continue reading.

Derivation of the Demand Curve in Terms of Utility Analysis:

Dr. Alfred Marshal was of the view that the law of demand and so the demand curve can be derived with the help of utility analysis.

Comparison Between Indifference Curve Analysis and Marginal Utility Analysis:

There is difference of opinion among economists about the superiority of indifference analysis over cardinal utility analysis.Professor Hicks is of the opinion that the indifference analysis is more objective and scientific.Professor D.H. Rebertson is of the view that the Hicksian indifference curve technique is simply “old wine in new bottle”.

We give in brief the main points of similarly between these two types of analysis and then discuss the superiority of Hicksian indifference curve analysis over the Marshallian Utility Approach.

Similarities Between the Two Approaches:

(i) Rationality assumption: In the two approaches, it is assumed that the consumer behaves rationality for obtaining satisfaction from his expenditure on consumer goods. Marshall uses the term utility, and Hicks satisfaction.

(ii) Proportionality rule: The equilibrium condition of the consumer in both the analysis is the proportionality rule. In cardinal utility analysis , the equilibrium condition of the consumer is:

MU_a / P_a = MU_b / P_b = MU_c / P_c …………. = MU_n / P_n

In the Hicksian analysis, this ratio of marginal utility has been substituted by marginal rate of substitution is: MRS_xy  = P_x / P_y

(iii) Diminishing MU and MRS: Another similarity between the two types of analysis is that both assume that as the consumer gets more and more of a commodity, there is diminishing satisfaction to the consumer.

(iv) Same conclusion: The cardinal utility analysis and the Hicksian indifference curve analysis both reach at the same conclusion about the consumer behavior. There is nothing new in the indifference approach.

Superiority of Hicksian Indifference Curve Analysis:

 The indifference curve analysis is an improved form of utility analysis. It is consider more scientific and particularly accepted able on the following grounds:

 (i) It dispenses with cardinal measurement of utility: Professor R.G.D. Allen and J.R Hicks claims that the indifference curve technique is scientific and more realistic than the Marshall’s utility analysis. The foundation of utility analysis is based, they say, on the cardinal utility function which assumes that the utility is measurable; whereas utility is purely subjective phenomena and cannot be exactly measured. It varies from person to person and time to time. Any effort to measure it precisely will be a futile one.

On the the other hand, the indifference approach is based on ordinal utility function, i.e., it does not assign any number to a commodity , representing the amount of the utility. It simply assumes that the consumer weighs in his mind the relative desirability of the different combinations of goods and services.

(ii) It explains the income effect and price effect: Marshall assumes that the marginal utility of money remains constant whereas the fact is that with a rise or fall in income, the marginal utility of the money changes. The indifference curve approach, however, takes into consideration the income effect changes in price of the commodity.

(iii) It studies combination of two goods: It assumed in the Marshallian utility analysis that a consumer can measure the utility of a commodity in isolation from other commodities, i.e., it confines itself to a single commodity model. The indifference curve approach, on the other hand; studies combinations of two goods commodity and analysis the relationship of substitutable and complementarily.

(iv) Application of the principle of MRS: The law of diminishing marginal utility has now been replaced by the principle of diminishing marginal rate of substitution. This law is more scientific and realistic and is well applicable in the field of consumption, production and distribution.

(v) Popularity of indifference curve technique for the analysis of welfare economies: The indifference curve technique is more popular among the British economists and is mostly used for the analysis of welfare economies. For instance,

the indifference curve approach helps us to explain that the direct tax imposes a lesser burden than an indirect tax upon the consumer.

(a) The indifference curve approach helps us to explain that the direct tax imposes a lesser burden than an indirect tax upon the consumer.

(b) The Hicksian indifference approach is also used for constructing the supply curve of labor in the country. We can explain with the help of indifference technique that when the wages of the workers rise, they begin to prefer leisure. For example, if wife and husband both work and the wages of the husband increases, wife often leaves the service and begins to do the domestic work.

(c) The indifference curve technique is also used for illustrating the concept of consumer's surplus.

(d) In case of rationing in the country, the indifference approach tells us that as the income and preferences of consumers differ, therefore, the goods should not be distributed equally. The income and tastes of the consumers should always be kept in view.

 Criticism of Indifference Curve Approach:

The indifference curve approach has been criticized on the following grounds:

(i) Old wine in new bottle: Professor D.H. Roberson is of the view that the difference between Marshallian utility analysis and the indifference approach is that an old wine has been put in a new bottle. The only change which Hicks and Allen has made is that they have used the words marginal rate of substitution instead, of marginal utility.

(ii) Away from reality: The indifference curve technique is away from reality as the indifference hypothesis are more complicated.

(iii) Midway house: Schumpeter describes indifference analysis as a midway house as it particularly no better than the utility analysis.

(iii) The consumer is not rational: The consumer is not rational as he acts under various social, economic and legal disabilities.

(iv) Two goods model unrealistic: Two goods model unrealistic because a consumer buys large number of commodities to satisfy his unlimited wants.

(v) All commodities are not divisible: There is no doubt that indifference curve technique is not without defects, but when we take into consideration the position as a whole, we find that the indifference approach is superior to that of utility approach because it is more realistic and less restrictive.

What is the 'Law of Demand'

The law of demand states that quantity purchased varies inversely with price. In other words, the higher the price, the lower the quantity demanded. The reason for this phenomenon is that consumers' opportunity cost increases, so they must give something else up or switch to a substitute product.

Meaning of Demand:

The demand for a commodity is its quantity which consumers are able and willing to buy at various prices during a given period of time.

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So, for a commodity to have demand the consumer must possess willingness to buy it, the ability or means to buy it, and it must be related to per unit of time i.e. per day, per week, per month or per year. Demand is a function of price (p), income (y), prices of related goods (pr) and tastes (f) and is expressed as D=f (p, y, pr, t). When income, prices of related goods and tastes are given, the demand function is D=f(p). It shows the “quantities of a commodity purchased at given prices. In the Marshallian analysis, the other determinants of demand are taken as given and constant.

Factors Influencing Demand:

The factors which determine the level of demand for any commodity are the following:

1. Price:

The higher the price of a commodity, the lower the quantity demanded. The lower the price, the higher the quantity demanded.

2. Prices of other Commodities:

There are three types of commodities in this context.

Substitutes:

If a rise (or fall) in the price of one commodity leads to an increase (or decline) in the demand for another commodity, the two commodities are said to be substitutes. In other words, substitutes are those commodities which satisfy similar wants, such as tea and coffee.

If the price of coffee falls, the demand for coffee rises which brings a fall in the demand for tea because the consumers of tea shift their demand to coffee which has become cheaper. On the other hand, if the price of coffee rises, its demand will fall. But the demand for tea will rise because the consumers of coffee will shift their demand to tea.

Complementary Commodities:

Where the demand for two commodities is linked to each other, such as cars and petrol, bread and butter, tea and sugar, etc., they are said to be complementary goods. Complementary goods are those which cannot be used without each other. If, say, the price of cars rises and they become expensive, the demand for them will fall and so will the demand for petrol. On the contrary, if the price of cars falls and they become cheaper, the demand for them will increase and so will the demand for petrol.

Unrelated Goods:

If the two commodities are unrelated, say refrigerator and bicycle, a change in the price of one will have no effect on the quantity demanded of the other.

3. Income:

A rise in the consumer’s income raises the demand for a commodity, and a fall in his income reduces the demand for it.

4. Tastes:

When there is a change in the tastes of consumers in favour of a commodity, say due to fashion, its demand will rise, with no change in its price, in the prices of other commodities, and in the income of the consumer. On the other hand, a change in tastes against a commodity leads to a fall in its demand, other factors affecting demand remaining unchanged.

An Individuals Demand Schedule and Curve:

An individual consumer’s demand refers to the quantities of a commodity demanded by him at various prices, other things remaining equal (y, pr and t). An individual’s demand for commodity “is shown on the demand schedule and on the demand curve. A demand schedule is a list of prices and quantities and its graphic representation is a demand curve.

Table 10.1: Demand Schedule:

Price (Rs.)	Quantity (units)
6	10
5	20
4	30
3	40
2	60
1	80

The demand schedule reveals that when the price is Rs. 6, the quantity demanded is 10 units. If the price happens to be Rs 5, the quantity demanded is 20 units, and so on. In Figure 10.1, DD₁ is the demand curve drawn on the basis of the above demand schedule. The dotted points D, P, Q, R, S, T and U show the various price-quantity combinations.

Marshall calls them “demand points”. The first combination is represented by the first dot and the remaining price- quantity combinations move to the right toward D₁.

The Market Demand Schedule and Curve:

In a market, there is not one consumer but many consumers of a commodity. The market demand of a commodity is depicted on a demand schedule and a demand curve. They show the sum total of various quantities demanded by all the individuals at various prices.

Suppose there are three individuals A, В and С in a market who purchase the commodity. The demand schedule for the commodity is depicted in Table 10.2.

The last column (5) of the Table represents the market demand of the commodity at various prices. It is arrived at by adding columns (2), (3) and (4) representing the demand of consumers A, В and С respectively. The relation between columns (1) and (5) shows the market demand schedule. When the price is very high Rs. 6 per kg. the market demand for the commodity is 70 kgs. As the price falls, the demand increases. When the price is the lowest Re. 1 per kg., the market demand per week is 360 kgs.

Definition: The Demand for a product refers to the quantity of goods and services that the consumers are willing to buy at a particular price for a given point of time.

 Types of Demand

The demand can be classified on the following basis:

1.      Individual Demand and Market Demand: The individual demand refers to the demand for goods and services by the single consumer, whereas the market demand is the demand for a product by all the consumers who buy that product. Thus, the market demand is the aggregate of the individual demand.

2.      Total Market Demand and Market Segment Demand: The total market demand refers to the aggregate demand for a product by all the consumers in the market who purchase a specific kind of a product. Further, this aggregate demand can be sub-divided into the segments on the basis of geographical areas, price sensitivity, customer size, age, sex, etc. are called as the market segment demand.

3.      Derived Demand and Direct Demand: When the demand for a product/outcome is associated with the demand for another product/outcome is called as the derived demand or induced demand. Such as the demand for cotton yarn is derived from the demand for cotton cloth. Whereas, when the demand for the products/outcomes is independent of the demand for another product/outcome is called as the direct demand or autonomous demand. Such as, in the above example the demand for a cotton cloth is autonomous.

4.      Industry Demand and Company Demand: The industry demand refers to the total aggregate demand for the products of a particular industry, such as demand for cement in the construction industry. While the company demand is a demand for the product which is particular to the company and is a part of that industry. Such as demand for tyres manufactured by the Goodyear. Thus, the company demand can be expressed as the percentage of the industry demand.

5.      Short-Run Demand and Long-Run Demand: The short term demand is more elastic which means that the changes in price or income are reflected immediately on the quantity demanded. Whereas, the long run demand is inelastic, which shows that demand for commodity exists as a result of adjustments following changes in pricing, promotional strategies, consumption patterns, etc.

6.      Price Demand: The demand is often studied in parlance to price, and is therefore called as a price demand. The price demand means the amount of commodity a person is willing to purchase at a given price. While studying the demand, we often assume that the other factors such as income of the consumer, their tastes, and preferences, the prices of other related goods remain unchanged. There is a negative relationship between the price and demand Viz. As the price increases the demand decreases and as the price decreases the demand increases.

7.      Income Demand: The income demand refers to the willingness of an individual to buy a certain quantity at a given income level. Here the price of the product, customer’s tastes and preferences and the price of the related goods are expected to remain unchanged. There is a positive relationship between the income and demand. As the income increases the demand for the commodity also increases and vice-versa.

8.      Cross Demand: It is one of the important types of demand wherein the demand for a commodity depends not on its own price, but on the price of other related products is called as the cross demand. Such as with the increase in the price of coffee the consumption of tea increases, since tea and coffee are substitutes to each other. Also, when the price of cars increases the demand for petrol decreases, as the car and petrol are complimentary to each other.

These are some of the important types of demand that the firms must cater to before deciding on the price and other factors related to their products.

10 Determinants of Demand for a Product

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The demand of a product is influenced by a number of factors.

An organization should properly understand the relationship between the demand and its each determinant to analyze and estimate the individual and market demand of a product.

The demand for a product is influenced by various factors, such as price, consumer’s income, and growth of population.

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For example, the demand for apparel changes with change in fashion and tastes and preferences of consumers. The extent to which these factors influence demand depends on the nature of a product.

An organization, while analyzing the effect of one particular determinant on demand, needs to assume other determinants to be constant. This is due to the fact that if all the determinants are allowed to differ simultaneously, then it would be difficult to estimate the extent of change in demand.

Following are the determinants of demand for a product:

i. Price of a Product or Service:

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Affects the demand of a product to a large extent. There is an inverse relationship between the price of a product and quantity demanded. The demand for a product decreases with increase in its price, while other factors are constant, and vice versa.

For example, consumers prefer to purchase a product in a large quantity when the price of the product is less. The price-demand relationship marks a significant contribution in oligopolistic market where the success of an organization depends on the result of price war between the organization and its competitors.

ii. Income:

Constitutes one of the important determinants of demand. The income of a consumer affects his/her purchasing power, which, in turn, influences the demand for a product. Increase in the income of a consumer would automatically increase the demand for products by him/her, while other factors are at constant, and vice versa.

For example, if the salary of Mr. X increases, then he may increase the pocket money of his children and buy luxury items for his family. This would increase the demand of different products from a single family. The income-demand relationship can be analyzed by grouping goods into four categories, namely, essential consumer goods, inferior goods, normal goods, and luxury goods.

The relationship between the income of a consumer and each of these goods is explained as follows:

a. Essential or Basic Consumer Goods:

Refer to goods that are consumed by all the people in the society. For example, food grains, soaps, oil, cooking fuel, and clothes. The quantity demanded for basic consumer goods increases with increase in the income of a consumer, but up to a fixed limit, while other factors are constant.

b. Normal Goods:

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Refer to goods whose demand increases with increase in the consumer’s income. For example, goods, such as clothing, vehicles, and food items, are demanded in relatively increasing quantity with increase in consumer’s income. The demand for normal goods varies due to .different rate of increase in consumers’ income.

c. Inferior Goods:

Refer to goods whose demand decreases with increase in the income of consumers. For example, a consumer would prefer to purchase wheat and rice instead of millet and cooking gas instead of kerosene, with increase in his/her income. In such a case, millet and kerosene are inferior goods for the consumer.

However, these two goods can be normal goods for people having lower level of income. Therefore, we can say that goods are not always inferior or normal; it is the level of income of consumers and their perception about the need of goods.

d. Luxury Goods:

Refer to goods whose demand increases with increase in consumer’s income. Luxury goods are used for the pleasure and esteem of consumers. For example, expensive jewellery items, luxury cars, antique paintings and wines, and air travelling.

iii. Tastes and Preferences of Consumers:

Play a major role in influencing the individual and market demand of a product. The tastes and preferences of consumers are affected due to various factors, such as life styles, customs, common habits, and change in fashion, standard of living, religious values, age, and sex.

A change in any of these factors leads to change in the tastes and preferences of consumers. Consequently, consumers reduce the consumption of old products and add new products for their consumption. For example, if there is change in fashion, consumers would prefer new and advanced products over old- fashioned products, provided differences in prices are proportionate to their income.

Apart from this, demand is also influenced by the habits of consumers. For instance, most of the South Indians are non-vegetarian; therefore, the demand for non- vegetarian products is higher in Southern India. In addition, sex ratio has a relative impact on the demand for many products.

For instance, if females are large in number as compared to males in a particular area, then the demand for feminine products, such as make-up kits and cosmetics, would be high in that area.

iv. Price of Related Goods:

Refer to the fact that the demand for a specific product is influenced by the price of related goods to a greater extent.

Related goods can be of two types, namely, substitutes and complementary goods, which are explained as follows:

a. Substitutes:

Refer to goods that satisfy the same need of consumers but at a different price. For example, tea and coffee, jowar and bajra, and groundnut oil and sunflower oil are substitute to each other. The increase in the price of a good results in increase in the demand of its substitute with low price. Therefore, consumers usually prefer to purchase a substitute, if the price of a particular good gets increased.

b. Complementary Goods:

Refer to goods that are consumed simultaneously or in combination. In other words, complementary goods are consumed together. For example, pen and ink, car and petrol, and tea and sugar are used together. Therefore, the demand for complementary goods changes simultaneously. The complementary goods are inversely related to each other. For example, increase in the prices of petrol would decrease the demand of cars.

v. Expectations of Consumers:

Imply that expectations of consumers about future changes in the price of a product affect the demand for that product in the short run. For example, if consumers expect that the prices of petrol would rise in the next week, then the demand of petrol would increase in the present.

On the other hand, consumers would delay the purchase of products whose prices are expected to be decreased in future, especially in case of non-essential products. Apart from this, if consumers anticipate an increase in their income, this would result in increase in demand for certain products. Moreover, the scarcity of specific products in future would also lead to increase in their demand in present.

vi. Effect of Advertisements:

Refers to one of the important factors of determining the demand for a product. Effective advertisements are helpful in many ways, such as catching the attention of consumers, informing them about the availability of a product, demonstrating the features of the product to potential consumers, and persuading them to purchase the product. Consumers are highly sensitive about advertisements as sometimes they get attached to advertisements endorsed by their favorite celebrities. This results in the increase demand for a product.

vii. Distribution of Income in the Society:

Influences the demand for a product in the market to a large extent. If income is equally distributed among people in the society, the demand for products would be higher than in case of unequal distribution of income. However, the distribution of income in the society varies widely.

This leads to the high or low consumption of a product by different segments of the society. For example, the high income segment of the society would prefer luxury goods, while the low income segment would prefer necessary goods. In such a scenario, demand for luxury goods would increase in the high income segment, whereas demand for necessity goods would increase in the low income segment.

viii. Growth of Population:

Acts as a crucial factor that affect the market demand of a product. If the number of consumers increases in the market, the consumption capacity of consumers would also increase. Therefore, high growth of population would result in the increase in the demand for different products.

ix. Government Policy:

Refers to one of the major factors that affect the demand for a product. For example, if a product has high tax rate, this would increase the price of the product. This would result in the decrease in demand for a product. Similarly, the credit policies of a country also induce the demand for a product. For example, if sufficient amount of credit is available to consumers, this would increase the demand for products.

x. Climatic Conditions:

Affect the demand of a product to a greater extent. For example, the demand of ice-creams and cold drinks increases in summer, while tea and coffee are preferred in winter. Some products have a stronger demand in hilly areas than in plains. Therefore, individuals demand different products in different climatic conditions.

Elasticity of Demand: Meaning and Types of Elasticity (explained with diagram)

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Meaning of Elasticity of Demand:

Demand extends or contracts respectively with a fall or rise in price. This quality of demand by virtue of which it changes (increases or decreases) when price changes (decreases or increases) is called Elasticity of Demand.

“The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price”. – Dr. Marshall.

Elasticity means sensitiveness or responsiveness of demand to the change in price.

This change, sensitiveness or responsiveness, may be small or great. Take the case of salt. Even a big fall in its price may not induce an appreciable ex appreciable extension in its demand. On the other hand, a slight fall in the price of oranges may cause a considerable extension in their demand. That is why we say that the demand in the former case is ‘inelastic’ and in the latter case it is ‘elastic’.

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The demand is elastic when with a small change in price there is a great change in demand; it is inelastic or less elastic when even a big change in price induces only a slight change in demand. In the words of Dr. Marshall, “The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and diminishes much or little for a given rise in price.”But the demand cannot be perfectly ‘elastic’ or ‘inelastic’.

Completely elastic demand will mean that a slight fall (or rise) in the price of the commodity concerned induces an infinite extension (or contraction) in its demand. Completely inelastic demand will mean that any amount of fall (or rise) in the price of the commodity would not induce any extension (or contraction) in its demand. Both these conditions are unrealistic. That is why we say that elasticity of demand may be ‘more or less’, but it is seldom perfectly elastic or absolutely inelastic.

Types of Elasticity:

Distinction may be made between Price Elasticity, Income Elasticity and Cross Elasticity. Price Elasticity is the responsiveness of demand to change in price; income elasticity means a change in demand in response to a change in the consumer’s income; and cross elasticity means a change in the demand for a commodity owing to change in the price of another commodity.

Degrees of Elasticity of Demand:

We have seen above that some commodities have very elastic demand, while others have less elastic demand. Let us now try to understand the different degrees of elasticity of demand with the help of curves.

 (a) Infinite or Perfect Elasticity of Demand:

Let as first take one extreme case of elasticity of demand, viz., when it is infinite or perfect. Elasticity of demand is infinity when even a negligible fall in the price of the commodity leads to an infinite extension in the demand for it. In Fig. 10.1 the horizontal straight line DD’ shows infinite elasticity of demand. Even when the price remains the same, the demand goes on changing.

(b) Perfectly Inelastic Demand:

The other extreme limit is when demand is perfectly inelastic. It means that howsoever great the rise or fall in the price of the commodity in question, its demand remains absolutely unchanged. In Fig. 10.2, the vertical line DD’ shows a perfectly inelastic demand. In other words, in this case elasticity of demand is zero. No amount of change in price induces a change in demand.

In the real world, there is no commodity the demand for which may be absolutely inelastic, i.e., changes in its price will fail to bring about any change at all in the demand for it. Some extension/contraction is bound to occur that is why economists say that elasticity of demand is a matter of degree only. In the same manner, there are few commodities in whose case the demand is perfectly elastic. Thus, in real life, the elasticity of demand of most goods and services lies between the two limits given above, viz., infinity and zero. Some have highly elastic demand while others have less elastic demand.

(c) Very Elastic Demand:

Demand is said to be very elastic when even a small change in the price of a commodity leads to a considerable extension/con­traction of the amount demanded of it. In Fig. 10.3, DD’ curve illustrates such a demand. As a result of change of T in the price, the quantity demanded extends/contracts by MM’, which clearly is comparatively a large change in demand.

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(d) Less Elastic Demand:

When even a substantial change in price brings only a small extension/contraction in demand, it is said to be less elastic. In Fig. 10.4, DD’ shows less elastic demand. A fall of NN’ in price extends demand by MM’ only, which is very small.

emand Forecasting: Concept, Significance, Objectives and Factors

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An organization faces several internal and external risks, such as high competition, failure of technology, labor unrest, inflation, recession, and change in government laws.

Therefore, most of the business decisions of an organization are made under the conditions of risk and uncertainty.

An organization can lessen the adverse effects of risks by determining the demand or sales prospects for its products and services in future. Demand forecasting is a systematic process that involves anticipating the demand for the product and services of an organization in future under a set of uncontrollable and competitive forces.

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Some of the popular definitions of demand forecasting are as follows:

According to Evan J. Douglas, “Demand estimation (forecasting) may be defined as a process of finding values for demand in future time periods.”

In the words of Cundiff and Still, “Demand forecasting is an estimate of sales during a specified future period based on proposed marketing plan and a set of particular uncontrollable and competitive forces.”

Demand forecasting enables an organization to take various business decisions, such as planning the production process, purchasing raw materials, managing funds, and deciding the price of the product. An organization can forecast demand by making own estimates called guess estimate or taking the help of specialized consultants or market research agencies. Let us discuss the significance of demand forecasting in the next section.

Significance of Demand Forecasting:

Demand plays a crucial role in the management of every business. It helps an organization to reduce risks involved in business activities and make important business decisions. Apart from this, demand forecasting provides an insight into the organization’s capital investment and expansion decisions.

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The significance of demand forecasting is shown in the following points:

i. Fulfilling objectives:

Implies that every business unit starts with certain pre-decided objectives. Demand forecasting helps in fulfilling these objectives. An organization estimates the current demand for its products and services in the market and move forward to achieve the set goals.

For example, an organization has set a target of selling 50, 000 units of its products. In such a case, the organization would perform demand forecasting for its products. If the demand for the organization’s products is low, the organization would take corrective actions, so that the set objective can be achieved.

ii. Preparing the budget:

Plays a crucial role in making budget by estimating costs and expected revenues. For instance, an organization has forecasted that the demand for its product, which is priced at Rs. 10, would be 10, 00, 00 units. In such a case, the total expected revenue would be 10* 100000 = Rs. 10, 00, 000. In this way, demand forecasting enables organizations to prepare their budget.

iii. Stabilizing employment and production:

Helps an organization to control its production and recruitment activities. Producing according to the forecasted demand of products helps in avoiding the wastage of the resources of an organization. This further helps an organization to hire human resource according to requirement. For example, if an organization expects a rise in the demand for its products, it may opt for extra labor to fulfill the increased demand.

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iv. Expanding organizations:

Implies that demand forecasting helps in deciding about the expansion of the business of the organization. If the expected demand for products is higher, then the organization may plan to expand further. On the other hand, if the demand for products is expected to fall, the organization may cut down the investment in the business.

v. Taking Management Decisions:

Helps in making critical decisions, such as deciding the plant capacity, determining the requirement of raw material, and ensuring the availability of labor and capital.

vi. Evaluating Performance:

Helps in making corrections. For example, if the demand for an organization’s products is less, it may take corrective actions and improve the level of demand by enhancing the quality of its products or spending more on advertisements.

vii. Helping Government:

Enables the government to coordinate import and export activities and plan international trade.

Objectives of Demand Forecasting:

Demand forecasting constitutes an important part in making crucial business decisions.

The objectives of demand forecasting are divided into short and long-term objectives, which are shown in Figure-1:

The objectives of demand forecasting (as shown in Figure-1) are discussed as follows:

i. Short-term Objectives:

Include the following:

a. Formulating production policy:

Helps in covering the gap between the demand and supply of the product. The demand forecasting helps in estimating the requirement of raw material in future, so that the regular supply of raw material can be maintained. It further helps in maximum utilization of resources as operations are planned according to forecasts. Similarly, human resource requirements are easily met with the help of demand forecasting.

b. Formulating price policy:

Refers to one of the most important objectives of demand forecasting. An organization sets prices of its products according to their demand. For example, if an economy enters into depression or recession phase, the demand for products falls. In such a case, the organization sets low prices of its products.

c. Controlling sales:

Helps in setting sales targets, which act as a basis for evaluating sales performance. An organization make demand forecasts for different regions and fix sales targets for each region accordingly.

d. Arranging finance:

Implies that the financial requirements of the enterprise are estimated with the help of demand forecasting. This helps in ensuring proper liquidity within the organization.

ii. Long-term Objectives:

Include the following:

a. Deciding the production capacity:

Implies that with the help of demand forecasting, an organization can determine the size of the plant required for production. The size of the plant should conform to the sales requirement of the organization.

b. Planning long-term activities:

Implies that demand forecasting helps in planning for long term. For example, if the forecasted demand for the organization’s products is high, then it may plan to invest in various expansion and development projects in the long term.

Factors Influencing Demand Forecasting:

Demand forecasting is a proactive process that helps in determining what products are needed where, when, and in what quantities. There are a number of factors that affect demand forecasting.

Some of the factors that influence demand forecasting are shown in Figure-2:

The various factors that influence demand forecasting (“as shown in Figure-2) are explained as follows:

i. Types of Goods:

Affect the demand forecasting process to a larger extent. Goods can be producer’s goods, consumer goods, or services. Apart from this, goods can be established and new goods. Established goods are those goods which already exist in the market, whereas new goods are those which are yet to be introduced in the market.

Information regarding the demand, substitutes and level of competition of goods is known only in case of established goods. On the other hand, it is difficult to forecast demand for the new goods. Therefore, forecasting is different for different types of goods.

ii. Competition Level:

Influence the process of demand forecasting. In a highly competitive market, demand for products also depend on the number of competitors existing in the market. Moreover, in a highly competitive market, there is always a risk of new entrants. In such a case, demand forecasting becomes difficult and challenging.

iii. Price of Goods:

Acts as a major factor that influences the demand forecasting process. The demand forecasts of organizations are highly affected by change in their pricing policies. In such a scenario, it is difficult to estimate the exact demand of products.

iv. Level of Technology:

Constitutes an important factor in obtaining reliable demand forecasts. If there is a rapid change in technology, the existing technology or products may become obsolete. For example, there is a high decline in the demand of floppy disks with the introduction of compact disks (CDs) and pen drives for saving data in computer. In such a case, it is difficult to forecast demand for existing products in future.

v. Economic Viewpoint:

Play a crucial role in obtaining demand forecasts. For example, if there is a positive development in an economy, such as globalization and high level of investment, the demand forecasts of organizations would also be positive.

Apart from aforementioned factors, following are some of the other important factors that influence demand forecasting:

a. Time Period of Forecasts:

Act as a crucial factor that affect demand forecasting. The accuracy of demand forecasting depends on its time period.

Forecasts can be of three types, which are explained as follows:

1. Short Period Forecasts:

Refer to the forecasts that are generally for one year and based upon the judgment of the experienced staff. Short period forecasts are important for deciding the production policy, price policy, credit policy, and distribution policy of the organization.

2. Long Period Forecasts:

Refer to the forecasts that are for a period of 5-10 years and based on scientific analysis and statistical methods. The forecasts help in deciding about the introduction of a new product, expansion of the business, or requirement of extra funds.

3. Very Long Period Forecasts:

Refer to the forecasts that are for a period of more than 10 years. These forecasts are carried to determine the growth of population, development of the economy, political situation in a country, and changes in international trade in future.

Among the aforementioned forecasts, short period forecast deals with deviation in long period forecast. Therefore, short period forecasts are more accurate than long period forecasts.

4. Level of Forecasts:

Influences demand forecasting to a larger extent. A demand forecast can be carried at three levels, namely, macro level, industry level, and firm level. At macro level, forecasts are undertaken for general economic conditions, such as industrial production and allocation of national income. At the industry level, forecasts are prepared by trade associations and based on the statistical data.

Moreover, at the industry level, forecasts deal with products whose sales are dependent on the specific policy of a particular industry. On the other hand, at the firm level, forecasts are done to estimate the demand of those products whose sales depends on the specific policy of a particular firm. A firm considers various factors, such as changes in income, consumer’s tastes and preferences, technology, and competitive strategies, while forecasting demand for its products.

5. Nature of Forecasts:

Constitutes an important factor that affects demand forecasting. A forecast can be specific or general. A general forecast provides a global picture of business environment, while a specific forecast provides an insight into the business environment in which an organization operates. Generally, organizations opt for both the forecasts together because over-generalization restricts accurate estimation of demand and too specific information provides an inadequate basis for planning and execution.

Steps of Demand Forecasting:

The Demand forecasting process of an organization can be effective only when it is conducted systematically and scientifically.

It involves a number of steps, which are shown in Figure-3:

The steps involved in demand forecasting (as shown in Figure-3) are explained as follows:

1. Setting the Objective:

Refers to first and foremost step of the demand forecasting process. An organization needs to clearly state the purpose of demand forecasting before initiating it.

Setting objective of demand forecasting involves the following:

a. Deciding the time period of forecasting whether an organization should opt for short-term forecasting or long-term forecasting

b. Deciding whether to forecast the overall demand for a product in the market or only- for the organizations own products

c. Deciding whether to forecast the demand for the whole market or for the segment of the market

d. Deciding whether to forecast the market share of the organization

2. Determining Time Period:

Involves deciding the time perspective for demand forecasting. Demand can be forecasted for a long period or short period. In the short run, determinants of demand may not change significantly or may remain constant, whereas in the long run, there is a significant change in the determinants of demand. Therefore, an organization determines the time period on the basis of its set objectives.

3. Selecting a Method for Demand Forecasting:

Constitutes one of the most important steps of the demand forecasting process Demand can be forecasted by using various methods. The method of demand forecasting differs from organization to organization depending on the purpose of forecasting, time frame, and data requirement and its availability. Selecting the suitable method is necessary for saving time and cost and ensuring the reliability of the data.

4. Collecting Data:

Requires gathering primary or secondary data. Primary’ data refers to the data that is collected by researchers through observation, interviews, and questionnaires for a particular research. On the other hand, secondary data refers to the data that is collected in the past; but can be utilized in the present scenario/research work.

5. Estimating Results:

Involves making an estimate of the forecasted demand for predetermined years. The results should be easily interpreted and presented in a usable form. The results should be easy to understand by the readers or management of the organization.