UNIT -II

Demand Analysis – Determinants of Demand – Law of Demand - Elasticity of Demand –Factors

determining elasticity of demand - Demand Forecasting: Factors involved in demand forecasting –
Objectives – Methods of demand forecasting – Opinion polling and statistical methods

DEMAND ANALYSIS
Introduction & Meaning:
Demand in common parlance means the desire for an object. But in economics demand is
something more than this. According to Stonier and Hague, “Demand in economics means demand backed
up by enough money to pay for the goods demanded”. This means that the demand becomes effective only
it if is backed by the purchasing power in addition to this there must be willingness to buy a commodity.
Thus demand in economics means the desire backed by the willingness to buy a commodity and the
purchasing power to pay. In the words of “Benham” “The demand for anything at a given price is the
amount of it which will be bought per unit of time at that Price”. (Thus demand is always at a price for a
definite quantity at a specified time.) Thus demand has three essentials – price, quantity demanded and
time. Without these, demand has to significance in economics.
It deals with four aspects:
1. Consumption
2. Production
3. Exchange
4. Distribution
Definition of demand:
According to Benham: “The demand for anything, at a given price, is the amount of it, which will be
bought per unit of time, at that price.”
According to Bobber, “By demand we mean the various quantities of a given commodity or service which
consumers would buy in one market in a given period of time at various prices.”
Demand = Desire + Ability to Pay + Willingness to Pay
Above conditions must be there to create demand.
Nature and types of demand
The different types of demand are;
1. Consumer Vs producer goods
Consumer goods refer to such products and services which are capable of satisfying human need. Goods
can be grouped under consumer goods and producer goods. Consumer goods are those which are available
for ultimate consumption. These give direct and immediate satisfaction. For example bread, apple rice etc.
whereas producer goods are those which are used for further production. For example seeds and machinery.
2. Autonomous Vs derived demand
Refers to the classification of demand on the basis of dependency on other products. The demand for a
product that is not associated with the demand of other products is known as autonomous or direct demand.
The autonomous demand arises due to the natural desire of an individual to consume the product. On the
other hand, derived demand refers to the demand for a product that arises due to the demand for other
products. For example demand for college comes under autonomous demand and the demand for canteen
and stationary shop around the college comes under derived demand.
3. Durable Vs perishable goods
Refers to the classification of demand on the basis of usage of goods. The goods are divided into two
categories, perishable goods and durable goods. Perishable or non-durable goods refer to the goods that
have a single use. For example, cement, coal, fuel, and eatables. On the other hand, durable goods refer to
goods that can be used repeatedly.

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4. Firm Vs industry demand Refers to the classification of demand on the basis of market. The demand
for the products of a firm at given price over a point of time is known as firm demand. For example, the
demand for Toyota cars is organization demand. The sum total of demand for products of all organizations
in a particular industry is known as industry demand.
5. Short run Vs long run demand
Refers to the classification of demand on the basis of time period. Short-term demand refers to the demand
for products that are used for a shorter duration of time or for current period. This demand depends on the
current tastes and preferences of consumers.
6. New product Vs replacement demand
New demand refers to the demand for the new products and it is addition to the new stock. In replacement
demand the item is purchased to maintain the asset in good condition. For example the demand for car is
new demand the demand for spare parts comes under replacement demand.
7. Total market Vs segment market demand
Let us take the consumption of sugar in a given region. The total demand for sugar in the region is the total
market demand. The demand for the sweet making industry from this region is the segment market
demand.
DETERMINANTS OF MARKET DEMAND
Definition: The Market Demand is defined as the sum of individual demands for a product per unit of
time, at a given price. Simply, the total quantity of a commodity demanded by all the buyers/individuals at
a given price, other things remaining same is called the market demand.

1. Price of a product

The price of a product is one of the most important determinants of its demand in the long run and the only
determinant in the short run. The quantity of the product demanded by the consumer inversely depends
upon the price of the product. If the price rises demand falls and vice versa. The relation between price and
demand is called Law of demand. It is not only the existing price but also the expected changes in price
which affect demand.
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2. Price of related goods.
The demand for a commodity is also affected by the changes in the price of its related goods. Related goods
may be substitutes or complementary goods.
(a) Substitutes
Two commodities are substitutes for one another if change in the price of one affects the demand for the
other in the same direction. For example X and Y are substitutes for one another. If price for X increases,
demand for Y increases and vice versa. Tea and coffee, hamburgers and hot dogs, Coke and Pepsi are some
examples of substitutes in the case of consumer goods.
(b) Complements
Complementary goods are those goods which complete the demand for each other, such as car and petrol or
pen and ink. There is an inverse or negative relationship between the demand for first good and price of the
second which happens to be complementary to the first. For example an increase in the price of petrol
causes a decrease in the demand of car and other petrol run vehicles, other things remaining same
3. Income of the consumer:
Income is the basic determinant of quantity of product demanded since it determines the purchasing power
of the consumer. Income as determinant of demand is equally important in both short run and long run. The
relationship between the demand for a commodity say, X and the household income Y, assuming all other
factors to remain constant, is expressed by a demand function such as:
Experience shows that numerically there is a positive relationship between income of the consumer and his
demand for a good. In other words, an increase in income would cause an increase in demand and
economists therefore call such goods as normal goods. Normal goods are goods for which an increase in
consumer’s income results in an increase in demand. There are some goods, however which are called
inferior goods. Inferior good is a good for which an increase in consumer’s income results in a decrease in
its demand.
4. Consumer taste and preference
The demand for any goods and service depends on individual’s taste and preferences. They include fashion,
habit, custom etc. Tastes and preferences of the consumers are influenced by advertisement, changes in
fashion, climate, and new invention. Other things being equal demand for those goods increases for which
consumers develop taste and preferences. Contrary to it, an unfavorable change in consumer preferences
and tastes for a product will cause demand to decrease.
5. Advertisement effect
Advertisement costs are incurred with the objective of promoting sale of the product. Advertisements help
in increasing the demand in the following ways:
By informing potential consumers about the product and its availability’
By showing its superiority over rival product
By influencing consumer’s choice against the rival products
By setting new fashions and changing tastes.
There are instances when advertisements have changed lifestyle of people. Cadbury India has
revolutionized the market for its leading product Dairy Milk through high profile advertising featuring
Amitabh Bachchan with a slogan “Kuch mitha ho jai”.
6. Consumer’s expectations of future income and price:
Consumers do not make purchases only on the basis of current price structure. Especially in case of
durables, when demand can be postponed, consumers decide their purchase on the basis of future price and
income. If they expect their income to increase or price to fall in future, they will postpone their demand on
the other hand if they expect price to increase in future they will hasten the purchase. For example,
purchase of cars and other durables increases before budget is announced if consumers fear that prices may
rise after budget. Or, when people expect pay revisions, they wait for major purchases till pay is revised.

7. Size of population

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Size of population, age distribution, rural urban distribution and gender distribution affect aggregate
demand. If population of a country is constantly increasing, more food items and other goods and services
will be needed to satisfy the needs of the people. Age distribution of the population determines what kind
of commodities will be demanded. If population mostly consists of aged people, there will be demand of
more medicines and health care services. On the other hand if major section of population is youth, there
will be more demand for education, employment opportunities and designer apparels.
8. Other factors:
Distribution of national income, demonstration effect, credit facility, technical policy, climatic conditions
all these are the factors which affect to the demand of the product.
DEMAND FUNCTION
A demand function expresses the relationship between the quantity demanded of a commodity and its
determinants. Taking the determinants of a commodity and its determinants. Taking the determinants of
demand discussed above, we can represent a demand function as follows:
Qx = f (Px,Y,Ps,Pz,T,N,E,A,I,S)
Where, Qdx = quantity demand of commodity x
F = functional relationship
Px = price of commodity x
Y = consumers income
Ps = price of a substitute commodity
Pz = price of a complementary commodity
T = taste and preferences
N = size and distribution of population
E = future expectations
A = expenditure on advertising and promotion
I = interest rate
S = social-cultural
Factors some point to be noted about a demand function:
(a) It represents a relationship between the quantity demanded and determination of demand.
(b) The factors or variable listed in the above demand function represent only some of the possible
explanatory variables affecting demand for the community
(c) Demand in inversely related to some of the variables and directly related to some others.
For example, if X a normal commodity, then Qx is inversely related to Px, Pz and I. But in case of most of
the other variables the relationship is direct.
(d) Some of the variables are easily quantifiable, like price, prices of related commodities, income, interest
rate, expenditure advertisements, size and distribution of population.
(e) The degree of control that a firm has over the variables differs in degree. For example, a firm's
management does not have control over variables like consumer’s income, size and distribution of
population, interest rate and prices of related commodities. But a firm has greater control over price,
expenditure on advertisements and promotion.
LAW OF DEMNAND
Law of demand shows the relation between price and quantity demanded of a commodity in the market. In
the words of Marshall, “the amount demand increases with a fall in price and diminishes with a rise in
price”.
A rise in the price of a commodity is followed by a reduction in demand and a fall in price is
followed by an increase in demand, if a condition of demand remains constant.
The law of demand may be explained with the help of the following demand schedule.
Demand Schedule.

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 Price of Apple (In. Rs.) Quantity Demanded

10 1

8 2

6 3

4 4

2 5

When the price falls from Rs. 10 to 8 quantity demand increases from 1 to 2. In the same way as price
falls, quantity demand increases on the basis of the demand schedule we can draw the demand curve.

The demand curve DD shows the inverse relation between price and quantity demand of apple. It is
downward sloping.
Assumptions:
Law is demand is based on certain assumptions:
1. This is no change in consumers taste and preferences.
2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity
5. The commodity should not confer at any distinction
6. The demand for the commodity should be continuous
7. People should not expect any change in the price of the commodity

Exceptional demand curve:

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

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When price increases from OP to Op1 quantity demanded also increases from to OQ1 and vice versa. The
reasons for exceptional demand curve are as follows.
1. Giffen paradox:
The Giffen good or inferior good is an exception to the law of demand. When the price of an inferior good
falls, the poor will buy less and vice versa. For example, when the price of maize falls, the poor are willing
to spend more on superior goods than on maize if the price of maize increases, he has to increase the
quantity of money spent on it. Otherwise he will have to face starvation. Thus a fall in price is followed by
reduction in quantity demanded and vice versa. “Giffen” first explained this and therefore it is called as
Giffen’s paradox.
2. Veblen or Demonstration effect: ‘Veblen’ has explained the exceptional demand curve through his
doctrine of conspicuous consumption. Rich people buy certain good because it gives social distinction or
prestige for example diamonds are bought by the richer class for the prestige it possess. It the price of
diamonds falls poor also will buy is hence they will not give prestige. Therefore, rich people may stop
buying this commodity.
3. Ignorance:
Sometimes, the quality of the commodity is Judge by its price. Consumers think that the product is superior
if the price is high. As such they buy more at a higher price.
4. Speculative effect:
If the price of the commodity is increasing the consumers will buy more of it because of the fear that it
increase still further, Thus, an increase in price may not be accomplished by a decrease in demand.
5. Fear of shortage:
During the times of emergency of war People may expect shortage of a commodity. At that time, they may
buy more at a higher price to keep stocks for the future.
6. Necessaries:
In the case of necessaries like rice, vegetables etc. people buy more even at a higher price.

CHANGE IN DEMAND:
The increase or decrease in demand due to change in the factors other than price is called change in
demand. Change in demand leads to a shift in the demand curve to the right or to the left.
Increase and Decrease in Demand:
Increase and decrease in demand are referred to change in demand due to changes in various other factors
such as change in income, distribution of income, change in consumer’s tastes and preferences, change in
the price of related goods, while Price factor is kept constant Increase in demand refers to the rise in
demand of a product at a given price.
On the other hand, decrease in demand refers to the fall in demand of a product at a given price. For
example, essential goods, such as salt would be consumed in equal quantity, irrespective of increase or
decrease in its price. Therefore, increase in demand implies that there is an increase in demand for a
product at any price. Similarly, decrease in demand can also be referred as same quantity demanded at
lower price, as the quantity demanded at higher price.

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Increase and decrease in demand is represented as the shift in demand curve. In the graphical representation
of demand curve, the shifting of demand is demonstrated as the movement from one demand curve to
another demand curve. In case of increase in demand, the demand curve shifts to right, while in case of
decrease in demand, it shifts to left of the original demand curve.
Following Figure shows the increase in demand:

The above figure shows that, the movement from DD to D1D1 shows the increase in demand with price at
constant (OP). However, the quantity has also increased from OQ to OQ1.
Following Figure shows the decrease in demand:

The above figure shows that, the movement from DD to D2D2 shows the decrease in demand
with price at constant (OP). However, the quantity has also decreased from OQ to OQ2.

Expansion and Contraction of Demand:

The variations in the quantities demanded of a product with change in its price, while other factors are
at constant, are termed as expansion or contraction of demand. Expansion of demand refers to the
period when quantity demanded is more because of the fall in prices of a product. However,
contraction of demand takes place when the quantity demanded is less due to raise in the price o a
product.

For example, consumers would reduce the consumption of milk in case the prices of milk increases
and vice versa. Expansion and contraction are represented by the movement along the same demand
curve. Movement from one point to another in a downward direction shows the expansion of demand,
while an upward movement demonstrates the contraction of demand.

Figure-11 demonstrates the expansion and contraction of demand:

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When the price changes from OP to OP1 and demand moves from OQ to OQ1, it shows the expansion
of demand. However, the movement of price from OP to OP2 and movement of demand from OQ to
OQ2 show the contraction of demand.

ELASTICITY OF DEMAND
Elasticity of demand explains the relationship between a change in price and consequent change in
amount demanded. “Marshall” introduced the concept of elasticity of demand. Elasticity of demand
shows the extent of change in quantity demanded to a change in price.
In the words of “Marshall”, “The elasticity of demand in a market is great or small according as the
amount demanded increases much or little for a given fall in the price and diminishes much or little for
a given rise in Price”
Elastic demand: A small change in price may lead to a great change in quantity demanded. In this
case, demand is elastic.
In-elastic demand: If a big change in price is followed by a small change in demanded then the
demand in “inelastic”.
Types and measurements of Elasticity of Demand:
There are three types of elasticity of demand:

1. Price elasticity of demand

2. Income elasticity of demand
3. Cross elasticity of demand
4. Advertising elasticity of demand
1. Price elasticity of demand:
Marshall was the first economist to define price elasticity of demand. Price elasticity of demand
measures changes in quantity demand to a change in Price. It is the ratio of percentage change in
quantity demanded to a percentage change in price.

Proportionate change in the quantity demand of commodity

Price elasticity =
Proportionate change in the price of
commodity

There are five cases of price elasticity of demand

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 A. Perfectly elastic demand:
When small change in price leads to an infinitely large change is quantity demand, it is called
perfectly or infinitely elastic demand. In this case E=∞

The demand curve DD1 is horizontal straight line. It shows the at “OP” price any amount is
demand and if price increases, the consumer will not purchase the commodity.
B. Perfectly Inelastic Demand
In this case, even a large change in price fails to bring about a change in quantity demanded.

When price increases from ‘OP’ to ‘OP’, the quantity demanded remains the same. In other words
the response of demand to a change in Price is nil. In this case ‘E’=0.
C. Relatively elastic demand:
Demand changes more than proportionately to a change in price. I.e. a small change in price
leads to a very big change in the quantity demanded. In this case
E > 1. This demand curve will be flatter.

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 When price falls from ‘OP’ to ‘OP’, amount demanded increase from “OQ’ to “OQ1’ which is
larger than the change in price.
D. Relatively in-elastic demand.
Quantity demanded changes less than proportional to a change in price. A large change in price
leads to small change in amount demanded. Here E < 1. Demanded carve will be steeper.

When price falls from “OP’ to ‘OP1 amount demanded increases from OQ to OQ1, which is
smaller than the change in price.
E. Unit elasticity of demand:
The change in demand is exactly equal to the change in price. When both are equal E=1 and
elasticity if said to be unitary.

When price falls from ‘OP’ to ‘OP1’ quantity demanded increases from ‘OP’ to ‘OP1’, quantity
demanded increases from ‘OQ’ to ‘OQ1’. Thus a change in price has resulted in an equal change
in quantity demanded so price elasticity of demand is equal to unity.

2. Income elasticity of demand:

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

Proportionate change in the quantity demand of commodity

Income Elasticity =
Proportionate change in the income of the people

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

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 A. Zero income elasticity:
Quantity demanded remains the same, even though money income increases. Symbolically, it can be
expressed as Ey=0. It can be depicted in the following way:

As income increases from OY to OY1, quantity demanded never changes.

B. Negative Income elasticity:

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

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

c. Unit income elasticity:
When an increase in income brings about a proportionate increase in quantity demanded, and then
income elasticity of demand is equal to one. Ey = 1

When income increases from OY to OY1, Quantity demanded also increases from OQ to OQ1.
d. Income elasticity greater than unity:
In this case, an increase in come brings about a more than proportionate increase in quantity
demanded. Symbolically it can be written as Eye > 1.

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 It shows high-income elasticity of demand. When income increases from OY to OY1,
Quantity demanded increases from OQ to OQ1.

e. Income elasticity leas than unity:

When income increases quantity demanded also increases but less than proportionately. In this case E
< 1.
An increase in income from OY to OY, brings what an increase in quantity demanded from OQ to OQ1,
But the increase in quantity demanded is smaller than the increase in income. Hence, income elasticity of
demand is less than one.
3. Cross elasticity of Demand:
A change in the price of one commodity leads to a change in the quantity demanded of another
commodity. This is called a cross elasticity of demand. The formula for cross elasticity of demand is:
Proportionate change in quantity demand of commodity X
Cross elasticity =
Proportionate change in the price of commodity “Y”
a. In case of substitutes, cross elasticity of demand is positive. E.g.: Coffee and Tea
When the price of coffee increases, Quantity demanded of tea increases. Both are substitutes.

Price of Coffee
b. In case of compliments, cross elasticity is negative. If increase in the price of one
commodity leads to a decrease in the quantity demanded of another and vice versa.
When price of car goes up from OP to OP, the quantity demanded of petrol decreases from OQ to
OQ!. The cross-demanded curve has negative slope.

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 c. In case of unrelated commodities, cross elasticity of demanded is zero. A change in the
price of one commodity will not affect the quantity demanded of another.Quantity demanded of

commodity “b” remains unchanged due to a change in the price of ‘A’, as both are unrelated
goods.
4. Advertising elasticity of demand:
Advertising elasticity of demand shows the change in quantity demanded as a result of a
change in cost of Advertisement. Advertising elasticity of demand may be slated in the form of a
formula.

Proportionate change in the quantity demand of commodity

Advertising Elasticity = ------------------------------------------------------------------
Proportionate change in the advertisement cost

Factors influencing the elasticity of demand

Elasticity of demand depends on many factors.
1. Nature of commodity
Elasticity of demand of a commodity is influenced by its nature. A commodity for a person may be
A necessity, a comfort or a luxury.
i. When a commodity is a necessity like food grains, vegetables, medicines, etc., its demand is
generally inelastic as it is required for human survival and its demand does not fluctuate much
with change in price.
ii. When a commodity is a comfort like fan, refrigerator, etc., its demand is generally elastic as
consumer can postpone its consumption.

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 iii. When a commodity is a luxury like AC, DVD player, etc., its demand is generally more elastic
as compared to demand for comforts.
iv. The term ‘luxury’ is a relative term as any item (like AC), may be a luxury for a poor person
but a necessity for a rich person.
2. Availability of substitutes
Demand for a commodity with large number of substitutes will be more elastic. The reason is that even
a small rise in its prices will induce the buyers to go for its substitutes. For example, a rise in the price
of Pepsi encourages buyers to buy Coke and vice-versa.
Thus, availability of close substitutes makes the demand sensitive to change in the prices. On the other
hand, commodities with few or no substitutes like wheat and salt have less price elasticity of demand.
3. Income Level:

Elasticity of demand for any commodity is generally less for higher income level groups in comparison
to people with low incomes. It happens because rich people are not influenced much by changes in the
price of goods. But, poor people are highly affected by increase or decrease in the price of goods. As a
result, demand for lower income group is highly elastic.
4. Level of price:

Level of price also affects the price elasticity of demand. Costly goods like laptop; Plasma TV, etc.
have highly elastic demand as their demand is very sensitive to changes in their prices. However,
demand for inexpensive goods like needle, match box, etc. is inelastic as change in prices of such
goods do not change their demand by a considerable amount.
5. Postponement of Consumption:

Commodities like biscuits, soft drinks, etc. whose demand is not urgent, have highly elastic demand
as their consumption can be postponed in case of an increase in their prices. However, commodities
with urgent demand like life saving drugs, have inelastic demand because of their immediate
requirement.

Number of Uses:

If the commodity under consideration has several uses, then its demand will be elastic. When price of
such a commodity increases, then it is generally put to only more urgent uses and, as a result, its
demand falls. When the prices fall, then it is used for satisfying even less urgent needs and demand
rises.
For example, electricity is a multiple-use commodity. Fall in its price will result in substantial increase
in its demand, particularly in those uses (like AC, Heat convector, etc.), where it was not employed
formerly due to its high price. On the other hand, a commodity with no or few alternative uses has less
elastic demand.
6. Share in Total Expenditure:

Proportion of consumer’s income that is spent on a particular commodity also influences the elasticity
of demand for it. Greater the proportion of income spent on the commodity, more is the elasticity of
demand for it and vice-versa.
Demand for goods like salt, needle, soap, match box, etc. tends to be inelastic as consumers spend a
small proportion of their income on such goods. When prices of such goods change, consumers
continue to purchase almost the same quantity of these goods. However, if the proportion of income
spent on a commodity is large, and then demand for such a commodity will be elastic.
7. Time Period:

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Price elasticity of demand is always related to a period of time. It can be a day, a week, a month, a year
or a period of several years. Elasticity of demand varies directly with the time period. Demand is
generally inelastic in the short period.
It happens because consumers find it difficult to change their habits, in the short period, in order to
respond to a change in the price of the given commodity. However, demand is more elastic in long rim
as it is comparatively easier to shift to other substitutes, if the price of the given commodity rises.
8. Habits:

Commodities, which have become habitual necessities for the consumers, have less elastic demand. It
happens because such a commodity becomes a necessity for the consumer and he continues to
purchase it even if its price rises. Alcohol, tobacco, cigarettes, etc. are some examples of habit forming
commodities.
Finally it can be concluded that elasticity of demand for a commodity is affected by number of factors.
However, it is difficult to say, which particular factor or combination of factors determines the
elasticity. It all depends upon circumstances of each case.
Importance of Elasticity of Demand:
The concept of elasticity of demand is of much practical importance.
1. Price fixation
The elasticity of demand for a product is the basis of its price determination. The ratio in which the
demand for a product will fall with the rise in its price and vice versa can be known with the
knowledge of elasticity of demand
If the demand for a product is inelastic, the producer can charge high price for it, whereas for an elastic
demand product he will charge low price. Thus, the knowledge of elasticity of demand is essential for
management in order to earn maximum profit.
2. Determination of factors of Production
The concept of elasticity for demand is of great importance for determining prices of various factors of
production. Factors of production are paid according to their elasticity of demand. In other words, if
the demand of a factor is inelastic, its price will be high and if it is elastic, its price will be low.
3. In Demand Forecasting:
The elasticity of demand is the basis of demand forecasting. The knowledge of income elasticity is
essential for demand forecasting of producible goods in future. Long- term production planning and
management depend more on the income elasticity because management can know the effect of
changing income levels on the demand for his product.
4. In the Determination of Government Policies:
The knowledge of elasticity of demand is also helpful for the government in determining its policies.
Before imposing statutory price control on a product, the government must consider the elasticity of
demand for that product. The government decision to declare public utilities those industries whose
products have inelastic demand and are in danger of being controlled by monopolist interests depends
upon the elasticity of demand for their products.
5. In the Determination of Output Level:
For making production profitable, it is essential that the quantity of goods and services should be
produced corresponding to the demand for that product. Since the changes in demand are due to the
change in price, the knowledge of elasticity of demand is necessary for determining the output level.

6.Helpful in Adopting the Policy of Protection:

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The government considers the elasticity of demand of the products of those industries which apply for
the grant of a subsidy or protection. Subsidy or protection is given to only those industries whose
products have an elastic demand. As a consequence, they are unable to face foreign competition unless
their prices are lowered through subsidy or by raising the prices of imported goods by imposing heavy
duties on them.
7.In the Determination of Gains from International Trade:
The gains from international trade depend, among others, on the elasticity of demand. A country will
gain from international trade if it exports goods with less elasticity of demand and import those goods
for which its demand is elastic.
In the first case, it will be in a position to charge a high price for its products and in the latter case it
will be paying less for the goods obtained from the other country. Thus, it gains both ways and shall
be able to increase the volume of its exports and imports.
Demand Forecasting

Introduction:
The information about the future is essential for both new firms and those planning to expand the scale of
their production. Demand forecasting refers to an estimate of future demand for the product. It is an
‘objective assessment of the future course of demand”. In recent times, forecasting plays an important role in
business decision-making. Demand forecasting has an important influence on production planning. It is essential for
a firm to produce the required quantities at the right time.

It is essential to distinguish between forecasts of demand and forecasts of sales. Sales forecast is
important for estimating revenue cash requirements and expenses. Demand forecasts relate to
production, inventory control, timing, reliability of forecast etc. However, there is not much difference
between these two terms.
⚫ Demand forecasting essentially involves ascertaining the expected level of demand during
the period under consideration.
⚫ Sales are a function of demand. Likewise, even cost of production depends upon demand.

⚫ Production of any commodity requires time and resources.

⚫ In order to plan the level of production and make arrangements for the resources to
be consumed, it is important to estimate future demand.

Stages in forecasting demand

⚫ Specification of objective(s)

⚫ Selection of appropriate technique

⚫ Collection of appropriate data

⚫ Estimation and interpretation of results

⚫ Evaluation of the forecasts

Factors governing elasticity of demand

⚫ functional nature of demand

T.DEVA PRASAD, M.B.A, M.Com,(Ph.D),APSET Page 16

 ⚫ Types of forecasts

⚫ Forecasting level
⚫ Degree of orientation

⚫ Established or new products

⚫ Nature of goods
⚫ Degree of competition

⚫ Other factors: change in technology, change in political conditions, changes in

customer preference and fashions etc.
Types of demand Forecasting:
Based on the time span and planning requirements of business firms, demand forecasting can be
classified in to
1. Short-term demand forecasting and
2. Long – term demand forecasting.
1. Short-term demand forecasting:
Short-term demand forecasting is limited to short periods, usually for one year. It relates to policies
regarding sales, purchase, price and finances. It refers to existing production capacity of the firm.
Short-term forecasting is essential for formulating is essential for formulating a suitable price policy. If
the business people expect of rise in the prices of raw materials of shortages, they may buy early. This
price forecasting helps in sale policy formulation. Production may be undertaken based on expected
sales and not on actual sales. Further, demand forecasting assists in financial forecasting also. Prior
information about production and sales is essential to provide additional funds on reasonable terms.
2. Long – term forecasting:
In long-term forecasting, the businessmen should now about the long-term demand for the product.
Planning of a new plant or expansion of an existing unit depends on long-term demand. Similarly a
multi product firm must take into account the demand for different items. When forecast are mode
covering long periods, the probability of error is high. It is very difficult to forecast the production, the
trend of prices and the nature of competition. Hence quality and competent forecasts are essential.
Prof. C. I. Savage and T.R. Small classify demand forecasting into time types. They are:

1. Economic forecasting,
2. Industry forecasting,
3. Firm level forecasting.

Economic forecasting is concerned with the economics, while industrial level forecasting is used for
inter-industry comparisons and is being supplied by trade association or chamber of commerce. Firm
level forecasting relates to individual firm.

Demand forecasting techniques

1. survey method
(a) survey of buyers intention

(b) sales force opinion

2. Statistical methods

T.DEVA PRASAD, M.B.A, M.Com,(Ph.D),APSET Page 17

 ⚫ Trend projection methods
⚫ census method
⚫ Sample method
(a) Barometric techniques
⚫ trend line by observation

⚫ Least squares method

⚫ Time series analysis

⚫ Moving averages method

⚫ Exponential smoothing
(b) Simultaneous equation
method
(c) correlation and regression
method
3. Other methods
(a) Expert opinion method
(b) Test marketing
(c) Controlled experiments
(d) Judgmental approach
(a) Survey method
Consumer’s Survey Method or Survey of Buyer’s Intentions:
In this method, the consumers are directly approached to disclose their future purchase plans. This is
done by interviewing all consumers or a selected group of consumers out of the relevant population.
This is the direct method of estimating demand in the short run. Here the burden of forecasting is
shifted to the buyer. The firm may go in for complete enumeration or for sample surveys. If the
commodity under consideration is an intermediate product then the industries using it as an end
product are surveyed
(b) Sales Force Opinion Method:

This is also known as collective opinion method. In this method, instead of consumers, the opinion of
the salesmen is sought. It is sometimes referred as the “grass roots approach” as it is a bottom-up
method that requires each sales person in the company to make an individual forecast for his or her
particular sales territory.

These individual forecasts are discussed and agreed with the sales manager. The composite of all
forecasts then constitutes the sales forecast for the organization. The advantages of this method are
that it is easy and cheap. It does not involve any elaborate statistical treatment. The main merit of this
method lies in the collective wisdom of salesmen. This method is more useful in forecasting sales of
new products.

1. Statistical Method:
Statistical methods have proved to be immensely useful in demand forecasting. In order to maintain
objectivity, that is, by consideration of all implications and viewing the problem from an external point
of view, the statistical methods are used.

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The important statistical methods are:
(i) Trend Projection Method:
A firm existing for a long time will have its own data regarding sales for past years. Such data when
arranged chronologically yield what is referred to as ‘time series’. Time series shows the past sales
with effective demand for a particular product under normal conditions. Such data can be given in a
tabular or graphic form for further analysis. This is the most popular method among business firms,
partly because it is simple and inexpensive and partly because time series data often exhibit a persistent
growth trend.
(a)Trend line by observation method
This is the simplest technique to determine the trend. All values of output or sale for different years
are plotted on a graph and a smooth free hand curve is drawn passing through as many points as
possible. The direction of this free hand curve—upward or downward— shows the trend.
(b) Least Square Method:
Under the least square method, a trend line can be fitted to the time series data with the help of
statistical techniques such as least square regression. When the trend in sales over time is given by
straight line, the equation of this line is of the form: y = a + bx. Where ‘a’ is the intercept and ‘b’
shows the impact of the independent variable. We have two variables—the independent variable x
and the dependent variable y. The line of best fit establishes a kind of mathematical relationship
between the two variables .v and y. This is expressed by the regression у on x.
In order to solve the equation s = x + y(T), we have to make use of the following normal
equations:
Σ S =Nx + yΣ

Σ ST=x Σ T+Y Σ T2
Whereas S= sales, T= year number, N= number of years
(c) Time series analysis:
Time series has got four types of components namely, Secular Trend (T), Secular Variation (S),
Cyclical Element (C), and an Irregular or Random Variation (I). These elements are expressed by the
equation O = TSCI. Secular trend refers to the long run changes that occur as a result of general
tendency.
Seasonal variations refer to changes in the short run weather pattern or social habits. Cyclical
variations refer to the changes that occur in industry during depression and boom. Random variation
refers to the factors which are generally able such as wars, strikes, flood, and famine and so on.
When a forecast is made the seasonal, cyclical and random variations are removed from the observed
data. Thus only the secular trend is left. This trend is then projected. Trend projection fits a trend line
to a mathematical equation.
(ii) Barometric Technique:
A barometer is an instrument of measuring change. This method is based on the notion that “the future
can be predicted from certain happenings in the present.” In other words, barometric techniques are
based on the idea that certain events of the present can be used to predict the directions of change in
the future. This is accomplished by the use of economic and statistical indicators which serve as
barometers of economic change.
c. Regression and correlation method:
Regression and correlation are used for forecasting demand. Based on post data the future data trend
is forecasted. If the functional relationship is analyzed with the independent variable it is simple
T.DEVA PRASAD, M.B.A, M.Com,(Ph.D),APSET Page 19
correction. When there are several independent variables it is multiple correlation. In correlation we
analyze the nature of relation between the variables while in regression; the extent of relation between
the variables is analyzed. The results are expressed in mathematical form. Therefore, it is called as
econometric model building. The main advantage of this method is that it provides the values of the
independent variables from within the model itself.
(d)Simultaneous Equations Model:
Under simultaneous equation model, demand forecasting involves the estimation of several
simultaneous equations. These equations are often the behavioral equations, market-clearing
equations, and mathematical identities.

The regression technique is based on the assumption of one-way causation, which means independent
variables cause variations in the dependent variables, and not vice-versa. In simple terms, the
independent variable is in no way affected by the dependent variable.

For example, D = a – bP, which shows that price affects demand, but demand does not affect the
price, which is an unrealistic assumption.
On the contrary, the simultaneous equations model enables a forecaster to study the simultaneous
interaction between the dependent and independent variables. Thus, simultaneous equation
model is a systematic and complete approach to forecasting. This method employs several
mathematical and statistical tools of estimation.
III) OTHER METHODS
(a)Expert opinion method
In this method of demand forecasting, the firm makes an effort to obtain the opinion of experts who
have long standing experience in the field of enquiry related to the product under consideration. If the forecast is
based on the opinion of several experts then the approach is called forecasting through the use of panel consensus.
Although the panel consensus method usually results in forecasts that embody the collective wisdom of consulted
experts, it may be at times unfavorably affected by the force of personality of one or few key individuals.

To counter this disadvantage of panel consensus, another approach is developed called the Delphi
method. In this method a panel of experts is individually presented a series of questions pertaining to
the forecasting problem. Responses acquired from the experts are analyzed by an independent party
that will provide the feedback to the panel members. Based on the responses of other individuals, each
expert is then asked to make a revised forecast. This process continues till a consensus is reached or
until further iterations generate no change in estimates.

The advantage of Delphi technique is that it helps individual panel members in assessing their
forecasts. However Delphi method is quite expensive. Often, the most knowledgeable experts in the
industry will command more fees. Besides, those who consider themselves as experts may be reluctant
to be influenced by the opinions of others on the panel.

The main advantage of the Experts Opinion Survey Method is its simplicity. It does not require
extensive statistical or mathematical calculations however this method has its own limitations. It is
purely subjective. It substitutes opinion in place of analysis of the situation. Experts may have

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Different forecasts or any one among them may influence others. Who knows experts
may be biased or have their own intentions behind providing their opinions. If the
consulted experts are genuinely reliable then panel consensus could be perhaps the best
method of forecasting.
(b) Test marketing:
The Test Marketing is one of the methods used under the Market Test. What The Test
Marketing is yet another method of sales forecasting, wherein the new product is
launched in the selected geographical areas, the representative of the final market, to
check the viability of the product and its demand among the selected group of people.
(c) Controlled Experiments:
Under this method, an effort is made to ascertain separately certain determinants of
demand which can be maintained, e.g., price, advertising etc. and conducting the
experiment, assuming etc., and conducting the experiment, assuming that the other
factors remain constant.
(d) Judgmental methods

When none of the above methods are directly related to the given product or service, the
management has no alternative other than using its own judgment. Judgmental
forecasting methods incorporate intuitive judgment, opinions and subjective probability
estimates. Judgmental forecasting is used in cases where there is lack of historical data or
during completely new and unique market condition.
Consumers Equilibrium
When consumers make choices about the quantity of goods and services to consume, it
is presumed that their objective is to maximize total utility. In maximizing total
utility, the consumer faces a number of constraints, the most important of which are
the consumer’s income and the prices of the goods and services that the consumer
wishes to consume. The consumer's effort to maximize total utility, subject to these
constraints, is referred to as the consumer's problem. The solution to the consumer's
problem, which entails decisions about how much the consumer will consume of a
number of goods and services, is referred to as consumer equilibrium.
Determination of consumer equilibrium: Consider the simple case of a consumer who
cares about consuming only two goods: good 1 and good 2. This consumer knows the
prices of goods 1 and 2 and has a fixed income or budget that can be used to purchase
quantities of goods 1 and 2. The consumer will purchase quantities of goods 1 and 2 so
as to completely exhaust the budget for such purchases. The actual quantities purchased
of each good are determined by the condition for consumer equilibrium, which is

This condition states that the marginal utility per dollar spent on good 1 must equal the
marginal utility per dollar spent on good 2. If, for example, the marginal utility per dollar

spent on good 1 were higher than the marginal utility per dollar spent on good 2, then it
would make sense for the consumer to purchase more of good 1 rather than purchasing
any more of good 2. After purchasing more and more of good 1, the marginal utility of
good 1 will eventually fall due to the law of diminishing marginal utility, so that the

T.DEVA PRASAD, M.B.A, M.Com,(Ph.D),APSET Page

marginal utility per dollar spent on good 1 will eventually equal that of good 2. Of
course, the amount purchased of goods 1 and 2 cannot be limitless and will depend not
only on the marginal utilities per dollar spent, but also on the consumer's budget.

T.DEVA PRASAD, M.B.A, M.Com,(Ph.D),APSET Page