CHAPTER 2 : THEORY OF DEMAND AND SUPPLY

UNIT I – LAW OF DEMAND AND ELASTICITY OF DEMAND.

Definition of Demand

Demand refers to different possible quantities of a commodity that the consumer is ready to buy at
a given price and at a given time.

Demand Schedule

The table showing the relation between different quantities of a commodity to be purchased at
different prices of that commodity is known as demand schedule.

Types of Demand Schedule

(a) Individual Demand Schedule

It refers to demand schedule of an individual buyer of a commodity in the market .It shows
quantity of a commodity which an individual buyer buys at different possible prices of that
commodity at a point of time.

Price of Ice Quantity

Cream (Rs.) Demanded (units)
A 1 4
B 2 3
C 3 2
D 4 1

(b) Market Demand Schedule

It is a table showing different quantity of a commodity that all the buyers in the market are
ready to buy at different possible prices of the commodity at a point of time.

Price of P’s Q’s Market

Ice Cream Demand Demand Demand
(Rs.) (P+Q)
A 1 4 5 9
B 2 3 4 7
C 3 2 3 5
D 4 1 2 3

DEMAND CURVE
Graphical representation of demand schedule is known as demand curve .It basically is a curve
that shows how quantity demanded of a commodity is related to its price.
TYPES OF DEMAND CURVE
(a) Individual Demand Curve
(b) Market Demand Curve
(a) Individual Demand Curve
• It is a curve showing different quantity of a commodity that one particular buyer is ready to
buy at different prices of the commodity at a point of time.
• The Demand Curve slopes downward from left to right indicating inverse relationship
between price of commodity and its quantity demanded.

(b) Market Demand Curve

• It shows various quantities of various commodities that all the buyers in the market are
ready to buy at different possible prices of the commodity.
• It is horizontal summation of the Individual Demand Curve.
DEMAND FUNCTION
It shows the relationship between demand for a commodity and its various determinants (factors
affecting demand).

Dx = f (P,Pr,Y,T,E,N,Yd)

Here, Dx = Quantity demanded of commodity X.

Px = Price of Commodity X.
Pr = Price of Related Commodity.
Y = Consumer’s Income.
T = Taste and Preference.
E = Consumer’s Future Expectation.
N = Number of Population (Size of Population)
Yd = Distribution of Income.

DETERMINANTS OF DEMAND

(A) Price of Commodity :Other things being constant,with a rise in price of commodity,its
demand contracts (reduces) and with a fall in price,its demand extends i.e. rises.

(B) Price of Related Goods : Demand for a commodity is influenced by change in price of related
goods.They are of two types :

(i) Substitute Goods – The goods which can be used in place of each other or which can be
substituted for each other .Example- Tea and Coffee ,Increase in price of Tea,decreases the
demand for tea and eventually increase the demand for coffee as due to increase in price of
tea,the consumers will shift to consumption of coffee.

(ii) Complementary Goods – The goods which complete the demand for each other and
therefore are demanded together , Example – Pen and Ink,Car and Petrol.In case of
complementary goods a fall in price of one,causes increase in demand of the other and a rise in
price of one causes decrease in demand for another.

Substitute Goods –

Price of Demand for tea(kg.) Demand for tea(kg.)

Tea(Rs./kg) (When Pc = Rs. (When Pc = Rs.
250/kg.) 300/kg.)
250 5 10
225 8 14
200 11 18
175 14 22
150 17 26
100 20 30
 Complementary Goods –

Price of Ink (Rs.) Demand for ink (units) Demand for ink (units)
(When Price of pen = Rs. 50) (When Price of pen= Rs. 100)
30 5 2
25 8 4
20 12 6
18 16 8
15 20 10

(C) Income of the Consumer – The demand for a commodity may increase/decrease with a rise in
income depending on nature of commodity .For this, the goods are divided into –

(i) Normal Goods: The goods whose demand increases with rise in income and decreases
with fall in income are termed as normal income. They have positive effect related to
income.
Eg. Rice, Wheat etc.

(ii) Inferior Goods : The goods whose demand decreases with rise in consumer’s income
and increases with the fall in income is termed as inferior goods.There is an inverse
relation between income of consumer and demand for goods.The income effect is
negative.
Eg. Jowar,Bajra,etc.

LAW OF DEMAND

Statement of Law –

The law of demand states that other things remaining constant (ceteris paribus) the demand for a
commodity expands with fall in its price and contracts with a rise in its price .In short, it shows
inverse relationship between price of a commodity and its demand.
WHY DOES DEMAND CURVE SLOPES DOWNWARD?

OR
WHY DOES THE LAW OF DEMAND OPERATE?
OR
WHY MORE OF A GOOD IS PURCHASED WHEN ITS PRICE FALLS?

The Law of Demand indicates more demand as price falls and less demand as price rises.The
reasons are as follows :

1. LAW OF DIMINISHING MARGINAL UTILITY :

According to this law the marginal utility of a good falls with an increase in its quantity or we can
say that marginal utility decreases with increase in consumption of the commodity,Accordingly
for every additional unit to be purchased the consumer is willing to pay less and less price
because consumer would purchase a commodity where its marginal utility becomes equal to its
price.Thus the diminishing marginal utility curve takes the form of a demand curve and slopes
downward.

2. INCOME EFFECT :

It refers to change in quantity demanded when real income of the buyer changes due to change
in price of the commodity. In simple words, with a fall in price of commodity the real income
increases and enables the consumer to purchase more of the commodity and thus demand
expands.

3. SUBSTITUTION EFFFECT :
It refers to substitution of one commodity for the other when it becomes relatively cheaper. In
short ,when the price of commodity X falls it becomes cheaper in relation to commodity Y ,so the
consumers now start substituting commodity X for Y .Thus with a fall in the price of X ,the
demand for it increases.

4. NEW CUSTOMERS :
When the price of commodity falls some new consumers start purchasing the commodity as now
even they can afford to buy it. Contrary to it ,when price rises some old consumers might stop
purchasing the good and thus demand decreases.

5. DIFFERENT USES :
A commodity can be put to several uses amongst which some uses are important and others are
less important.When the rice of commodity increases the consumer reduces the use of
commodity for less important uses ,hence purchase is reduced.
Eg. Milk is used for making different products like curd,cheese,butter,etc.If the price of milk
reduces it will be used for different uses.

EXCEPTIONS TO THE LAW OF DEMAND :

When with the increase in price,more quantity of a commodity is purchased and with a decrease
in price less of it is purchased this is something which is contradictory to the law of demand.This
is known as exception to the law of demand.In this the demand curve slopes upwards from left to
right.
 Following are the exceptions:

1. Articles of Distinction/Prestige Goods/Conspicious Goods : Certain goods are purchased to

emphasise status/prestige.Such goods will be purchased when sold at higher price and are
demanded less at a lower price.Eg. Precious Diamonds,Vintage cars,etc.

2. Giffen Goods : They are highly inferior goods showing a very high negative income effect.As a
result whenprice of such commodities falls,the demand also falls even when they happen to be
relatively cheaper thanother goods.This is also known as Giffen Paradox.Eg. Bajra,Coarse
grain,etc.

3. Expectation of Further Change in Price : When buyers expect a further rise in the price they
purchase increased quantity of the commodity even at a higher price and vice versa.Eg. Gold
Prices.

4. Necessities :Those goods which are a must for living and necessities of life for which a minimum
quantity has to be purchased by the consumer irrespective of the price.Eg. Food Grains,Salt,etc.

MOVEMENT ALONG THE DEMAND CURVE AND SHIFT IN DEMAND CURVE –

1. MOVEMENT ALONG DEMAND CURVE – It refers to the situation when the demand extends
or contracts due to fall/rise in the own prices of commodity.
2. SHIFT IN DEMAND CURVE – It refers to all such situations when demand for a commodity
increases or decreases due to changes in other determinants of demand other than own price of
commodity.
1. Movement along Demand Curve- It is of two types :
(a) Extension of Demand Curve.
(b) Contraction of Demand Curve.

(A) EXTENSION OF DEMAND

• Other things being equal when more quantity is purchased because of fall in its prices, it is
called extension of demand.
• It is also known as Increase in quantity demanded.
• It is shown by downward/rightward movement along the same demand curve.
• Example:
Px Dx
10 20
8 25
 (B) CONTRACTION OF DEMAND
• Other things being equal when less quantity is purchased because of rise in its prices, it is
called contraction of demand.
• It is also known as decrease in quantity demanded.
• It is shown by the upward or leftward movement along the same demand curve.
• Example:
Px Dx
10 20
12 15

SHIFT IN DEMAND CURVE –

• It occurs due to change in other factors other than price of the commodity.
• Eg. Change in income, change in price of related goods, etc.

(1) Increase in Demand

(A) When due to change in factors other than the price of commodity concerned,more quantity
at same price or same quantity at higher price is demanded,this is termed as increase in
demand.
(B) It is also known as forward shift.
(C) It is indicated by rightward shift or upward shift to new demand curve.
(D) The important causes of increase in demand are :
• When income of consumer increases.
• When price of substitute good increase.
• When price of complementary goods fall.
• When taste of consumer shifts in favour of the commodity.
• When availability of commodity is expected to reduce in near future.
• Example1:
Px Dx
10 20
10 25
• Example2:
Px Dx
10 20
12 20

(2) Decrease in Demand

(A) When because of factors other than the price of the commodity concerned less quantity at
the same price or same quantity at a lower price is demanded this is termed as decrease in
demand.
(B) It is also known as backward shift,
(C) The Demand Curve shifts to a new Demand Curve on its left or downward.
(D) The causes for decrease in demand are :
• Fall in Consumer’s income.
• Fall in price of substitute.
• Rise in price of compliment.
• Change in taste away from the commodity.
• Example1:
Px Dx
10 20
10 15
• Example2:
Px Dx
10 20
8 20
 PRICE ELASTICITY OF DEMAND :
• It is defined as a measurement of percentage change in quantity demanded in response to a
given percentage change in own price of the commodity.
• It is denoted by ‘Ed’.

DEGREES OF PRICE ELASTICITY OF DEMAND :

1. Perfectly Elastic Demand
2. Perfectly Inelastic Demand
3. Unitary Elastic Demand
4. More than unitary elastic demand
5. Less than unitary elastic demand
1. Perfectly Elastic Demand:
(a) When the demand curve becomes zero with the slight rise in the price of commodity or
when the demand is infinite at the given price,it is called as perfectly elastic demand.
(b) This curve is horizontal curve parallel to the x-axis.
(c) Hence the coefficient of elasticity of demand would be equal to infinity.
(d) It is an imaginary situation.

2. Relatively or Highly Elastic Demand:

(a) When the proportionate or percentage change in the quantity demanded is greater than
the proportionate or percentage change in price,it is called as elastic or relatively elastic
demand.
(b) Hence elasticity of demand is greater than one,i.e. Ed>1.
(c) Example : If the percentage change in quantity demanded is 30% while percentage
change in price is 25% then it is case of elastic demand.
(d) Example of Highly elastic demand:
• Want is not that urgent.
• Luxury Goods.
• Close substitutes are available.
3. Unitary Elasticity of Demand
(a) When the proportionate change in quantity demanded and the proportionate change in
price are equal it is termed as unitary elastic demand.
(b) It is denoted by Ed=1.
(c) The shape of unitary elastic demand will be a rectangular hyperbola.
(d) Example : Percentage change in price =20% and Percentage change in quantity = 20%.
(e) Example : Comfort Goods

4. Perfectly Inelastic Demand

(a) When there is no change in the quantity demanded with the change in the price.
(b) Its demand curve is vertical curve parallel to Y- Axis.
(c) Example : Demand for rare medicines or demand for opium for the person who becomes
addicted to it are examples of perfectly inelastic demand.
(d) Example: When price is Rs. 2 ,demand is 4 units and when price rises to Rs. 4 still the
demand remains constant at 4 units.
 5. Less Than Unitary Elastic Demand (Ed<1)
(a) When the proportionate percentage change in quantity demanded is less than
proportionate percentage change in price.
(b) For example : Due to decrease in price by 40% the demand increases by 10%.
(c) Example : Necessity goods like salt,basic food items,etc.

MEASUREMENT OF PRICE ELASTICITY OF DEMAND :

(1) Percentage or Proportionate Method.

(2) Geometrical Method or Point Elasticity Method.
(3) Total Expenditure Method /Total Outlay Method.
(4) Arc Elasticity Method.

(1) Percentage or Proportionate Method :

• It is the most popular method of measuring Ed.
• Under this method, elasticity is measured by the ratio of proportionate
(percentage) change in quantity demanded to proportionate (percentage)
change in price.
 • Formula –
Ed = % Change in Quantity
% Change in Price
OR
Ed = Proportionate Change in Quantity Demanded
Proportionate Change in Price

OR

△𝑄 𝑃
Ed = △𝑃 𝑥 𝑄

Note: Price and Quantity move in opposite direction. Therefore elasticity of

demand will always be negative, but for convenience minus sign is dropped.

Geometric Method/Point Elasticity:

1. Geometric method measures price elasticity of demand.

2. It is also called point method of measuring elasticity of demand.This method determines
elasticity of demand at different points along the same DC.
3. For this method, the straight line DC needs to be expanded to the x and y axis.

The point at which ed is to be completed, divides the DC into 2 parts- (a) lower sector (b) upper
sector.
4. Thus, ed = lower sector (i.e. lower segment)
Upper sector (i.e. upper segment)

5. Following fig details about elasticity at diff points

➔ ed = 1(unity): if point P is at the middle of the DC, then lower segment = upper segment
price
Accordingly: PN = 1
PM
➔ ed > 1 (greater than unity): At point A, ed = AN > 1 because AN > AM
AM
➔ ed < 1 (less than unity): At point B, ed = BN < 1 because BN > BM
BM
➔ ed = 0 (zero): At point N, where DC touches the x-axis, ed = O = 0
NM
➔ ed = ∞ (infinity): At point M, where DC touches the y-axis, ed = MN = ∞
* Total Expenditure method or Total outlay method or Relationship between elasticity f demand &
total expenditure.

1. Total expenditure = The quantity demanded x Price of good

2. TE = q(x) x p(x)

3. According to this method, elasticity of demand is measured by comparing total expenditure of the
commodity before and after the price undergoes change.

4. There may be 3 possibilities in this case:

a) → Elasticity of demand is greater than unity (ed > 1) or demand is elastic.

In this case, total expenditure increase with fall in price and decrease with rising price.

* Price & total expenditure move in opposite direction

b) Elasticity of demand is equal to unity (ed=1) or demand is unitary elastic.

When total expenditure remains the same with fall or rise in price, then ed derived = 1

In this case, the total expenditure does not change.

c) Elasticity of demand is less then unitary (ed < 1) or demand is inelastic.

When total expenditure decrease with fall in price and increase with rise in price.

The price and total expenditure move in same direction.

ARC ELASTICITY METHOD:

• When Price elasticity is to be found between two prices or two points on demand curve then
generally mid point method is used i.e. averages of two prices and quantities are taken (i.e
original and new) base.
• The Arc Elasticity can be found using formula:
𝑞1−𝑞2 𝑝1+𝑝2
• ep = 𝑞1+𝑞2 𝑥 𝑝1−𝑝2

Factors affecting elasticity of demand

a) Nature of commodity
A) Necessity of goods: they are less than unitary elastic or inelastic demand eg: salt,
kerosene ec.
B) Luxuries: they are greater than unitary elastic demand eg: AC, costly furniture etc.
C) Comforts: They are neither very elastic nor very inelastic demand, eg. Cooler, furniture
etc.

b) Availability of substitutes
A) Goods which have closer substitutes: Here, the elasticity of demand is higher i.e. more
elastic as when price of a commodity rises, the consumer has options of drifting to its
substitutes eg. Tea and coffee.
B) Goods without close substitutes: These goods are less elastic in demand s the consumer
has no other option than that good eg. Cigarette, liquor.

c) Diverse/variety of uses
A) Goods with many uses: The commodities which can be put to a variety of uses have
elastic demand as if the price of such good ↑, the demand is restricted for important
purposes eg. electricity, if its price increases, it’s use may be restricted to important uses
such as lighting.
B) Goods with less use: Its demand is likely to be less elastic eg. Paper
d) Postponement of use
A) The consumption of good which can be postponed, the demand will be elastic, eg:
demand for residential houses is postponed when interest rates on loans are high.
B) When consumption cannot be postponed, then it has less elastic demand.
 e) Income level of the buyer:
A) Consumers with high level of income will not be bothered by a rise in price of
commodity. Thus ed is expected to be low, eg: demand for luxury cars by multi-
billionaires.
B) The demand of middle income consumer is more elastic, eg: demand for small cars by
middle class people in India.
f) Habit of consumer
If the consumer becomes accustomed/habitual for a commodity, then the demand will be
inelastic as he cannot reduce the demand even when the goods are highly taxed, eg:
cigarettes, liquor.
g) Proportion of expenses/proportion of Income spent on commodity
A) Goods on which consumer does not spend higher proportion of income, they will have
inelastic demand, eg: needle, matchbox/
B) Goods on which the consumer spends a larger proportion of their income, then the
elasticity is high, eg: clothes etc.
h) Price Level
Elasticity of demand will be high at higher level of price and lower at the lower level of price.
i) Time period
A) Long period: It is more elastic as consumer can change his consumption habits more
conveniently.
B) Short period: The demand is inelastic as the consumer cannot change the consumption
very easily.

Income Elasticity of dd

Ei = % Change in Quantity
% Change in Price
△𝑄 △𝑌
 𝑄 𝑥 𝑌

△𝑄 𝑌
= △𝑌 𝑥 𝑄

CROSS ELASTICITY OF DEMAND

➔ Cross dd refers to quantity of commodity or service which will be purchased with reference to
change in price, not of that particular commodity but of other inter-related commodities, other
things remaining the sme.
➔ Change in dd for one good in response to change in price of another good represents cross
elasticity of dd

△𝑞𝑥 𝑝𝑦
ec = △𝑝𝑦 𝑥 𝑞𝑥
eg, Price of tea = Rs.30/kg
At this price 5Kg of tea is dd. If price of coffee rises from Rs.25 to Rs.35/kg, the quantity dd of tea
rises from 5 kg to 8kg. Find cross price elasticity of tea.

△𝑞𝑥 𝑝𝑦
Cross elasticity = = 𝑥
△𝑝𝑦 𝑞𝑥

8−5 25
35−25
𝑥 5

3 25
10
𝑥 5

= +1.5

Advertisement elasticity
Advertisement elasticity of sales/promotional elasticity of demand.
➔ Responsiveness of goods dd to changes in firms spending on advertising
➔ It measures the effectiveness of an advertisement campaign in bringing about new sales
➔ Increase in advertisement value, therefore greater will be responsiveness of demand

ea = % change in dd
% change in spending on advertisement

△𝑞𝑑 △𝐴
ea = 𝑥
𝑞𝑑 𝐴

△𝑞𝑑 𝐴
= 𝑥
△𝐴 𝑞𝑑

Demand Forecasting
Meaning
➔ Forecasting of dd is art and science of predicting probable dd for product/service at
some future date on basis of certain past behaviour patterns.
➔ it is estimated scientifically on basis of certain facts.

Usefulness
➔ helps in planning & decision-making
➔ its importance has increased due to mass production and production in response to
demand
➔ good forecast enables firms to perform efficient business planning
➔ provides information for formulation of suitable pricing and advertisement strategies.

Types of Forecasts:
1. Macro Level Forecasting – It deals with general economic environment prevailing in the
economy as measured by Index of Industrial Production.
2. Industry Level Forecasting – It is concerned with the demand for a particular industry’s
product as a whole, say the demand for cement in India.
3. Firm Level Forecasting –It refers to forecasting the demand of particular firm’s product, e.g.
Demand for ACC Cement.

Based on Time Period:

1. Short Term Demand Forecasting covers a short span of time, depending of the nature of
industry. It is done usually for six months or less than one year.

2. Long Term Forecasts are for longer periods of time, say two to five years and more. It
provides information for major strategic decisions of the firm such as expansion of plant
capacity.

DEMAND DISTINCTIONS:

1. Producer’s Goods and Consumer’s Goods :

• Producer’s Goods are those which are used for the production of other goods –
either consumer goods or producer goods themselves. E.g. Machines, plants and
machine, etc.
• Consumer’s Goods are those which are used for final consumption. Eg.Readymade
clothes.

2. Demand for Durable Goods and Non-Durable Goods:

1. Non-Durable Goods are those which cannot be consumed more than once. Eg. Raw
Material, Fuel, etc.
2. Durable Goods do not quickly work out, can be consumed more than once and yield
utility T a period of time. E.g. Building, Plant and machinery, etc.

3. Derived demand and Autonomous demand:

• The demand for a commodity that arises because of the demand for some other
commodity called ‘parent product’ is called derived demand. For e.g. The demand
for cement is derived demand related building activity.
• If the demand for a product is independent of the demand for other goods, it is
called autonomous demand.

4. Demand for firm’s product and industry demand:

• The term industry demand is used to denote the total demand for the products of a
particular industry, e.g. total demand for steel in the country.
• The demand for firm’s product denotes the demand for the products of a particular
firm. Eg. Demand for steel produced by the Tata Iron and Steel Company.

5. Short Run and Long Run demand:

• This is distinguished on the basis of time.
 METHODS OF DEMAND FORECASTING

1. SURVEY OF BUYER’S INTENTIONS :

• In this it is to be asked from the consumers what they are planning to buy during the year by
following methods :
(a) Complete enumeration method.
(b) Sample Survey method.
(c) End-Use Method.
• In this method the burden of forecasting is on the customers.

2. Collective Opinion Method :

• It is known as sales force opinion method or grass root approach.
• Firms have wide network of sales personal who can use their knowledge, experience and skills
of the sales force to forecast future demand.
• It is a simple method giving first hand information.
• This is a technique which can be used for short run.

3. EXPERT OPINION METHOD:

• Professional market experts and consultants have specialised knowledge about the numerous
variables that affect demand.
• Information is elicited through them in the form of interviews and questionnaires.
• Experts are asked to provide forecasts and the reasons for forecast.

4. STATISTICAL METHOD :

(a) TREND PROJECTION METHOD :Also known as classical method, it is considered as a naïve
approach. Such data when arranged chronologically is known as time series.
(i) Graphical Method: Also known as Free hand Projection method. The direction of curve
shows the trend. Drawback is that the data shown may not be reliable.
(ii) Fitting Trend equation :Least Square Method :It is a mathematical procedure for fitting
a line to a set of observed data points in such a manner that the sum of the squared
differences between calculated and observed value is minimised.

(b) Regression Analysis : It is most popular method of forecasting demand.Under this method a
relationship is established between the quantity demanded and the independent variables
such as income,price of good,price of related goods,etc.The equation will be in form of
Y = a+bX.

5. CONTROLLED EXPERIMENTS : Under this method, future demand is estimated by conducting

market studies and experiments on consumer behaviour under actual, though controlled, market
conditions. This method is expensive as well as time consuming. Also it is risky as they may lead to
unfavourable reactions from dealers, consumers and competitors.

6. BAROMETRIC METHOD OF FORECASTING :

This method is based on past experience and try to project the past into the future. Such
projections is not effective where there are economic ups and downs. This information is then
used to forecast demand prospects of a product though not actual quantity demanded.Just as
meteorologists use the barometer to forecast weather the economists use economic indicators to
forecast trends in business activities.
Measurement of Price Elasticity of Demand (Two important
methods of measuring Price Elasticity of Demand)
1. Proportionate or Percentage Method: This is the most popular method of
measuring the price elasticity of demand. Under this method, Elasticity of
Demand is measured by the ratio of the proportionate (percentage) change in
quantity demanded to the proportionate change in the price of the
commodity.
2. Geometric Method: Geometric method measures
the price elasticity of demand at different points on
the demand curve. It is also called the 'Point Method
of measuring Elasticity of Demand'.
Demand Forecasting
Tool of business decision making and future planning
Meaning

 Demand forecasting means estimating the future demand for a product or

service based on past and present data, market trends, and other
influencing factors.
 It is a tool of economics analysis which estimates the potential demand for a
commodity in future which is based on some factual information and past
data.
 It avoids over production and under production.
Example:

 A smartphone company may forecast demand for the next year to decide how
many units to produce, how much raw material to purchase, and what
marketing strategy to adopt.
 Demand forecasting is a grocery store predicting its weekly tomato needs by
analyzing past sales, considering seasonal trends like summer picnics, and
anticipating events like local festivals to ensure enough stock without
excessive waste.
 Features:

 It is a systematic process of predicting demand.

•It uses historical sales data, consumer behavior, market
conditions, seasonal patterns, and economic indicators.
•It includes short-term forecasting (for operational decisions) and
long-term forecasting (for strategic planning).
•It can be qualitative (expert opinion, market surveys) or quantitative
(statistical models, time series, regression).
•It reduces business risks and uncertainties, ensure efficient
resource allocation, and support decision-making.
Objectives of Demand Forecasting
 Short-Term Objectives:
To ensure the effective working of the organisation, estimation
of sales for the past six months is done. Let us now go through
the following purpose of demand forecasting in the short run

 Formulation of Production Policy: Demand forecasting aims at meeting the demand by

ensuring uninterrupted production and supply of goods and services.
 Formulation of Price Policy: It helps in formulating an effective price mechanism to
deal with the market fluctuations and conditions like inflation.
 Maximum Utilization of Machines: It streamlines the production process and
operations such that there is the optimum utilisation of machines.
 Proper Control of Sales: Forecasting the regional sales of a particular product or service
provides a base for setting a sales target and evaluating the performance.
 Regular Supply of Material: Sales forecast determines the level of production, leading
to the estimation of raw material. Thus, a continuous supply of raw material and
inventory management can be done.
 Arrangement of Finance: To maintain short-term cash in the organisation it is essential
to forecast the sales as well as liquidity requirement accordingly.
 Regular Availability of Labor: Estimation of the production capacity provides for the
acquisition of suitable skilled and unskilled labour.
 Long-Term Objectives:
Demand forecasting is inevitable for the long-term
existence of an organization. Following objectives justify
the statement:
 Long-Term Finance Management: Forecasting sales for the long-
term contributes to long-term financial planning and acquisition of
funds at reasonable rates and suitable terms and conditions.
 Decisions Regarding Production Capacity: Demand forecast
determines the production level, which provides a base for decisions
related to the expansion of the production unit or size of the plant.
 Labour Requirement: Demand forecasting initiates the expansion
of business, thus leading to the estimation of required human
resource to accomplish business goals and objectives.
 Importance of Demand Forecasting

1) Production Planning:
Expansion of output of the firm should be abased on the estimates of likely
demand, otherwise there may be overproduction and consequent losses may
have to be faced.

2) Sales Forecasting:
Sales forecasting is based on the demand forecasting.
Promotional efforts of the firm should be based on the sales forcasting
Importance of Demand Forecasting

3) Control of Business:
For controlling the business, it is essential to have a well
conceived budgeting of costs and profits that is based on
the forecast of annual demand.

4) Inventory Control:
A satisfactory control of business inventories, raw
materials, intermediate goods, finished product, etc.
requires satisfactory estimates of the future requirements
which can be traced through demand forecasting.
Importance of Demand Forecasting

5) Economic Planning and Policy Making:

The government can determine its import and export
policies in view of the long-term demand forecasting for
various goods in the country.

6) Growth and Long- term Investment Programs:

Demand forecasting is necessary for determining the
growth rate of the firm and its long-term investment
programs and planning.
Factors Affecting Demand Forecasting
 Price of Goods: Demand estimation is highly dependant on the price of goods or services. The pricing
policy and fluctuation in the present price can give an idea of change in demand for that particular
commodity.
 Type of Goods: The kind of commodity, its features and usability determines the customer base it is
going to cater. The demand for existing goods can be easily estimated by following the previous sales
trend, competitors’ analysis and substitutes available. Whereas, the demand for a new product on the
market is difficult to predict.
 Competition: The level of competition in the market supports the process of demand forecasting. It is
easy to predict sales in a less competitive market, whereas the same becomes difficult in a market
where the new firms can freely enter.
 Technology: The demand for any product or service changes drastically with the advancement in
technology. Therefore, it is essential for an organisation to be aware of technological development while
forecasting the demand for any commodity.
 Economic Perspective: Being updated with economic changes and growth is necessary for demand
forecasting. It assists the organisation in preparing for future possibilities and analysing the impact of
economic development on sales.
Supply

Supply is the quantity of a good or service that a seller or producer is willing and
able to offer for sale at a given price and time.
Key Aspects of Supply
 Quantity Supplied: The amount of a good or service that a seller is willing
and able to sell.
 Price: The specific amount at which the seller offers the commodity for sale.
 Time: The period during which the seller is willing to offer the commodity for
sale.
Factors Affecting Supply

 Cost of Production:
Changes in the cost of raw materials, labor, or energy can affect a company's willingness and
ability to produce, influencing supply.
 Technology:
Advancements in technology can increase production efficiency, lower costs, and lead to an
increase in supply.
 Government Policies:
Taxes, subsidies, and other regulations can influence a producer's profitability and impact
the quantity supplied.
 Number of Suppliers:
More producers entering a market will increase the overall supply of a good or service.
 Expectations:
Producers' expectations about future prices can influence their current supply decisions.
Law of supply

The law of supply describes the relationship between price and amount
supplied when all other variables remain constant (ceteris paribus).

 The law of supply states that other things remaining constant (ceteris
paribus), the quantity of a commodity supplied increases when its price
rises, and decreases when its price falls.
 👉 In short: Price ↑ → Supply ↑ (direct relationship)
Price ↓ → Supply ↓

This happens because producers are willing to sell more at

higher prices to earn greater profits.
 The Supply Schedule
:This is a table that shows the relationship between price and quantity supplied.
Price per Widget ($) Quantity Supplied (widgets per week)

2 10

4 30

6 50

8 70

10 90
 Supply Curve:
This is a graphical representation of the supply schedule. It is typically upward-
sloping from left to right, illustrating the direct relationship between price and
quantitysupplied .

In this diagram, you can see that

as the price (P) rises, the
quantity supplied (Qs) also rises,
forming an upward-sloping
curve.
Assumptions

For the law to hold true, some conditions must remain unchanged (ceteris
paribus):
 No change in cost of production – input prices (wages, raw materials) remain
constant.
 No change in technology – methods of production stay the same.
 No change in government policy – taxes, subsidies, or regulations remain
unchanged.
 No change in prices of related goods – producers are not influenced by
substitutes or complementary goods.
 No change in expectations of future prices – sellers are not holding back
goods for future higher prices.
 Normal economic conditions – no strikes, natural calamities, or emergencies.
Examples of Law of supply

1.Industrial Example
 A smartphone company notices that the price of its model has increased from
₹15,000 to ₹20,000.
 To take advantage, the company increases production and supplies more units
in the market.
 If prices drop, the firm may cut production or move resources to more
profitable products.
2. Service Example
 A tutor charges ₹500 per hour. If demand increases and students are willing to
pay ₹800 per hour, the tutor will increase available teaching hours.
 If the price drops to ₹300, the tutor may reduce supply of classes.
Supply function:

 The expression for the supply function is:

SX = f(PX, CX, TX)
Where:
 SX represents the quantity supplied.
 PX represents the price of the commodity.
 CX represents the cost of production.
 TX represents the technology of production.
Determinants of Supply
 Cost of the factors of production
 This includes expenses related to labor, raw materials, machinery, land, and other inputs required for production.
 A rise in the cost of production decreases supply because it makes producing goods more expensive for firms. Conversely, a decrease in
production costs increases supply.
 For example, if the price of oil increases, it raises transportation costs, impacting the cost of production for many industries, leading to a
decrease in supply.
 Change in technology
 Technological developments can result in higher production process efficiency, therefore lowering costs and raising supply availability.
 New technologies might let companies generate more output with the same level of inputs, hence boosting supply.
 On the other hand, old technology might lead to lower supply and more manufacturing expenses.
 For example, the implementation of automated technology in manufacturing operations can produce lower prices and higher rates of
output, therefore generating more supplies.
 Price of related goods
 Complementary products are eaten together; substitute goods are those that can be used in place of one another.
 Rising the cost of substitute items could force manufacturers to redirect resources into the manufacturing of the present good, therefore
increasing its availability.
 On the other hand, a drop in the price of complementing products could cut supply if companies expect less demand for their offering.
 For instance, buyers might choose tea instead of coffee if its price rises, which would force coffee growers to boost their output.
 Change in the number of companies in the industry
 Firm entrance or departure within an industry can influence supply and market competitiveness.
 A rise in the number of companies could intensify competitiveness, which would result in more supplies as companies
try to take market share.
 On the other hand, the departure of companies might lower supply, especially if the surviving companies cannot
satisfy the market need.
 If new companies join the smartphone market, for example, the more competitiveness can result in more supplies as
companies try to draw consumers with fresh ideas.
 Taxes and Subsidies
 Taxes increase production costs, reducing supply, while subsidies lower costs, increasing supply.
 For example, an increase in corporate taxes may lead to higher production costs for businesses, resulting in a decrease
in supply. Conversely, government subsidies for renewable energy may lower production costs for solar panels,
increasing their supply.
 The goal of a business firm
 Companies want to maximize earnings by creating items and services with best returns.
 Changes in government policy or state of the market could affect companies' profit incentives and, hence, their supply
choices.
 For a commodity whose demand rises, for instance, companies might boost supply to profitably take advantage of
better prices.