Unit II- Concepts of Demand and Demand forecasting

17

Topics
1. Fundamentals of Demand and Law of
Demand
2. Elasticity of Demand
3. Demand Estimation and forecasting

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Fundamentals of Demand and Law of Demand

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 Meaning and Definition of Demand
19

 Demand is the core of all the major decisions of a

firm i.e. planning production, inventory control and
management, distribution and channels, manpower
planning, planning of finance etc.
 According to Yogesh Maheshwari “Demand may be
defined as the quantity of goods or services
desired by an individual, backed by the ability and
willingness to pay.”

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 Law of Demand
20

 Law of demand explains the relationship between

price and quantity demanded of a commodity. It
states that when the price of a commodity
decreases demand for the same increases and when
the price increases, demand decreases. We call it
an inverse relationship.
P  Qd 
P  Qd 
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 Basic assumptions of the Law of Demand
21

 Size of population, income, tastes and preferences

remain constant
 Price of substitutes and compliments remain
constant.
 There is no hope of change in the price of
commodity in recent future.
 Prestige commodities are not considered

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 Demand schedule
22

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23

 The tabular representation of Law of Demand is

called Demand Schedule. Both individual demand
and market demand can be expressed in tabular
form.

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 Demand curve
24
6
Y
D
5
Demand Curve
Price of oranges

1 D

0
1 3 5 7 9 X
Quantity Demanded
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25

 Demand curve is the graphical representation of

law of demand. It is a downward sloping curve
from left to right.

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 Why demand curve slopes
26
downwards?
Law of diminishing marginal utility.

Income effect

Substitution effect

Different uses of a commodity

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 Exceptions to the law of demand
27

Inferior or Giffen Goods

Prestige goods.
Demand for necessaries
Emergency
Speculation effect
Fear of shortage
Ignorance
Out of fashion goods
Festival, marriages other special events.
Brand loyalty
cosmetics.
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 Determinants of demand
28

A. Individual Demand
1. Price of the commodity
2. Nature of the commodity. Necessity, luxury or
prestigious.
3. Income and wealth of consumers
4. Tastes and preferences of consumers
5. Price of related goods.
1. Substitute goods
2. Complementary goods
6. Consumers expectations
7. advertisement
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29

B. Market Demand
1. Price of Product
2. Changes in population
3. Distribution of income and wealth
4. Change in the quantity of money in circulation
5. Change in climate
6. Technological progress
7. Govt. policy
8. Business cycle
9. Demonstration effect or contact effect
10. Availability of credit

11. Social customs and ceremonies.

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 Demand function
30

 A function expresses relationship between two

variables i.e. dependent and independent.
 Demand function means the algebraic expression of
the relationship between price and demand of a
product.
D=f(P, Y, T, Ps, U)

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 Extension and contraction of demand
31

a) If the other factors of demand remain

constant, change in demand due to a change in
price only may be either extension or contraction
of demand. When demand raises due to a fall in
price, it is called extension and when demand falls
due to a rise in price, it is called contraction of
demand.

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32

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 Shifts in demand
33

 As we have already stated, demand for a product

depends upon various factors. Shifts in demand
refers the change in demand due to change in
factors other than price. It may be an upward shift
or a downward shift. Upward shift indicates
increase and downward shift for decrease in
demand. It can be diagrammatically expressed as
under.

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34

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Elasticity of Demand

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 Elasticity of demand
36

 Elasticity refers to the degree of responsiveness of

demand to change in a factor. It is based on the
law of demand. The concept was first introduced by
Marshall to measure the change in demand.
Following are the types of elasticity.

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 Types of elasticity
37

Elasticity

• Price elasticity: change in demand due to a change in

price
• Income elasticity: change in demand due to change in
income of the consumer
• Zero elasticity
• Negative elasticity
• Positive elasticity
• Cross elasticity: change in demand due to a change in
price of substitutes or complements.

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 Types of price elasticity(degree of
38
price elasticity)
 1.Perfectly elastic demand: Here, a small change in
price leads to a substantial change in quantity
demanded. It is an extreme situation of hyper
sensitivity. The demand curve in this case is a
horizontal straight line. Elasticity in this case is
denoted by e 

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




39

 2.Perfectly inelastic demand: It is a case of zero

sensitivity. Demand for the product remains constant
at any change in price. Demand curve in this case is
a vertical straight line as
e 0
shown below. Elasticity is
denoted by e  0

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40

 3.Unitary elastic demand: In this case, change in

price causes for an equal change in quantity
demanded. i.e. % of change in price will be equal
to the % of change in demand. The demand curve
takes the shape of a rectangular hyperbola in this
case. Here e=1

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41

4. Relatively elastic demand: It is also called highly

elastic demand. Here, a proportionate change in
price causes for a more than proportionate change
in demand. Demand curve in this case is a flat line.
Elasticity is denoted by e= >1

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42

5. Relatively inelastic demand: Here, the case is just

opposite to elastic demand. Change in quantity
demanded is less than the percentage of change in
price. Demand curve takes the shape of a steep line
in this case. Inelastic demand is denoted by e=<1.

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 Measurement of elasticity of demand
43

1. Proportional or percentage method or formula

method: In this method, the percentage change in
demand and price is compared to find out the
elasticity.
Proportionate change in
ED= Quantity Demanded
Proportionate change in price

ED  Change in demand Change in price


Original quantity of demand Original Price
ED  Q  P OR Q  P OR Q  P
Q P Q P P Q

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 example. A particular product is sold at Rs.20. The
demand for the same is 10Kg. Price falls to 15 and
demand increases to 12Kg. Find out the elasticity.
Q P
ED  
P Q
Q  2
P  5
P  20
Q  10
2 20
ED  
5 10

40  4 OR
ED  
50 5
ED  0.8
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 2. Expenditure or outlay method: Using this
method, elasticity is calculated by measuring the
changes in total expenditure as a result of
changes in price and quantity demanded. It is
clear from the following example.

Price of Pen Quantity Expenditure Elasticity of

Demanded demand

5.00 30 150
Case 1 E>1
4.75 40 190
4.00 75 300
Case 2 E=1
3.75 80 300
3.50 84 294
Case 3 E<1
3.25 87 286

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46

The above table can be explained with the help of a diagram as follows

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47

 The method is summerized as follows

1. There is elastic demand if total expenditure moves in
the opposite direction of change in price. i.e. when
price decreases expenditure increases and when
price increases expenditure decreases.
2. There is unitary elastic demand when there is no
change in expenditure to a change in price.
3. Demand in inelastic when both price and expenditure
move in the same direction.

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 3. Geometric or Point method: We use a demand
curve to measure the elasticity of demand at any
point on a straight line demand curve.
ED  lower section of thedemand curve
Uppersection of thedemand curve
PM 5
ED   1
PN 5
AN
7.5
ED( A)  
 3 1
AM 2.5
MN 10
ED(M )   
M 0
BN 2.5
ED(B)    0.33  1
BM 7.5
N 0
ED(N )   0
NM 10
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  If the curve is not a straight line as in the previous
example, elasticity is measured with the help of a
tangent. A tangent is drawn at the point where we
want to measure the elasticity and use the following
formula.
Lower section of the tangent
ED 
Uppersection of the tangent
To determine the elasticity at
point T of demand curve DD the
tangent PM is drawn. The
tangent P’M’ is drawn to find
out the elasticity of T’
This method is applicable only when there is very small
change in price and demand
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 4. Arc method: This method is used when the change
in demand and price is very large. Elasticity in
such case can’t be measured at a point on a
demand curve. Elasticity between two points are
measured here. The formula used is
ED  Q  P1  P2 


Q1  Q2 


P
Q Change in quantity
P Change in price
Q1  Original quantity
Q2 New quantity
P1  Original price
P2  New price
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51 MANAGERIAL ECONOMICS FOR UG-LECTURES BY AP SHAREEF 06-Jul-19
 Factors affecting Elasticity of Demand
52

 Nature of commodity: comforts, luxuries, necessaries

 Availability of substitutes
 Income of consumers
 Proportion of income spent.
 Habit of consumers
 Number of uses of the commodity
 Postponement of the use of commodity
 Demand of complementary product
 Durability of a commodity
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 Practical importance of elasticity
53

 Price determination
 Helpful in price discrimination
 Demand forecasting
 Helpful to the government in taxation policy

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Demand estimation and forecasting

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 Demand Forecasting
55

 Demand forecasting is the process of ascertaining

the expected level of demand during the period
under consideration with a view to minimize the risks
associated with the future by making reasonable
assumptions about the course that the future is likely
to take.
 Business organizations always try to use the most
accurate forecasting technique among many
available techniques. An overview of forecasting
techniques is done below.
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 Forecasting
techniques

Qualitative Quantitative
Techniques Techniques
Expert Trend Econometric
Barometric
Survey Projection Techniques
opinion Method Techniques
Method Methods

Complete Regression Simultaneous

Enumeration Method Equations Method
Survey

Sample
Survey

Sales Force
Opinion
Survey

End use
Survey
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  Qualitative techniques depend upon information about
the likes and dislikes of the consumers, but the latter
methods uses quantitative data from the past and
extrapolate it to project future demand
I. Expert Opinion Method/Delphi method: There are
experts in every field, and they are the bank of
information and embodiment of enriched experience.
Future demand can be developed on the basis of
expert insights. Biased and vested interests is the most
important disadvantage of this method. Advantages
are
a) Simple to conduct.

b) Suitable where quantitative data is not available

c) Reliable.
d) inexpensive
57 MANAGERIAL ECONOMICS FOR UG-LECTURES BY AP SHAREEF 06- Jul-19
e) Time saving
 II. Survey method: Under survey method, we will approach
different people connected to the product under
consideration such as consumers, sales force etc. Each method
is discussed one by one.
1. Consumers complete enumeration method: In this
case, interviews and questionnaires are used to ask all
the consumers about the quantity of commodity they
would like to buy during a particular period.
Advantages Disadvantages
A. It is accurate as it surveys A. It is costly and time
all the consumers consuming
B. Simple to use B. Many practical difficulties
C. No personal bias are involved
D. It is based on collected C. Useful only for products
data with limited customers

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 2. Consumers Sample Survey: It is an extension of
complete survey. A sample of customers are
selected and their views are collected. A sample is
considered as a true representation of the
population.

Advantages Disadvantages
A. Suitable for short term A. Conclusions are made on the
projections basis of a few
B. Simple and cost effective B. Sample selection is very
C. Time saving difficult
D. Gives excellent results if used
properly

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 3. Sales force opinion survey: We are using our sales
force for data on demand. Sales force are the
people who come in contact with the customers.
They have real information on likes and dislikes of
people.
Advantages Disadvantages
A. Simplest form of demand A. Opinion of sales force may be
forecasting erroneous since the tastes and
B. Less costly preferences may change over time
B. There is a possibility of biased
opinions since demand projection
may affect their future sales
targets.

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 4. Consumer’s end use survey: This method is used in
case of intermediary goods which are used for
final consumption as well as for production of
some other finally consumable goods. For
example, Milk is an intermediary goods which is
used for final consumption as well as for
production of other final goods such as ice
cream, milk peda etc.
Dm  Dmc  Dme  I m  xi  Oi  x p  Op  xn  On
Dmc  Demand for final consumption milk
Dme  Export demand for milk
Im  Import demand for milk
xi  Per unit milk requirement of ice cream industry
Oi  Totaloutput of ice cream industry
xp  Per unit milk requirement of peda industry
Op  Totaloutput of Peda industry
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 Quantitative Techniques
62

1. Trend projection method: We can project future

trend of demand by analyzing the past data.
Here, we assume the past behavior will continue in
future also. There are two ways to project future
trend
1. Graphical method
2. Algebraic method

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  In graphical method, we plot the trend in a graph
as shown below. The past trend line will be
extended into future.

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  Algebraic method: This method is also known as
least square method. The demand and time data
are fitted into a mathematical equation. If there is a
constant change in demand depending on a change
in time, then there is a linear relationship between
both. This is algebraically expressed as follows.
Y=a+bX, a and b are constants. Two normal
equations are to be solved for finding the value of
a and b.
∑Y=na+b∑X
∑XY=a ∑X+b ∑X2

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 Following data is taken from the sales particulars of a watch
company for the past five years.
Year 2010 2011 2012 2013 2014

Sales in thousands 12 13 15 14 16

Estimate the demand for watches in the year 2019. If the

present trend will persist.
Year X Y X2 Y2 XY

2010 1 12 1 144 12

2011 2 13 4 169 26

2012 3 15 9 225 45

2013 4 14 16 196 56

2014 5 16 25 256 80

Total 15 70 55 990 219

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66

2. Barometric techniques: Some economic variables

change consistently over time. Others depend
upon those variables. Here , we can say some
leading indicators or barometers. The time series
of first variables is called the leading series and
the following series is called the lagging series.
This lead lag relationship could be used for
predicting future demand for a particular product.
This technique is called barometric techniques.

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 c) Econometric techniques: These methods combine
economic theory and mathematical or statistical
tools and systematically analyze economic
relations to forecast demand.
a) Regression method
b) Simultaneous equation method
a) Regression method: According to this method, we
are using regression equations to estimate the
relationship between demand and other
independent variables. The relevant equation is
Dx  a  bPx  cI  dA  ePy
Dx  Demand for X
Px  Price of X
I  Consumers income
A  Advertisement outlay
Py  Price of substitute
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  Advantages
 Method is based on causal relationship
 It forecasts and explains the economic phenomenon

 Disadvantages
 It uses complex calculations
 Costly and time consuming

b) Simultaneous equation method: This method is useful

when the relationship between demand and other
variables is complex. It is a complex statistical process
that uses multiple simultaneous equations

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