UNIT - I

INTRODUCTION TO MANAGERIAL
ECONOMICS AND DEMAND ANALYSIS
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Objectives:
The main objectives of this lesson are

 To understand the concept and nature of managerial economics

 To discuss the concept of Demand and Elasticity of Demand
 To impart knowledge about Managerial Economics and relation with other subjects
 To get knowledge of estimating the Demand for a product and the relationship between
price and demand

Structure of the unit:

1.1 Introduction to Economics

1.2 Introduction to Management
1.3 Introduction to Managerial Economics
1.4 Nature of Managerial Economics
1.5 Chief Characteristics of Managerial Economics
1.6 Scope of Managerial Economics
1.7 Decision Making in Managerial Economics
1.8 Importance or Application of Managerial Economics
1.9 Relation with other subjects
1.10 Functions of Managerial Economist
1.11 Role of Managerial Economist
1.12 Responsibilities of Managerial Economist

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2. DEMAND ANALYSIS

2.1 Introduction
2.2Demand Function
2.3 Law of Demand
2.4 Types of Demand
2.5 Extension and Contraction of Demand & Increase of Demand and Decrease
in Demand
2.6 Elasticity of Demand
2.7 Types of Price Elastic of demand
2.8 Measurement of Price Elasticity of Demand
2.9 Factors Determining Price elasticity of Demand
2.10 Demand Forecasting
2.11 Types of Demand Forecasting
2.12 Importance of Demand Forecasting
2.13 Approaches to Forecasting
2.14 Demand Forecasting Methods
2.15 Requisites of a Good Forecasting Method

1.1 Introduction to Economics

Economics is the science related to the production, distribution and consumption of wealth or the
material welfare of mankind, political economy, economic questions, affairs or aspects. Various
economists defined economics in different ways. In general, economics can be defined as “a
social science which deals with human behavior, how he uses limited income to satisfy the
unlimited wants”.

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 The definitions of economics can be broadly classified into three different categories.

1. Economics as Science of Wealth:

Adam smith (the father of economics) defined economics as a science of wealth. According to
him “economics is concerned with an inquiry into the nature and causes of wealth of nations”.
He has given primary importance to wealth and secondary importance to mankind.

2. Economics as Science of Human Welfare:

According to Alfred Marshall “economics is on one side a study of wealth and on the other and
more important side a part of study of man”. He has given primary importance to making and
secondary importance to wealth

3. Economics as Science of Scarcity:

Here there are two important definitions to be considered.
1. According to Lionel Robbins, “Economics is a science which studies human behavior as
a relationship between unlimited wants, and scarce resources which have alternative
uses”.

2. According to J.M.Keynas, “Economics is the study of administration of scare resources

and how the level of income and employment will be determined in the country”.

Economics influences the technical decisions of any industry by using the techniques such as
demand analysis, elasticity of demand, demand forecasting, break-even analysis, production
function, capital budgeting etc.

Kinds of Economics:

1. Micro Economics

Micro Economics is also called “Theory of Firm”. Micro economics is that branch of economics
which is concerned with the analysis of the behavior of the individual units or variables such as
individual demand or the price of the product.

Micro economics basically deals with individual decision making and the problem of resource
allocation. It is concerned with applications such as Law of Demand, Price Theory etc.

2. Macro Economics:
Macro economics is that branch of economics which deals with the aggregate behavior of the
economy as a whole,which makes a study of the economic systems in general. E.g. National
income, Total saving, Total Consumption, Unemployment, Economic Growth rate.

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*Difference between Micro and Macro Economics
S.N Micro Macro
1. It is study of the behavior of the It is study of the behavior of the
individual firms or units economy as a whole.

2. It is individualistic. It is aggregate.

3. It is concerned with the behavior of It is concerned with the behavior of

the micro variable such as individual macro variables such as National
demand, supply etc., Income, National Output, Total
Savings.
4. Its scope is limited. Its scope is vast.

5. It deals with the data of individual It deals with the data of total industry.
firm.

1.2 Introduction to Management

Management is what managers do. It also refers to people at the top level in the organization,
concerned with decision-making. In the present context, managing has become one of the most
important areas of human activity because of increasing role of large and complex organizations
in the society. Because of their increasing role, the organizations have attracted the attention of
both practitioners and academicians to find out the solutions for business problems.

M
A --- The Manager
N
A
G --- Knowledge
E
M
E --- The People
N
T --- Technology/Techniques/Tactics

In the above, Man refers to the manager who leads the groups and organization and is
responsible for the performance of other activities. Here age does not means chronological age, it
refers to the knowledge to be possessed by a manager to operate the organization successfully.
Knowledge can be secured through experience, study and exposure.

The word men stands for the term people, i.e the team of subordinates working under the
supervision and control of the managers. They achieve the objectives with the assistance of
subordinates. T denotes technology, it means know how. Managers should also possess skills,
techniques and tactics to win the game and to achieve the objects.

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1.3 Introduction to Managerial Economics
Economics is concerned with the problem of allocation of scare resources among competing
wants. The economic principles, concepts, methods, tools and techniques that can be applied
practically to solve the problems of Business Management is known as managerial economics.

Economic ManagerialEconomics, Solutions to

Principles, Application of business
Concepts, Economics to solve the problems/
T ools and problems of business managers
T echniques management

Decision making problems of

Business Management

Therefore, Managerial Economics is a part of Economics and it is concerned with business

practice for the purpose of facilitating decision making.

Definitions:

“Managerial Economics is the use of economic modes of thought to analyze business situations”.
Mc Nair and Meriam.

“Managerial Economics is the economics applied in decision- making”.

Haynes, Mote and Paul

“Managerial Economics is the application of economic theory and methodology to business

administration practice” Brigham and Pappas

“Managerial Economics is a price theory in the service of business executives”

Watson.

“Managerial Economics is the integration of economic theory with business practice for the
purpose of facilitating decision making and forward planning by management”.
M. H. Spencer and Louis Siegelman

Based on the above definitions the common view regarding managerial economics is as follows
1. Managerial Economics is concerned with decision making of economics nature.
2. Managerial economics is goal oriented.
3. Managerial Economics facilitates forward planning.
4. Managerial economics provides link between traditional economics and decision science.
5. Managerial Economics directs the utilization of scarce resources in a goal oriented
manner.

1.4 Nature of Managerial Economics:

Micro Economics in Nature

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 Normative Economics
Application Oriented
Take the help of Macro Economics
Evaluation of each alternative
Assumptions
Goal Oriented

Micro Economics in Nature:

Micro Economics studies about the individual firm. It studies how an individual firm can use
scarce resource to produce more output with minimum cost and maximum profit. Managerial
economics is mainly concerned with analysing and finding solutions to the problems of decision
making in a business firm.

Normative Economics:
A normative statement usually includes or implies the words ‘ought’ or ‘should’. They reflect
people’s moral attitudes and are expressions of what a team of people ought to do. Managerial
Economics tells a business firm to do certain things which will benefit them and not to do certain
things which leads to losses.

Application Oriented:
In managerial economics, we employ case study methods to conceptualize the problem, identify
the alternative and determine the best course of action. Managerial Economics tries to solve
some complicated business problems with the help of economics tools, techniques and
principles. Decision making skills can be improved by applying some principles and concepts of
economics. So managerial economics is application oriented.

Macro Economics in Nature:

Managerial Economics takes the help of Macro Economics. An organization affects and is
affected by many different factors of the environment in which it works. Most factors related to
this environment come under the subject matter of macro economics. In order to over come all
these problems an organization takes the help of macro economics.

Evaluation of each alternative:

Managerial economics gives an opportunity to evaluate each alternative depending on its cost
and profit. There is a scope that the managerial economist can decide on the best alternative to
maximize the profits for the firm.

Assumptions:
Managerial Economics is based on certain assumptions and the assumptions are not valid
universally. Therefore, if there is a change in assumption, the theory may not hold good.

Goal Oriented:
Managerial Economics is goal oriented and problem solving in nature. It uses the economic
theory and decision science for solving business oriented problems.

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1.5 Chief Characteristics of Managerial Economics:
Managerial Economics is the study of the allocation of the scarce resources available to a
firm among the activities of that unit to maximize profit.
The theory of managerial economics is based mainly on the theory of firm
Managerial economics is both conceptual and materialistic
Managerial economics is concerned with managerial decision making
Managerial economics takes the help of other sources to make optimum use of scarce
resources
Managerial economics is goal oriented in its approach
Managerial economics is micro-economics in character as it concentrated only on the
study of the firm and not on the working of the economy.

1.6 Scope of Managerial Economics:

The following topics come under the scope of managerial economics.
Objectives of the organization
Resource allocations
Demand analysis and Forecasting
Cost Analysis
Production Analysis
Marketing Strategies
Pricing Policies
Profit Management
Capital Management

Objectives of the organization:

Managerial Economics provides a sound frame work by facilitating a business firm to frame its
objectives both in the short run and long run i.e vision and mission of the organization.

Resource Allocation:
Managerial economics provides the methods effective resource allocation. It mainly aims at
achieving high output through low and proper allocation of resource. It is useful for getting
higher productivity
Marginal analysis is applied to the problem of determining the level of output, which
maximizes profit.

Demand analysis and Forecasting:

A business firm convert raw material into finished products and these products are sold in the
market, Hence the firm has to estimate and forecast the demand before starting production. A
forecast of future demand is essential. The firm will prepare production schedule on the basis of
demand forecast.

Production Analysis:
Production analysis refers to the physical terms of output,while cost analysis refers to monetary
terms. Production analysis deals with different production functions and their managerial uses.

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 Cost Analysis:
Every business firm wants to reduce cost. A study of economic costs and their estimates are
useful for management decisions. Estimation of cost is essential for decision making. An element
of cost uncertainty exists, as all the factors determining cost are not always known or
controllable. Cost control is essential for pricing policies.

Pricing Policies:
Pricing is an important area of managerial economics. Price is the basic thing for the revenue of a
firm, and the success of the price decisions taken by it. Different pricing methods and price
forecasting occupy an important place here.

Market Strategies:
Managerial Economics provides marketing strategies like Product, Price, Place and Promotion
strategies for better result in the organization. These strategies are called marketing mix or 4P’s.

Profit Management:
The primary aim of any firm is to maximize profits. Their exists an uncertainty in the estimation
of profits, because of differences in the costs and revenues, and the effects of its internal and
external factors. Therefore, profit management is the difficult area in managerial economics.
Profit theory guides in the measurement and management of profit, in calculating the pure return
on capital, besides future profit planning.

Capital management:
Capital Management implies planning of acquisition, disposition and control of capital.

1.7 Decision Making in Managerial Economics

The managers face number of problems in day to day managerial activities of the firm. He has to
find the solutions to these problems. Decision making is the process of choosing one best
alternative from a list of alternative. A manager has to weigh merits and demerits of each action.
He has to select the best alternative with the limited resources. The decisions made must take the
business firm in the right direction. These decisions are playing key role in the organization.
There are different types of decisions to be taken, among them the most important are
Product Decisions
Pricing Decisions
Quantity Decision and
Technological Decisions

Product Decisions:
These decision are related to the what products the firm will produce and offer for sale and
decision may be related to additions of a product or deleting the existing product. It also includes
the style or design, packing and size of the product.

Pricing Decisions:
These decisions are related to fixing a price for the products manufactured. If the price is very
high the firm may not be able to sell its products. Even if the price is low, the consumers think it

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is an inferior product. Application of pricing techniques helpful for the managers to attract the
customers.

Quantity Decisions:
These decisions are related to how much to be manufactured. The production depends normally
in anticipation of demand. It means it totally dependent on demand forecasting.

Technological Decisions:
It is concerned with the method to be adopted in manufacturing a product. One should see
whether a change in technology will benefit the business firm or not.

Hence, there may be more problems to be faced while planning for the future. It may relate to
production, pricing, capital and raw material. The resources are scarce but they have alternative
uses. Decision making is very important because it is related to uncertain. Managerial economics
understand these decision making problems and guides us in a purposeful direction.

1.8 Importance or Application of Managerial Economics

1. Managerial economics provides a number of tools and techniques to build models and
with the help of these models the managers can handle the real life situations.
2. Managerial economics provides most of the concepts that are needed for the analysis of
business problems.
3. it is helpful in making decisions such as (a) What should be the product mix? (b) Which
is the best production technique? (c) What should be the level of output and price for the
product?
(d). How to make investment decisions? The managerial economics helps us to
understand the economic behavior of individuals
4. The managerial economics helps us to explain the working of economic system.
5. Managerial economics helps to assess the performance of the economy.
6. Managerial economics provides a good knowledge about cause and effect of various
economic phenomena.
7. Managerial economics suggest how to improve the growth rates in developed
economies.

1.9 Relation with other subjects:

Managerial economics takes the help of economics tools, techniques, principles for the economic
analysis of business related problems. Managerial economics also take the help of other subjects
also. They are explained below.

Managerial Economics and Traditional Economics:

The relationship between managerial economics and traditional economics is very much like the
relation of engineering to physics and medicine to biology. Traditional economics provide
certain concepts, methods and principles which can be applied to solve the problems of business

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management. They both deal with the allocation of scarce resource in an maximum way. A
managerial economist must know about traditional economics in order to understand the
principles of managerial economics.

Managerial Economics and Operation Research:

Operation research is an activity carried out by functional specialist within the firm to help the
manager to do his job of solving decision making problems, while managerial economist is
purely an academic subject which seeks to understand and analyze decision making problems of
business. The tools of operation research like linear programming, transportation models and
queuing theory help managers to take right decision at right time.
Managerial economics and Statistics:
Statistics is widely used by managerial economics. Managerial economics aims at quantifying the past
economic activity to predict its future. Probability, correlation, interpolation are the concepts used by
managerial economics to solve certain problems. The concepts of statistics are very helps in decision
making.

Managerial economics and Accounting:

Managerial economics is closely related with accounting which is concerned with financial
operations of a business firm. Profitability position and financial position of the company will be
known through accounting information. Accounting information is one of the principle sources
of data used by managerial economist for his decision purpose.
Managerial economics and psychology:
Consumer psychology is the basis on which managerial economist acts upon. We always assume
that the behavior of the consumer is always rational, which is reality is not so. Psychology
contributes towards understanding the behavioral implications, attitudes and motivations of each
of the microeconomics variables such as consumer, supplier, investors, workers or an employee.

Managerial economics and Organizational behavior:

Organizational behavior facilitates a manager to study and develop the behavioral models of
the firm and group by integrating the managers’ behavior with that of the owner. It further
analyzes the economic rationality of the firm in a goal oriented way.

Managerial economics and Computer Science:

Development of technology improved the use of computers in business undertaking. Today
computers are used for maintaining data and accounts, demand and supply, inventory control etc.
Computerization of various business activities has limited their execution time and work load on
managerial personnel. Information sharing is very easy also.

Managerial Economics and Mathematics:

Mathematics provides us a set of tools which helps in the derivation and exposition of economic
analysis. Mathematics is closely linked to managerial economics. It tries to estimate and produce
the relevant economics factors for decision making and forward planning. The branches of
mathematics which are generally used by a managerial economist are geometry, Algebra and
calculus.

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1.10 Functions of Managerial Economist
The managerial economist has to gather economics data, analyse all crucial information about
the business environment. He may have to make a continuous assessment of the impact of
changing technology. In the Indian context a managerial economist is expected to perform the
following functions.
1. Macro-forecasting for demand and supply
2. Production planning at micro, macro levels.
3. Capacity planning and product-mix-determination.
4. Economic feasibility of new production process
5. Assistance in preparation of overall development plan
6. preparation of periodical economic reports
7. Keeping management information at various national and international developments on
economic matters
8. Preparing briefs, speeches, articles and papers for top management

1.11 Role
The managerial economist plays a very important role in an organization
The objective of a managerial economist plays a very important role in an organization
The managerial economist must try to maximize profits on their invested capital
Managerial economist must make an accurate forecast as possible, because forecast
depends on future which is uncertain.
he should advise the management on domestic and global economic issues
The managerial economist has to maintain contact with data sources. He has to obtain
statistical data on national income, price level and tax policies
He should identify new business opportunities
He should build micro and macroeconomic models to solve specific problems

1.12 Responsibilities of Managerial Economist

Sales forecasting
Industrial market research
Economic analysis of competing companies
Pricing problems of industry
Capital projects
Production programmers
Security analysis and forecast
Advice on trade and public relations
Advice on primary commodities
Advice on foreign exchange
Economic analysis on agriculture.
Analysis of underdeveloped economies
Environmental forecasting

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 2. DEMAND ANALYSIS
2.1 Introduction:
Demand is the basis for the starting of any business, as the product decision and amount of
product to be produced would be decided only on the basis of the demand prevailing in the
market i.e. depending on the market survey and demand forecast. Demand only decides
indirectly the amount of factors of production to be employed in the organization i.e. money,
men, material, machinery and management required. Without proper demand analysis, if
production activity is undertaken the business firm may suffer huge losses.
.
Demand in ecnomics means effective demand, which can be defined as a desire backed by
willingness and ability to pay for a particular product. Thus for a demand to be effective three
factors are impoartnat

Demand for a product refers to

 Desire of an individual for a product
 Ability to pay for the product
 Willingness to pay for the product.

If there is ability and willingness but no desire then it is nor a demand. Similarly, without
willingness if there is desire and ability, then also it is not a demand.

Definitions of Demand:
“Demand means the various quantities of a good that would be purchased per time period at
different prices in a given market” ----Hibdon

“By demand, we mean the quantity of a commodity that will be purchased at a particular price
and not merely the desire for a thing” ----Hausen

2.2 Demand Function:

The demand function for a commodity describes the relationship between quantities of the
commodity which consumers demand during a specific period and the factors which influence its
demand. Mathematically, demand function can be expressed as follows

Dx = F ( Y , PX , PS , Pc , T , E p , N , D, u , a)
Where
D = Quantity demanded for the product x
F = Function of
Y = Consumer’s income
Px = Price of good x
Ps = Price of substitute of x
Pc = Price of complements of x
T = Measure of consumer tastes and preferences
Ep = Consumer’s expectations above future prices.
N = No of customers
D = Distribution of consumers

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u = Other determinants of the demand for x
a = advertisement

Factors Influencing the Demand for A Product

1. Price of the Product

2. Income of the Consumers
3. Tastes, Habits and Preference of the Consumer
4. Relative price of Substitute Goods and Complement Goods
5. Consumer Expectation
6. Population
7. Climate and Weather
8. Advertisement effect

1. Price of the Product:

The most important factor affecting the amount demanded is the price of the product. The
amount of product demanded at a particular price is called as price demand. Normally a large
quantity is demanded at a lower price but not at a higher price. Not only the existing price but
also the expected changes in price will also affect demand.

2. Income of the Consumer:

When consumer’s income increases the demand will increase significantly. On the other hand if
the income of the consumer decreases the demand will also decrease. The is called income
demand.

3. Tastes, Habits and Preferences of the Consumer:

Demand for many goods depends upon the tastes, habits and preference of the consumer.
E.g.: Demand for several goods like ice-cream, chocolates, beverages depends on the taste of the
individual.

4. Relative Price of Substitute Goods and Complement Goods:

The demand for a product is also affected by the changes in price of the related products. Related
goods can be of two types
1. Substitutes which can replace each other in use
E.g.: Tea, Coffee and bournvita are substitutes.
2. Complementary goods are those which are jointly demanded
E.g.: Tea, Sugar and milk are complementary goods.

5. Consumer Expectation:
A consumer expectation about the future changes in the price of a given product may also affect
its demand. When the consumer expects the prices to fall in the future he tends to buy less and
vice versa.

6. Population:

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Increase in population increases demand for necessaries of life. Decrease in population will also
affect the demand for different products.

7. Climate and Weather:

The cool climatic areas demanded woolen clothes. On a rainy day, ice-cream is not much
demanded. Like this based on climatic conditions the demand is there for a product.

8. Advertisement Effect:
In modern times the consumer preference can be changed by advertisement and sales. Demand
for may products like tooth-paste, soaps, washing powder etc., is partially caused by the
advertisement affect.
The attractive and wise advertisement will influence the demand for a product.

2.3 Law of Demand

The law of demand is an important theory in micro-economics. According to law of demand
there is an inverse relationship or a negative relationship between the price of a product and its
demand. The law may be stated as follows “when the price falls, demand extends, price rises
demand falls, other things, remaining constant”.

Explanation of law of Demand

Demand schedule
Price in Rs. Quantity Demanded
(units)
5 1000
4 2000
3 3000
2 4000
1 5000

Demand schedule is the table showing the prices per unit of the commodity and the
amount demanded per period of time.

In the above table or schedule when the price of the product is Rs.5, its demand is only
1000 units. But when the price has fallen to Rs.1, demand for the product has gone up to 5000
units. This shows that a fall in the price deals to extension of demand. Similarly when we take
Rs. 1 price, the demand for the product is 5000 units, when the price started rising up to Rs.5 the
demand for the product has fallen to 1000 units. This shows that a rise in price leads to
contraction of demand.

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This can be shown with the help of diagram, DD=Demand Curve
On X-axis the quantity of a product demanded is represented. On Y-axis the price of the product
is represented. DD represents the demand curve. It slopes downwards from left to right as price
increases, demand is decreasing. As price decreases demand curve moves away from the point of
origin.

Demand curve
If we show the demand schedule graphically, we get a demand curve. The demand curve shows
the maximum quantities per unit of time that consumers will take at various prices.

Assumptions of Law of Demand:

The assumptions underlying the Law of Demand are:

No change in Consumer Income
No change in Consumer Preference
No change in the Tastes and Fashions
No change in the Price Related Product
No change in the population
No change in the Govt. Policy
No change in Weather Conditions

No change in Consumer Income:

If the income of the consumer increases, in spite of increase in the price of the goods the
demand will increase. Similarly if the income decreases, in spite of decrease in the price the
demand will decrease.

No change in Consumer Preference:

If the consumer have a specific preference of the product or he likes the product or he likes
the product very much he purchases the product if it is costlier also.

No change in the Tastes and Fashions:

If fashion of the product is outdated, the demand will decrease even if it is offered at a lower
price

No change in the Price Related Product:

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 If the price of the related product decreases, demand tends to decrease for the other similar
products also.

No change in the population:

If the population goes on increasing the demand tends to increase even though the price
increases. On the other hand if the population decreases demand tends to decline even
though the price is low

No change in the Govt. Policy:

The change in the government policies and political situation will influence the demand for
the product.

No change in Weather Conditions:

In summer season the demand for fans, air coolers, air-condition is increasing considerably
irrespective of changes in the price.

No expectation of future price changes.

No change in the range of foods available to customers.

Hence all these assumptions are kept as constant.

Why demand curve slopes downwards:
The law of demand states that, other things remaining the same, an individual consumer will but
more units of a commodity at a lower price and less of that commodity at a higher price.
Generally, the demand curve slopes downwards from left to right. Some of the reasons for this
are
Income effect
A commodity is utilized more when it become cheaper
Substitution effect
Multiple use of product

Income effect:
The income of a consumer affects the demand of the product. If the income is fixed i.e. there is
no change in income, but there is a change in the prices of the products, then it will affect the
demand and the curve slope downwards.

A commodity is utilized more when it become cheaper:

If the price of the product falls, the existing buyers purchase more and some new consumers
enter the market

Substitution effect:
A fall in the price of a product, while the prices of its substitutes remain unchanged will make it
attractive to the buyers who will now purchase more and vice versa.

Multiple use of product:

Some products can be used for multiple purpose. A fall in the price of steel, iron etc., will
increase demand considerably.

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 Exceptions Or Limitation To the Law of Demand
1. Giffen Goods/ Inferior Goods
2. Veblen Goods
3. Consumer Expectation
4. Consumer Psychological Bias
5. Necessaries
6. Impulse Buying

Giffen Goods/ Inferior Goods:

Robert Giffen, British economist observed that when the price of the product is decreasing the
demand for the product is decreasing. These Products are called as inferior goods or Giffen
goods. Similarly, when the price of the product is increasing the demand is also increasing. Such
types of products are called superior goods.

According to the Law of Demand, when the price of a commodity falls the demand for it rises.
Giffen's Paradox is an exception to this law. It is named after the 19th century British economist,
Sir Robert Giffen, who found that when the price of bread fell, the demand for it also fell. This
was because when the price fell, the real income of the consumer rose and he was in a position to
buy better quality/more bread.

Veblen Goods or Prestige Goods:

American economist, Veblen explained that, there are certain goods which are purchased by the
consumer not because they really need those goods but they purchase goods because of status
symbol i.e., to maintains status in the society. Prestige goods are those which consumers will
purchase even though they are costlier.

Consumer Expectations:
Whenever the consumer expects a further fall in the price in future he will not purchase the
products or goods immediately, when price decreases, demand tends to decline. Similarly when
the consumer expects a further increase in the price for the future he will buy the products
immediately

Necessaries:
The demand almost remains constant irrespective of the price changes concerned to these goods
as people tend to adjust their consumption on other goods as they feel these are most necessary
products.

Impulse buying:
In Exhibitions and functions, the social habit, place or situations force people to purchase goods
at higher prices

2.4 Types of Demand

1. Price Demand and Income Demand
2. Cross Demand and Joint Demand
3. Demand for Consumer Goods and Producer Goods
4. Durable Goods and Perishable Goods Demand

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 5. Derived Demand and Autonomous Demand
6. Industry Demand and Company Demand
7. Short run Demand and Long run Demand
8. New demand and Replacement Demand
9. Total Market Demand and Segment Market Demand

Price Demand and Income Demand:

Price demand is that which explains the relationship between price and demand.the quantity
demanded changes with the change in price. There is an inverse relationship between price
and demand.
Incase of normal goods there is a direct positive relationship betweeen income and demand.
The quantity of commodities demand at different levels of income is called income demand.

Cross Demand and Joint Demand:

Cross demadn is that one which explain the relationship between price of one commodity and
the demand for another related commodity. If the price of one commodity increases the
demand for its substitutes increase.
The demand for one commodity may lead to demand for another commodity and that is
known as joiint demand. For example the demand for pen and ink is a joint demand.

Demand for consumer goods and producer goods:

When Goods are demanded by consumer for the direct satisfaction of their wants, they are called
demand for consumer goods.
E.g. Food items, readymade clothes etc.
When goods are demanded by producer for production of other goods including consumer goods,
they are called demand for producers’ goods.
E.g. Machines, tools, Equipment etc.

Durable goods and Perishable goods demand

Perishable goods are those which can’t consumed only once, while durable goods are those
goods which can be used more than once over a period of time.

Derived Demand and Autonomous Demand

When the demand for a product is tied with the purchase of some parent product. Its demand is
called derived demand.
E.g. Demand for cement depends upon demand for construction industry.

When goods are demanded independently for the direct satisfaction of the consumer wants, it is
called autonomous demand.
E.g. The demand for sugar is loosely tied up with the demand for drinks

Industry Demand and Company Demand

Industry is a group of firms producing or manufacturing the same or similar product. Company is
an individual business unit or business firm When goods are demanded which are produced or
manufactured by a particular company, that demand is called company’s demand.
E.g. Demand made for Maruti cars produced by Maruti Udyog Ltd.

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When goods are demanded which are produced or manufactured by a particular industry that
demand is called industry demand.
E.g. Total demand for cars produced by automobile industry.

Short run Demand and Long Run Demand

Short run demand refers to that demand which changes immediately due to reaction in price
changes and income fluctuation etc.
Long run demand refers to that demand which does not react immediately due to price change. It
will take some time for change in demand

New Demand and Replacement Demand :

New demand refers to the demand for the new products and it is the addition to the existing
stock. In replacement demand, the item is purchased to maintain the asset in good condition. The
demand for cars is new demand and the demand for spare parts is replacement demand

Total market Demand and Segment Market demand

Take the E.g of the consumption of sugar in a given region. The total demand for sugar in the
region is the total market demand. The demand for sugar from the sweet-making industry from
this region is the segment market demand.

Individual Demand Schedule and Market Demand Schedule

Consider the following table

Price Goods Demanded by individual Total
Rs. X in Y in Z in Demand
units units units in units
100 10 5 2 17
95 20 10 5 35
90 30 12 10 52
85 40 15 14 69
80 50 20 20 90

In the above table Mr. X is demanding 10 units at Rs. 100 and 50 units at Rs 80, this
demand is called individual demand. Individual demand refers to goods demanded by a single
individual. The table showing at different prices different units were demanded by Mr. X that is
called individual demand schedule.

Market demand refers to total demand made by all the individuals in the market. In the
above table total demand is 17 units at Rs. 100 and 90 units at Rs. 80. The table representing
different prices, different units were demanded by all the individuals that is called market
demand schedule

----
2.5 Extension and Contraction of Demand & Increase of Demand & and
Decrease in Demand:

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There is a difference between extension of demand and increase of demand. Extension of
demand may be happened doe to decline of the price level. For example, the price of one
commodity is Rs.5 and then there is a demand for 3 commodities. Suppose the price of the
commodity falls to Rs.3. As a result of this fall in price, the demand for commodity rises to 5.
This is called ‘extension of demand’. On the other hand, increase in demand may be happened
due to changes in factors other than price. Increase of demand may be happened doe to increase
of population, income or due to tastes and preferences of the consumers or due to substitution
effect etc.

Contraction and decrease of demand:

Contraction of demand may happen due to rise in price level. For example, when the price of
commodity is Rs.3, then there is a demand for 5 commodities. Suppose, the price of commodity
increase to Rs. 5, and then the demand for commodity reduces to 3 commodities. This is called
contraction of demand. On the other hand, a decrease in demand may happen due to factors other
than price. For examples, if the commodity goes out of fashion or the income of the consumer is
reduced and due to some other reasons, the demand for commodity may be decreased even
though the price remains the same. The extension and contraction of demand can be explained
with the help of following diagram.

In the diagram, at OP price level, OM commodities are demanded. For a higher price OP1 , the
amount demanded is reduced to OM1 . For lower price OP1 , the amount demanded goes up to
OM2 . These movements along the demand curve are called extension and contraction of demand.
The movement upwards to the left is contraction and the movement downward to the right is
extension of demand

Increase of demand and decrease of demand can be known with the help of following

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Increasing the demand can be shown by a shift of the entire demand to the left side as shown in
the first diagram. In this diagram the demand curve is shifted from DD to D1 D1 . In this even
though there is no change in price i.e. OP, the demand increases form OM to OM 1 .

A decrease in the demand can be shown by a shift of the entire demand to the left side as shown
in the diagram ‘B’. in this diagram the demand curve is shifted to left i.e. from D 1 D1 . in this
diagram, even though there is no change in price i.e. OP, the demand is decreased from OM to
OM1

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2.6 ELASTICITY OF DEMAND
Elasticity of Demand is the measure of the degree of change in the amount demanded of the
commodity in response to a given change in price of the commodity, price of some related goods
or change in consumer income.

There are four important kinds of elasticity of demand.

1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
4. advertising and promotional elasticity of demand

Price Elasticity of Demand:

Meaning:
Price elasticity of demand measures the responsiveness of demand to changes in price. The price
elasticity of demand for a commodity is the rate at which quantity bought changes as the price
changes. It is denoted by (Ep )

Pr oportionatechangein the quantity demanded

Ep  or
Pr oportionate changein price
Change inquantity demanded
Quantity demanded
Ep 
Change in Pr ice
Pr ice

(Q2  Q1 )
Q1
Ep 
( P2  P1 )
P1

Q
Q
 1
(P)
P1

Q P1
 
P Q1

Where
Q1 = Quantity demanded before price change
Q2 = Quantity demanded after price change
P1 = Price charged before price change
P2 = Price changed after price change

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Higher the elasticity of demand, greater will be the percentage change in quantity demanded
every percentage change in price.

Elastic Demand and Inelastic Demand

When a small change in price may bring about a big change in demand then it represents elastic
demand
What ever may be the changes in price if the demand remains more or less constant then it
represents inelastic demand.

2.7 Types of Price Elastic of demand

Types of Price Elastic of demand are generally classified into five categories.
Perfect Elastic demand
Perfect inelastic demand
Unit elasticity demand
Relative/Comparative Elasticity of demand
Relative/ Comparative Inelasticity of demand

Perfect Elasticity of Demand (E p=∞):

It is one in which a small change in price will cause a large change in amount demanded. A small
rise in price reduces the demand to zero. A small decrease in price leads to a big expansion in
demand.

In the above figure the quantity demanded increases from OQ to OQ 1 from OQ 1 to OQ 2 even
though there is no change in price. The price is fixed at OP.

Perfect Inelastic Demand (E p=0):

This is one which shows that whatever the change in price may be the amount demanded remains
same.

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 In the above figure it is shown that there is no change in the quantity demanded even
though the price is changing (increase or decrease).
Even though there is an increase in price from OP 0 to OP1 to OP2 there is no change in
demand.

Unit Elasticity of Demand (E p=1):

In this type of demand a given percentage change in price leads to exactly the same percentage
change in amount demanded. As there is no change in the demand and price it is called as unitary
demand.

The figure shows that the quantity demanded increases OQ to OQ 1 , as there is a decrease
in price from OP0 to OP1 . The amount of increase in the quantity demanded is equal to the
amount of fall in the price.

Relative Elastic Demand (E>1):

The demand is said to be relatively elastic when the change in demand is more than the
change in price. The figure shows that the quantity demanded increases from OQ to OQ 1 as there
is a decrease in price from OP 0 to OP1 . The amount of the increase in the quantity demanded is
greater than the amount of decrease in the price.

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Relative Inelastic Demand(E<1):
When the change in demand is less than the change in price, then the demand is said to be
inelastic.

In the figure the demand increases from OQ 0 to OQ 1 as there is a decrease in the price
from OP0 to OP1 . The amount of increase in the quantity demanded is lesser than the amount of
decreases in the price.

2.8 Measurement of Price Elasticity of Demand

There are four methods for the measurement of price elasticity of demand.
1. Percentage Method / Proportionate Change Method
2. Total Outlay Method
3. Point Method
4. Arc Method

1. Percentage Method/ Proportionate Change Method

In this method the proportionate change in Quantity of Demand is divided by the proportionate
change in price in order to know the elasticity of demand

Pr oportionatechangein the quantity demanded

Ep  or
Pr oportionate changein price

26
 Change inquantity demanded
Quantity demanded
Ep 
Change in Pr ice
Pr ice

(Q2  Q1 )
Q1
Ep 
( P2  P1 )
P1

Q
Q
 1
(P)
P1

Q P1
 
P Q1
Where
Q1 = Quantity demanded before price change
Q2 = Quantity demanded after price change
P1 = Price charged before price change
P2 = Price changed after price change

Higher the elasticity of demand, greater will be the percentage change in quantity demanded
every percentage change in price.

Total Outlay Method:

In this method elasticity is identifies on the basis of variation in the total outlay for a given
change in price. This can be through a schedule and diagram

In the above schedule when price decreases from Rs. 6 to 1 the Demand extends from 10 to 60.
But the total outlay does not change like that. In the first stage, when price decreased for Rs. 6 to
Rs.5 the Total outlay increased from Rs. 60 to Rs. 100. In the second stage when price decreased
from Rs. 4 to Rs. 3, the total outlay did not change. It remained constant. In the third stage, when
the priced decreased from Rs. 2 to Rs. 1, the total outlay decreased from Rs. 100 to Rs. 60.

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This is represented in the form of above diagram.

3. Point Method:
If the demand curve is a straight line sloping downwards from left to right then the elasticity at a
given point on that demand curve, can be given by dividing the lower segment by the upper
segment. This can be explained

If the LM is the demand curve and if we want elasticity of demand at point P on this demand
curve, it can be given by dividing the lower segment (PM) by the upper segment.

Lower Segment
Ep 
Upper Segment

PM
Ep 
PL
Here Ep = Elasticity at Point P
Lower Segment = PM
Upper Segment = PL

If we want elasticity at Q(eQ), it will be

QM
Ep 
QL
When P is the Mid-point of LM, the e=1. Point above that on the demand curve represent
whether elasticity (e>1) and points below that represent lower elasticity (e<1). At L, e=∞ and at
M, e=0. So elasticity of demand is different at different points on the same downward sloping
demand curve, if the demand curve is not a straight line, but a curve, then a tangent has to be
drawn at the point where elasticity is required. Then the lower segment of the tangent from that
point is to be divided by the upper segment to get elasticity.

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In the above figure we can get elasticity at point P in the Demand curve DD, we have to drawn a
target to DD at P. This tangent touches the x-axis at R and Y axis at T. its lower segment is Pr
and upper segment PT

PR Lower Segment
Ep  
PT Upper Segment

If we want to know elasticity at another point on the demand curve, then at that point another
tangent has to be drawn. By dividing the lower segment of that tangent by the upper segment, we
can get elasticity.

4.ARC ELASTICITY OF DEMAND / METHOD:

If we want, elasticity over a small range AB on the Demand curve DD, then the prices and
Quantities at A and B have to be identified.

Q1  Q P1  P
Arc elasticity of demand  
Q1  Q P1  P

In the above diagram P and P 1 are 5 and 4 respectively and Q and Q 1 are 100 and 110
respectively then Arc elasticity will be as given below

Q1  Q P1  P
Arc e  
Q1  Q P1  P

110  100 4  5
Arc e  
110  100 4  5

10  1
Arc e  
210 9

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 10 9
Arc e   
210 1

3
Arc e  
7
3
Arc e  ( NegtiveSymbol is avoided)
7
So Arce = 3/7(or e<1)

Factors Determine Price elasticity of Demand

The price of elasticity of demand depends on the following factors:
1. Nature of goods
2. Availability of substitutes
3. Income level
4. Variety of uses
5. Proportion of income spent on the commodity
6. Durability of a commodity
7. Time period
1. Nature of goods:
Goods may be classified into three groups. They are necessaries, comforts and luxuries. The
demand for necessaries like salt, clothes etc is inelastic where as demand for comforts and
luxuries like television vehicles etc is elastic

2. Availability of Substitutes:
A commodity having a number of substitutes has relatively elastic demand whereas a commodity
have less or without substitutes is relatively inelastic demand.
3. Income level:
High income group people are less affected by price changes than low income groups’ people.
Demand for high priced and quality goods in inelastic for high income groups whereas the same
is elastic for low income people
4. Proportion of income spent on the commodity
If the consumer spends less percentage on a commodity, then demand will be inelastic e.g. salt,
match box. On the other hand if consumer spends large proportion of his income on a
commodity, then the demand will be elastic
5. Durability
When a commodity is durable e.g. furniture, toothbrush etc, one is likely to use the commodity
for a longer period having high price, then higher is its elasticity of demand.
6. Time Period:
Demand of a commodity always has a reference to a specific period. Generally demand is
inelastic during short period and elastic during the long period.

2.9 Importance/ Significance of Price Elasticity of Demand

The concept of elasticity of demand is of much practical importance. Given the fact that the
actions of any enterprises are oriented towards improving its overall profitability. Here the

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concept of elasticity plays crucial role. It measures the proportionate change in sales and hence in
profit. Price elasticity of demand is highly useful in the following cases.
1. Price Fixation of a Product
2. Decision Regarding to Price Changes
3. Price discrimination
4. Taxation Policy

1. Price Fixation of a Product

The sale of any given product first of all depends upon its price. Hence the price fixed for any
product must suit the market conditions, more precisely, the consumers’ expectations and price
of competing brands. Before launching any product, the enterprise must analyze carefully the
price elasticity for it in order to match the expectations.

2. Decision Regarding to Price Changes

Price elasticity will be highly useful in effecting price changes. It is always desirable to decrease
the prices of those products, which have high price elasticity. The lowering of price leads to
more than proportionate change in sales and hence in profit. Similarly in case of the product that
show less elasticity the price increase will result in increase in overall profit

3. Price discrimination
Discrimination pricing implies charging different price for the same product in different markets.
This monopolist can do this decision depending upon the price elasticity of a given product in
different markets

4. Taxation Policy
Tax authorities study the price elasticity of each type of product before fixing its rate of tax, as
charging a higher rate of tax for a relatively elastic product lead to increase in price and
consequently reduce its sales and thus tax revenues

2.10 DEMAND FORECASTING

A forecasting is a prediction or estimation of future situation under given conditions. 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.
Demand forecasting means expectation about the future course of the market demand for
product. Demand forecasting is essentially reasonable judgment of future probabilities of the
future demand. It cannot be 100% precise.

Demand Estimation:
Demand estimation tries to find our expectation present sales level, given the present state of
demand determinants.

2.11 Types of Demand Forecasting:

Various types of demand forecasting are as follows
1. Passive forecasts

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 2. Active forecasts
3. micro forecasting
4. Short term Forecasting
5. Long term Forecasting
1. Passive Forecasting:
Here prediction about future is based on the assumption that the firm does not change the course
of its action.
2. Active Forecasting:
Forecasting is done assuming that, it will be changes in the actions by the firm.
3. Micro Forecasting:
When individual business firm forecast the demand for their products, it is known as micro level
forecasting.
4. Short term forecasting:
Short-term forecasting normally related to a period not more than a year. Short term forecasting
relate to the day-to-day information. In the short term forecasting a firm is primarily concerned
with the optimum utilization of its existing production capacity

5. Long term forecasting:

Long term forecasting refers to the forecasts prepared for long period during which the firm’s
scale of operations or the production capacity may be expanded or reduced.

2.12 Importance of Demand Forecasting:

For planning and Production analysis
Sales Forecasting
Control of Business
Inventory Control
Long term Investment Programs
Maintain Stability
Helpful for Planners and Policy Makers

For planning and Production analysis:

Demand forecasting is essential before starting any production activity. It is dependent on
accurate demand forecasting.

Sales Forecasting:
Sales forecasting is dependent on the demand forecasting. Advertisement pattern of the firm
should be based on sales forecasting.

Control of Business:
The business firm may have to prepare the budget of cost and revenue occurring in future. The
future accurate estimation of cost and revenues is based on the demand forecasting.

32
 Inventory Control:
The business form can have a better control on raw materials, semi- finished goods, finished
goods, spare parts etc., for future requirements of the firm with the help of demand forecasting.

Long term Investment Programs:

The growth rate and long term investment planning of the firm can be estimated with the help of
demand forecasting. For planning and Production analysis

Maintain Stability:
Production and employment growth rates can be stable through demand forecasting.

Helpful for Planners and Policy Makers:

Demand forecasting can be greatly used by planners and policy makers in making optimum
allocation of scare resources.

2.13 Approaches to Forecasting:

Identify and clearly state the objectives of forecasting. The objective may be short-term or
long-term
Select Appropriate method of forecasting
Identify the variables affecting the demand for the product and express them in appropriate
forms
Gather all relevant date o represent the variable.
It may be made either in terms of physical units or in terms of rupees of sales volume
It may be in terms of product group or individual products
It may be annual basis or moth wise or week wise on the basis of past records

33
34
 2.14 Demand Forecasting Methods
I. Intentions of Customer
1. Survey Method:
Under this method the consumers are contacted personally to disclose their future purchase
plans. This can be done by two ways
1. Census method
2. Sample Method
Census method:
Under this method all consumers are contacted to know their preferences for the products
in future. The interviews are conducted either orally or through questionnaire. With the help of
census method the probable demand of all consumers is summed up.
Sample method:
In this method a sample of consumers is selected for interview. The sample may be random
or stratified sampling. This method is easy, less costly and highly useful.
II. Collective Opinion Method:
Under this method the opinion of sales men are taken for demand forecasting. The sales
men can know the pulse of the consumer and they can give correct information about the likely
demand for the products.

III. Delphi Technique:

Opinions and views are taken from experts coming from different backgrounds. Under
this method experts are asked the likely demand for a particular product. The experts may give
different opinions on them. This process is repeated again and again unless a common view point
is emerged.

IV. Test Market:

This method is used for estimating demand of new products of estimating sales potential of
existing products in new geographical areas. In this method a test area is selected which truly
represent the market. The product is launched in this area exactly in the manner in which it is
intended to be launched in the market. If the product is found successful in the test area then the
sales are taken as a basis for estimating sales in the market as a whole.

2. Market Experimentation Method:

This method involves giving a sum of money to each consumer with which he is asked to shop
around in a simulated market. Consumer behavior is studied by varying prices, quantity, packing,
advertisement, colour etc.

3. Based on Fast Trends:

Fitting a Trend Linear of Trend Forecasting Method:

Under this method actual dales data is drawn on a chart and estimating by observation where
the trend line lies. That line can be extended further towards a future period and the
corresponding sales graph can be read from the graph.

35
 Least Square Method
This method uses statistical data to find the trend line which best fits the available data. The
following regression equation is used
S= a. T+b
Where
S= Sales
a, b = Past Data Calculation
T = The year for which forecast is required
Time Series Analysis:
This method attempts to build seasonal, trend, cyclical and irregular variation into the
estimating equation. A well established firm would have accumulated data. These data are
analyzed to determine the nature of existing trend. Then this trend is projected in to the future
and the results are used as the basis for forecast. This is called time series analysis
S=a+b+c+d
Where
a= Trend
b= Season
c= Cycle
d= irregular fluctuations
a, b, c, d= Constant calculated from past data.
Moving Average Method:
This method is based on past sales data and it is used for short term forecasting and it is based on
assumption that the future is the average of past performance
4. Economic Barometer:
This method forecasts the future based on the occurrence of present events, first we have to see
whether their exists a relationship between the demand for a commodity or product and certain
economic indicator. The above relationship can be established through the method of least
square. E.g. demand for tractors depends on the farmer’s income or agricultural income.
5. Statistical Method:
Naïve Method:
It is based on the past data of information available for example Historical Observation of sales
Regression Analysis:
This is a statistical technique by which the demand is forecasted with the help of certain
independent variables. There are two types of regression analysis
a. Simple
b. Multiple
Simple regression analysis is used when the quantity demanded is taken as a function of a single
independent variable. Multiple regression analysis is used to estimate demand as a function of
two or more independent variables that varies simultaneously.
6. Judgmental Approach:
If the management is unable to use any of the above method they have to make their own
judgment in forecasting the demand.
These are the demand forecasting techniques.
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2.15 Requisites of a Good Forecasting Methods:
Accuracy
Simple and Easy to Compute
Economy
Availability
Maintenance Should be Up to Date
Accuracy:
It is necessary to check the accuracy of past forecast against future performance and of present
forecast against past performance.
Simple and Easy to Compute:
Management must be able to understand and have confidence in the methods used for
forecasting.
Economy:
Costs must be weighted against the benefits of the forecast to the operation of the business.
Availability:
The methods employed should be able to produce meaning results quickly.

Maintenance Should be Up to Date :

The forecast should be capable of being maintained on an up-to-date basis

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