Module-2

Demand Estimation
In managerial economics we are concerned with demand for a commodity faced by the firm. Demand is
regarded as a life time of a business enterprise.
Demand analysis has the following important managerial purposes:
a) Forecasting sales
b) Manipulating Demand
c) Tracing the trend of the firms competitive position
d) Introduction of advertising policies
Demand- Meaning
Demand is a quantity of commodity which a customer is willing and able to buy or purchase at any
given price during some specific period of time and also a particular place.
Demand is the desire backed by ability and willingness for a commodity.
There are some essentials of Demand which are as follows:
1. Desire for a commodity
2. Capacity to pay for it
3. Willingness to pay for it
4. Quantity bought and sold
5. At a given price
6. At a given time, it may be a day, a week or a month
∴ Demand is an effective desire
Definition of demand
According to Banhour “The demand for anything, at a given price, is the amount of its which will be
bought per unit at that price”
Utility
The term utility refers to the want satisfying capacity of a commodity or a service utility of a commodity
depends on a consumer’s mental attitude and assessment regarding its power to satisfy his particular want.
To analyse the concept of utility, economics use imaginary measure, called ‘utils’. They express utility
in terms of number of ‘utils’ derived from the consumption of a good or service. However there is no scale
to measure utils. For convenience we express utils in money utils. Utility is different from satisfaction.
Definition of utility
According to prof. Wangh “Utility is the power of commodity to satisfy human wants”
Total Utility
It refers to the total satisfaction obtained from the conception of all possible unit of a commodity. It measures
the total satisfaction obtained from consumption of all units of that product. For eg: if the first ice cream gives
you a satisfaction of 20 utils and second one gives 16 utils , the total utility from 2 ice cream is 20+16=36
utils. If the 3rd ice cream generates satisfaction of 10 utils, then total utility from 3 ice cream will be
20+16+10=46
𝑇𝑈𝑛 = 𝑈1 + 𝑈2 + 𝑈3
TU= Total Utility
n = No. of utils
U= Utility
Marginal Utility
If the additional utility derived from the consumption of one more units of the given commodity. It is
the utility derived from the last unit of the commodity purchased. As per the given example when 3 rd ice
cream is consumed the total utility increases from 63 utils to 46 utils. The additional 10 utils from 3rd ice
cream is marginal utility.
Definition
In the words of Chapman “Marginal Utility is the addition made to total utility by consuming one
more unit of a commodity”.
MU= TUn-1
MU= Marginal utility
TU= Total utility
TUn-1=Total utility of (n-1) units
Law of diminishing marginal utility
Law of diminishing marginal utility is the fundamental Law of utility analysis. It explains the relation
between utility and quantity of commodity. It is a psychological fact that when a consumer gets more and
more units of a commodity, during a particular time the utility from the successive units will diminish.
Definition
According to Prof. Alfred Marshall the law states that “as the consumer consumers more and more units of a
commodity, the additional utility obtained from each additional units goes on decreasing.

The Law can be better explained with the help of following table and diagram
Unit consumed Marginal Utility (in utils) Total utility(in utils)
 0 0 0
1 20 20
2 18 38
3 15 53
4 11 64
5 6 70
6 0 70
7 -8 62

Law of demand
This law is also known as first law of purchase. It indicates the functional relationship between price
of a commodity and quantity demanded in the market. The law of demand states that other things being equal,
the demand for a commodity extends with a fall in price and contracts with rise in price. When price increases,
demand decreases. When price decreases demand will increase.
Definition
Prof. Marshall defines it as “The Law of Demand states that the amount demanded increase with a fall in
price and diminishes with a rise in price”
Assumptions of Law of demand
a) No change in the income of consumer
 b) No change in price of related goods
c) There should be no expectation of any change in the future price of the commodity
d) Consumer taste, preferences and choices remain constant
e) The commodity in question is not any prestigious value such as diamond etc.
f) No substitutes for the commodity in question are available.
Demand schedule
Demand schedule is a schedule which shows different quantities of a commodity, purchased at different
prices. It is a list of prices and quantities. It explains the functional relationship between price and demand of
a commodity. A hypothetical schedule is given below:

Price of apple Quantity demanded

60 1
50 2
40 3
30 4
20 5
10 6

Demand curve
Demand curve is a graphical representation of demand schedule. The demand curve depicts the relationship
between the price of the commodity and an estimate of the quantity demanded. The demand schedule is
represented below:

Demand curve
70
60
Price ofcommodity

50
40
30
20
10
0
0 1 2 3 4 5 6 7
Quantity demanded

Causes of the operation of Law of Demand/ Why does demand curve slopes downward?
i) Law of diminishing marginal utility: If a person consumes more units of a commodity he will
get less satisfaction from additional units. i.e., the utility from each additional unit goes on
 diminishing. The consumer will be ready to buy the additional unit only if it is available at a lower
price.
ii) Income effect: A change in price of a commodity affects consumer’s real income. When price
falls, Income of consumer increases. This will induce him to buy more of the commodity.
iii) Substitution effect: When the price of a commodity rises the consumer may substitute that
relatively costly commodity with a less costly one. Similarly if the price rises, to some extent may
substitute the costly commodity with a comparatively low priced commodity of a similar kind.
iv) Alternative uses of a commodity: Most of the commodities can be put to several uses due to
which the demand curve slopes downward from left to right. When price of such commodity is
high, its use will be restricted to that purpose which is considered to be most important by the
consumers. But if the price falls the commodity can be put to less important uses. Hence quantity
demanded increases with fall in price and vice-versa
v) Change in number of consumers: When price falls some more people will buy the commodity
as the price has become acceptable to them. Likewise when the price increases some existing
consumers will withdraw from buying the commodity.
Determinants of Demand/ Factors affecting demand
a) Price of the commodity: Basically, demand for a commodity depends on its price. If the price
increases demand falls and if price falls demand rises.
b) Income of the consumer: Income level determines the demand to a great extent. Normally there is
direct relationship between income and demand. In case of normal goods, if income rises demand
increases and if income falls demand decreases
c) Population: Demand for commodities depends up on the size of population. Increase in population
leads to more demand for all types of product and decrease in population leads to fall in demand.
Composition refers to the ratio of male female; Adults and children and the number of senior citizen
in the population.
d) Taste and preference: They include passion, habit, custom etc. Taste and preference of the
consumers are influenced by advertisement, climate and new invention etc. Demand for those goods
goes up for which consumers develop taste.
e) Climate and weather: Demand for commodities also depends on the climate of an area and weather.
In cold hilly areas woolen cloth have high demand.
f) Savings: If people save more, they will have less money to spend on goods, then demand decreases.
If people save less demand will increase
g) Advertisement effect: Advertisement has a major role in influencing demand. Expansion of demand
id often directly linked with the expenditure incurred on advertisement. Advertisement attracts new
customers to the product. In addition to encouraging more consumption by existing customers.
h) Demonstration effect: It refers to the change in demand for a product due to the change in
consumption habit of the consumers. According to Prof. Duesenberry, families may base their
spending not only on their own taste, but on the taste of neighbours too. In other words people will
imitate the consumption pattern of neighbours.
i) Price of related products: Related goods are substitute goods and complementary goods.
 The goods which can replace each other in use are substitute goods. Eg: tea and coffee, Rice
and wheat etc. When the price of a commodity increases then demand for its substitute commodity
goes up. Similarly the price reduction causes decline in the demand for its substitute.
Complementary goods are those goods which are jointly used. Eg: coffee and sugar, Bread
and butter, Car and Petrol etc. In case of complementary goods, increase in the price of one commodity
reduces the demand for other.

Exceptions of Law of Demand/ Limitation of Law of demand

Under certain circumstances, consumers buy more when the price of the commodity rises and less when price
falls. In such cases, the demand curve slopes upward.

a) Ignorance: Some consumers are of the notion that high priced goods are high quality goods. When
its price is lowered they think that the quality also had declined. So they may not buy when price falls.
b) Speculative effect: When the price of a commodity goes up people may buy larger quantity than
before if they anticipate or speculate a further rise in its price and vice versa. Thus the Law of demand
fails to operate, this is known as speculative effect.
c) Brand equity: If a consumer has strong brand preferences he will stick on to that even the price
increases.
d) The giffen paradox: A fall in price of inferior goods (Giffen goods) tends to reduce its demand and
a rise in its price tends to extend its demand. This phenomenon was firstly observed by Sir. Robert
Giffen, popularly known as Giffen paradox.
e) Fear of shortage: The people may buy more of a commodity even at higher prices when they fear of
a shortage of that commodity in near future. It may happen during thetime of war and inflation.
f) Prestigious goods/ Veblen effect: Prestige goods are bought for enhancing social prestige or for
displaying wealth. The higher the price, greater the prestige attached to the commodity. These types
of goods thus enjoy higher demand when price goes up. According to T. Veblen, these goods are not
purchased for their satisfaction. So he categorized these goods as ‘conspicuous consumption’ of
goods. It is also called Veblen effect or demonstration effect.
 g) Conspicuous necessities: Another exception occurs in use of such commodities as due to their
constant use, have become necessities for life. Eg: Refrigerator, Television etc. which are termed as
upper sector goods.

Changes in demand
Demand doesn’t remain fixed, however it changes. The change in demand can be of the following:
Movement in demand
a) Contraction and Extension of demand
Shift in demand
b) Increase or decrease in demand
Movement in demand.
Movements in demand are of two types:
a) Extension in demand
b) Contraction in demand
Extension in demand
Other things remaining the same, if with a fall in price, the amount of demand rises.
Price Demand

5(P1) 1(Q1)
1(P2) 5(Q2)
Contraction of demand
Other things remaining the same, if with a rise in price, the amount of quantity demand falls.
Price Demand

1(P1) 5(Q1)
5(P2) 1(Q2)

Shift in demand
An increase or decrease in demand due to any factors other than price is known as shift in demand. It
may be due to change in income, taste and preference, fashion, price of related goods, change in price in near
future.
Increase in demand
Rise in demand due to changes in factors other than price that means more is demanded at the same
price or some quantity demanded at a higher price. Demand curve shifts upward

Decrease in demand
 Fall in demand due to factors other than price. That means, less is demanded at the same quantity is
demanded at a lower price. The demand curve shift downwards.

Types of demand
According to the nature of products and markets the demand may classified in the following:
1) Demand for consumer goods and producers goods:
Consumer goods are the goods and services purchased for final consumption. Food items, clothes,
books are example of consumer goods. The demand for these goods are direct.
Producers goods are those goods that are used for the purpose of further production are also called
capital goods. Capital goods may be working capital goods or fixed capital goods. Working capital goods are
the goods which are used as raw materials for producing fixed capital goods. Eg. Machinery, Office furniture
etc.
Demand for producer’s goods is derived demand as it depends on demand for consumer goods. However
demand for these goods fluctuates violently as the buyers and professionals motivated by profit.
2) Demand for durable goods and perishable goods.
Durable goods, both producers' and consumers' goods, are put to repetitive uses. In fact, they are not
consumed as such, but only their services are used. E.g., machinery, radio, TV sets, furniture, clothes etc.
These goods are purchased for current use as well as for replacement of old products and for additional stock.
Since the replacement and storage can be postponed, the demand for durable goods is subject to sudden
change depending on price expectations
Perishable goods are those items which disappear on consumption. They can be used only once and hence
these goods are also known as single-use goods. Eg., food items, petrol, paint etc. Perishable goods are
purchased
3) Autonomous demand and deriveddemand
Autonomous demands are independent demands. These demands are in no way linked with the demand for
other commodities. Demands of necessary goods like food and clothing are examples of autonomous demand.
When a commodity is demanded as a result of the demand for another commodity, it is derived demand.
Demand for capital goods and complimentary goods may be cited as examples of derived demand.
4)Individual demand and market demand
The quantity of a commodity demanded by an individual at a particular price during a given period is
known as individual demand. It is the demand of each consumer for the product
Market demand may be defined as the estimates of quantity demanded of the commodity per time
period at various alternate prices by all the individual households in the market.
5) Company demand and Industry demand
The demand for the products of a particular firm or company is company demand. It is the demand
for the product of a manufacturing unit.
Industry demand denotes the total demand for the product. It is the sum total demand for the products
of all the companies in the industry.
Demand for MRF tyres is an example for company demand, while demand for tyres in the country
during a particular period is an example for industry demand there is only one firm in the industry, if there
will not be any difference between company demand and industry demand. Analysis of company and industry
demand helps a firm to understand its share of market in the industry. It is very essential to give shape to
future sales promotion techniques.
6) Short-run demand and long-run demand
Short-run refers to a period in which only minor changes are possible with regard to quantity, price,
income etc. Therefore, short-run demand relates to the existing demand with its immediate reaction to
changes in price, income etc.
Long-run refers to a sufficiently long period when major changes take place in the quantity of the
product, methods of production, availability of substitutes etc. Hence long-run demand indicates the likely
demand for the product as a result of changes in pricing policy, product improvement etc.
Elasticity of demand
The demand for product varies period after period due to the influence of demand determinants. The
change in demand is not always uniform. The rate of change differs from product to product and from time
to time. Elasticity of demand refers to the rate of change in demand for a commodity in response to the change
in its demand determinants. It shows the percentage change in demand due to one per cent change in its
demand determinants.
Kinds of Elasticity
The following are the different kinds of elasticity:
 1. Price elasticity
2. Advertisement elasticity
3. Income elasticity
4. Cross elasticity
Price elasticity
Price is the most dominant factor influencing demand. Price elasticity is known as ‘demand elasticity'. It
describes the effect of change in price on the quantity demanded. Price elasticity of demand shows the extent
of change in the quantity of commodity to change in the price of that commodity.
According to A.K. Caimcross “The elasticity of demand for a commodity is the rate at which quantity
bought changes as the price changes"
Degrees of Price elasticity of demand
i) Perfectly elastic demand
ii) Perfectly inelastic demand
iii) Unit elasticity
iv) Relatively elastic demand
v) Relatively inelastic demand
Perfectly elastic demand (Ep= 𝜶)
It refers to the situation in which small change in price will cause an infinitely large change in
demand. A small fall in price leads to an unlimited extension of demand. The elasticity of demand is infinity
𝛼

It shows demand curve as a straight line horizontal to x axis. It is hypothetical and not real.
Perfectly inelastic demand (Ep= 0)
It refers to that situation in which there is absolutely no change in demand as a result of change in price. The
demand remain the same irrespective of the price. Here elasticity of demand is zero.
Demand curve is vertically straight line parallel to Y axis. This is also imaginary case.

Unit elastic demand (Ep=1)

When a change in price brings about an equal and proportionate change in demand, we say that the
demand is unit elasticity. It refers to the situation where demand changes in exact proportion to the changes
in price. If the price becomes double, the demand falls by half and if price falls by half demand becomes
double.
The demand curve is a semi horizontal or semi vertical. This type of demand curve is called Rectangular
Hyperbola. The area of different rectangles decreases from different parts in this curve is always equal.
Elasticity of demand is equal to unitary or Ep=1
Relatively elastic demand (Ed= >1)
It refers to a situation in which change in demand is more than the proportionate change in price. The
demand for luxury goods is said to be highly elastic. The demand curve of this type is flatter and more
horizontal. The elasticity of demand is greater than one

Relatively inelastic demand (Ed=<1)

It refers to a situation in which the change in demand is less than proportionate change in price. The
demand for articles of necessity is of this type. The demand curve in such cases tends to be vertical though
 it poses a sharp steep. The elasticity of demand is less than unity or less than one

Factors determining price elasticity of demand

Responsiveness of demand to price change depends on many factors. The most important of them are:
a) Nature of commodity
The demand for necessary commodities is elastic. There demand does not change much with the
change in price. The demand for luxuries is elastic. When price of luxuries fall people will come
forward to buy more of them, and when price rises demand contracts
b) Extent of use
A commodity which is put to several uses has a comparatively elastic demand eg: electricity, steel,
coal etc. When cheap its use for less urgent needs will extend and when the price goes up, it will be
put only to more urgent uses and demand will contract.
c) Fashion
The elasticity of demand for a commodity which is in fashion will be inelastic, it becomes more or
less necessary for as consumer to purchase it.
d) Range of substitutes
If a commodity has substitutes, the demand for the commodity will be elastic. For eg: when the
price of tea rises, we may buy less of tea and more of coffee and vice versa. Demand for sugar is
inelastic, as it doesn’t have a suitable substitute.
e) Income level
Demand is inelastic among people with high incomes as they are not affected by price changes, but
in the case of low income people demand is elastic as they are affected very much by a change in
price.
f) Influence of habit
Goods consumed has matter of habit will have inelastic demand
g) Joint demand
Demand for jointly demanded goods is inelastic. E.g., Car and petrol- The elasticity of demand of
the second commodity depends upon the elasticity of demand of the major commodity.
 h) Durability
Durable goods are bought for current as well as future uses. In case of price rise the purchase for
replacement and future use will be postponed. Therefore, the demand for durable goods is elastic.
The demand for single use goods is inelastic as their use cannot be postponed.

Measurement of price elasticity of demand

Three methods are usually used to measure the price elasticity of demand,
They are:
(i) Point Elasticity Method
(ii) Total Expenditure Method, and
(iii) Arc Elasticity Method

(i) Point Elasticity Method

This method is used to measure elasticity of demand for small changes in price. .It is used to
measure the elasticity of demand at particular point on demand curve. Therefore it is known as point
elasticity. It is stated as:
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝐶ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
∆𝒒 ∆𝒑
=𝒒 / 𝒑

(ii) Total Expenditure Method

In this method elasticity of demand is measured by comparing total expenditure on the commodity before
and after the price change. There may be three possibilities:
a) Greater than unity.
With a fall in price, total expenditure on the commodity increases and with a rise in price, total
expenditure decreases, elasticity of demand is said to be greater than unity.
b) less than unity
If with a fall in price, total expenditure on the commodity decreases and with a rise in price, total
expenditure increases, elasticity of demand is said to be less than unity.
c) equal to unity
If the total expenditure on a commodity remains the same in spite of a rise or fall in price, elasticity of
demand is said to be equal to unity.
(iii) Arc elasticity/ Average elasticity method
This method is used to measure the elasticity of demand between two points on a demand curve
rather than at a point on it. The change in price is so big that it gives the points on the demand curve quite
apart. Under this method instead of taking old and new price of the quantity, we take average of both.
Importance of price elasticity
Helpful to monopolist
A monopolist while fixing the price of its product takes into consideration its price elasticity of
demand. If the demand for its product is elastic, he will earn more profit by fixing a low price. If the
demand is inelastic, he will be in a position to fix a high price.
Price discrimination
When a monopolist sells his product at different prices is called price discrimination. He will charge
high consumers those whose demand is inelastic and low price from those whose demand is elastic.
Determination of wages
The concept of elasticity of demand is important in the determination of wages of particular type of
labour. If the demand for labour in an industry is elastic, strikes and trade union tactics will not be of any
avail in raising wages. If however, demand for labour is inelastic strikes by union will compel the employer
to raise the wages of workers in the industry.

Income elasticity
It refers to the change in income of consumer. The rate of change in quantity demanded due to
change in the income of the consumer is known as “income elasticity”. Normally, larger the income of the
consumer, greater will be the quantity demanded and the relation between income and quantity demanded is
positive. However, the income elasticity is negative in the case of inferior goods. It is because an increase
in the consumer's income induces him to go for superior goods and hence the demand for inferior goods
decreases.
Advertisement elasticity
Advertisements are becoming a major factor influencing demand. Most of the business firms spend
a huge amount for advertisement and promotional activities. It is because advertisements create demand.
But the power of advertisement to create demand is not limitless. A firm will be benefited by adding to
advertisement only when the additional revenue that results because of advertisement is more than the
additional expenditure incurred on advertisement. Naturally, the management must ascertain the extent of
influence the advertisement exerts on demand before making decisions on advertisement expenditure
The advertisement elasticity refers to the degree of responsiveness of demand to change in
advertisement expenditure. Advertisement elasticity is also known as promotional elasticity.
Cross Elasticity of Demand
The cross elasticity of demand refers to the percentage change in the quantity demanded of a product
in response to a change in the price of another product.
Cross elasticity is positive among substitutes as the increase in the price of one substitute causes an
increase in the demand for the other. For instance, when the price of coffee increases, the demand for tea goes
up. But in the case of complementary goods, the cross elasticity is negative.
The demand for the goods used together moves in the opposite direction by the change in the price of
anyone of the complementary goods. For example, if the price of tyres goes up the demand for both tyres and
cars goes down. Thus the cross elasticity shows the relationship between the demand for one commodity and
price of another commodity. If two products are neutral or independent like TV and washing machine, the
cross elasticity will be zero.

Demand forecasting
A forecast is a prediction of future situation. In modern business, the production is made with anticipation of
demand. Anticipating the demand for a product during a specific period of time is called demand forecasting.
It helps to avoid over production as well as under production and losses resulting from it in addition to
minimizing production cost. Estimated demand may vary from actual demand; actual conditions differ from
expected ones. The reliability of forecasting depends on the techniques used for forecasting.
Definition
According to Evan J Douglas “Demand forecasting will be taken to mean the process of finding the values
for demand in future periods.
Levels of demand
Micro level
 It is done at business unit level.
Industry level
It is done at industry level by respective trade association for the use of their firms.
Macro level
It is done at wider level. It covers whole economy. The forecast may be done by making use of
industrial production index, national income or expenditure etc.
Importance of Demand Forecasting
Goods are produced to meet future demand. Demand forecasting helps to ascertain future demand. A correct
forecast makes possible production of goods at the right quantity at the right time. Demand forecasting helps
to arrange adequate raw materials, labour, capital and machinery at the right time. Demand forecasting is
essential for the preparation of a production plan that can ensure maximum profit. The importances of demand
forecasting are:
1. Production planning: Planning of production makes possible timely acquisition of the various factors of
production and to carry out production at the right quantity at the right time. It thus helps to avoid the
possibilities of over production and under production.
2. Pricing policy: Price is determined on the basis of the expected demand. Demand forecasting thus helps
formulation of an appropriate price policy.
3. Control of business: Forecast of demand helps preparation of a budget showing costs and profits that can
help control the business more effectively
4. Reduction of business risk: Scientific forecast of demand reduces the probability of risk.
5. Inventory control: Forecasting of demand makes possible ascertainment of an ideal level of inventory.
6. Control of cost of purchasing: Demand forecasting helps plan purchases well in advance which will help
control the cost of purchasing
7. Financial planning: Demand forecasting helps ascertainment of future short-term and long-term financial
requirements and thus to plan for the same.
8. Human resource planning: Demand forecasting helps timely planning and procurement of personnel
especially that of a skilled nature.
9. Rational resource allocation: Demand forecasting makes possible a judicious allocation of the firm's
resources among its various activities
Types of Demand Forecasting
A. Short-term Forecasting
Short-term forecasting is done for a period usually not exceeding one year. It goes as a supplement to long-
term forecasting. Short term demand forecasting helps to make necessary changes in the sales, purchasing,
pricing, financing policies etc. Short-term forecasting is done a taking into consideration the changes that are
taking place in the immediate future.
Purpose/Need/ Objectives of Short term demand forecasting.
The following are the purposes of short-term demand forecasting
1. To evolve a suitable production policy: A suitable production policy helps to avoid the problem of over-
production or under production. Short-term forecasting helps to make a forecast of demand of the near future
and to make necessary changes in the production schedule.
2. To reduce the cost of purchase: Demand forecast makes it possible to know when and how much raw
materials are needed. So the purchase of raw materials can be planned.
3. To determine appropriate price policy: Short-term demand forecasting helps to consider the current
market situations and to fix a suitable price. A high price is advisable for a favourable season and a low price
may be charged in an unfavourable season.
4. To set sales targets and establish control: Sales forecast helps the management to fix a suitable sales
target. This will help to plan the sales machinery and to establish controls. A too high or a too low sales target
is meaningless. An unattainably high target discourages salesmen and too low target can be achieved very
easily. If the target fixed is reasonable, it can be evaluated and necessary control can be exercised. It also
helps to plan effective sales incentive schemes.
B. Long-Term Forecasting
For the successful functioning of any business concern long term policies and short-term policies are
essential. All the business activities are ultimately dependent on sales. If there is no sale there is no meaning
in production. A long-term forecast of sales is essential to decide upon the size of the business unit, its fund
requirements, manpower requirements etc. It also helps to plan the future expansion and diversification
activities.
Purpose/Need/ Objectives of Long term demand forecasting
The purposes of long-term demand forecasting are:
1. Planning of a new unit or expansion of an existing unit: It requires an analysis of the long-term demand
potential of the product. Demand determines the size of the business unit.
2. Planning of long-term financial requirements: It is imperative to establish a sound financial structure.
It involves determination of funds required at different points of time, selection of different sources of funds.
3. Planning of man-power requirements: Training and development of personnel takes a long time. A long-
term forecast of sales makes possible an estimation of manpower requirements so that they can be selected
and trained in advance.
Steps in Demand Forecasting (Process of Demand Forecasting)
The following steps must be kept in mind when a demand forecast is made.
1. Determination of the objectives: The objective of forecasting to be made must be stated clearly, if the
forecast is for a short-term the approach needed is quite different from that of long term forecast.
2. Sub-dividing the task: The total task is sub-divided into small parts on the basis of products or sales
territories or markets.
3. Identifying of demand determinants: The factors affecting the demand for the product must be identified.
These factors vary with different products.
4. Selection of the method: A suitable method can be chosen only after taking into consideration the nature
of the product, the objective of the forecast, the type of data available etc.
5. Study the activities of competitors: The activities of the competitors affect the demand of the firm. So
the effect of the same must be considered before making a forecast.
6. Evaluation of sales forecasts: Every forecast is based on certain data and assumptions. Whenever better
data are available the forecast must be revised. So a monthly, quarterly, half yearly or yearly evaluation may
be necessary to make adjustments in the forecast.
7. Reporting: Report the findings to the management in an understandable form. The management may not
be experts in economics or statistics. The forecast result and how the result was arrived at must be presented
to the management in an understandable manner. Otherwise they will be reluctant to make use of the forecast
result.
Methods or Techniques of Demand Forecasting
Methods of demand forecasting refer to devices of estimating demand. The choice of a method depends
mainly upon the purpose, product and period, The different forecasting techniques are grouped into three.
They are:
(i) Survey methods
(ii) Market studies and experiment method and
(iii) Statistical methods.
1. Survey method

Survey methods denote the collection of data relating to future demand either from the
customers directly or from sales experts. These methods are very extensively employed for short-term
forecasting and for forecasting demand for consumer products. According to the source of
information, survey methods are classified into
(i) Direct interview method
(ii) Opinion survey method
(iii) Delphi method.

(i) Direct interview method: This method implies collection of information relating to future demand for
the product directly from the prospective customers. Here, the information may be collected either from all
the potential customers or from a selected group. The method of collecting details of demand from all the
potential customers is known as census or complete enumeration method of demand forecasting. On the other
hand if the forecast is made on the basis of details collected from a selected group of potential customers, it
is known as sample survey method.
(a) The buyers are likely to exaggerate their requirements if they anticipate shortage.
(b) Consumers may not stick to a particular brand. Hence, their buying intentions may not be steady.
(ii) Opinion survey method: In this method the demand forecasting made by analysing the opinions of
dealers, salesmen and other sports since these people are very close to the Customers, they can give reliable
information relating to the future demand for the product in their respective areas. As the salesmen are in
close touch with customers they can know the future purchase plans of the customers. These salesmen can
realise the reaction of the consumers to the changing market situations and also towards new product and the
demand competing products. Their estimates are put together to find out total demand of the firm's product.
Sometimes the opinion of the dealer or outside experts is also made use of.
Opinion survey method has the following advantages
• It is very simple.
• It involves minimum statistical work.
• It is economical when compared to direct interview method
• It is reliable as the estimate is based on the opinion of salesman

Limitations
• It is influenced by the personal prejudices of the salesmen
• It is often based on simple guess work or vague modification of certain data It is useful
mainly for short-term forecasting.

(iii) Delphi method: This method is a modified form of opinion survey method. Under this method forecast
is made on the basis of consensus among experts. Here, a team of experts are asked to give their opinion and
after evaluation of the opinions each one is asked to comment on the opinion of others supported by reasons.
When the process is repeated, often a consensus among them emerges. Thus this method gives due importance
to personality and intuition of the persons participating in it. It is suitable for long term forecasting especially
for manpower planning.
Features of Delphi method
• A panel of experts is selected to find a solution to the problem.
• The identity of each expert is not revealed to the other. This helps reduce the bias or ego of each
expert when they react to the other s opinions.
• There must be a coordinator to prepare questionnaires and to circulate it and collect the opinions. He
should be able to help the experts converge in their opinions

II. Market Studies and Experiment Method

 This method tries to find out the reactions of the customers under different market conditions and
helps to estimate elasticity coefficients of some important demand determinants like price, advertisements
etc. The elasticity coefficients are determined by altering the relevant demand determinants in different
markets having similar characteristics.
The markets in which experiments are conducted may be actual or simulated. The simulated market
is an artificial market consisting of some selected customers. Simulated markets are also called consumer
clinics. Here the customers are provided with necessary cash and asked to spend it on competing products.
Often the prices of these products and packing and other promotional techniques are changed to study the
change in the demand for the products. This helps to establish elasticity coefficients with which the demand
can be forecasted very easily. The market studies and experiment method has the following benefits:
a) It helps to know the buyer's response to change in the price and promotional techniques.
b) Unproductive heavy expenditure on advertisements can be avoided by studying the
customers' reactions towards the products in the selected markets.
The important limitations of the method are:
• It is very expensive and time consuming.
• Since the experiment is conducted over a short period, the result obtained may not be reliable. It only
reflects the buyer's initial emotional reactions.
• It does not consider the change in demand due to change in income, prices of related goods and other
uncontrolled factors during the period of experiment. Therefore the estimates based on the study of
influence of controlled factors on customers' behaviour may not be realistic.
• Simulated markets suffer from the fact that the participants often behave differently when they buy
things with their own money.

III. Statistical Methods

A good number of statistical techniques are very useful for demand forecasting. Some of these
techniques are highly complex and require mathematical competence. The following are the important
statistical methods of demand forecasting.
1. Trend projection method
This method is also called time series analysis method. Under this method a firm which has been in
existence for quite some time can present its past sales in chronological order. The chronologically arranged
data is called time series and it gives sales trend. This trend which shows the rate of change in sales in the
past, helps to forecast future sales. Often there may be fluctuations in the past sales which may cause
difficulties in evolving a straight line trend.
The effect of short-term fluctuations on trend setting can be avoided by the method of least squares
and moving averages.
2. Correlation and regression analysis
 These two statistical tools are very useful for forecasting. Correlation analysis deals with the
ascertainment of the degree of relationship that exists between two or more variables. Hence this technique
can be used to determine the relationship between demand and various demand determinants. Once the
relationship between two or more variables is clearly defined, we can estimate the value of an unknown
dependant variable from the given independent variable. This technique of estimating an unknown variable
from a known variable is known as regression analysis. For example, if we can determine the relation between
advertisement and sales, it is easy to forecast sales when the advertisement expenditure is known. These two
techniques are very widely used in almost all fields of human activities.
3. Barometric technique
Barometric technique is a method used to predict the directions of future changes based on the present
events. Under barometric method future events like inflation, depression etc., are forecasted with the help of
relevant economic and statistical indicators. Indicators refer to present level of activities and conditions that
help to predict future events, trend in share market, rainfall, stock position, agricultural price index etc. are
examples of indicators to make a forecast of demand. This is a very complex method.
Forecasting Demand for New Products
Forecasting demand for new products is very important for two reasons. Firstly, diversification of existing
business means introduction of new products. Business diversification is very essential for growth. Secondly,
when an existing product dies, the company goes in for new products. All these necessitate the demand
forecast of new products. The techniques of forecasting for the existing products and new products are the
same. But the past data relating to sales etc. are not available for new products. There are many possible
approaches to demand forecasting of new products such as:
1. Evolutionary Approach: Here the demand for the new product is projected as an out growth and evolution
of an existing product. For example, a company wishes to produce colour TV when only black and white TV
is available in the market. The colour TV picks up where the black and white TV lets off. The new product
is a mere improvement on the existing product.
2. Substitute Approach: The new product is treated as a substitute for some existing product. Any new brand
of tooth paste can be considered as a substitute for the existing tooth paste.
3. Growth-curve Approach: Estimate the rate of growth and the ultimate level of demand for the new
product on the basis of the pattern of growth of existing products. For example, a company is interested in
bringing out a washing machine. In this case, the growth trends of all the existing washing machines of
different brands are estimated.
4. Opinion Poll Approach: The consumers themselves are approached and the demand for the new product
is estimated. It may only a sample study and the result may be generalised,
5. Sales Experience Approach: In this case, the new product is offered in a sample market and from this,
total demand is arrived at The sample market selection should be done very cautiously. It should be
representative of the whole market.
6. Vicarious Approach: The consumer's reactions to a new product are studied indirectly, through
specialised dealers who have chance to study consumer's opinion. These methods are seldom independently
used. A combination of several of them is often desirable when they can supplement and check each other.
Characteristics of a Good Forecasting Technique
The various criteria to consider the one as the best method are as follows:
(a) Accuracy: Accuracy is measured by comparing the forecast result with the actual. The more near it is to
the actual the more accurate it is.
(b) Understandability: The management must be able to understand the forecasting techniques adopted by
the forecasting specialists. This understanding helps them to believe the forecasting results also.
(c) Durability: The forecasting method must be usable for a long period. If the method of forecasting
followed is durable the firm need not change it frequently.
(d) Flexibility: The method must be able to accommodate changes that take place in the economy. Then it
can be used for a longperiod. Flexibility is thus essential for durability.
(e) Availability: The immediate availability of forecasting results is of much importance for managerial
decision-making. A less accurate immediate data is more helpful to the management than a more accurate
late data.