Demand Forecasting and Estimation

Dr.Usha Nori
Introduction
 Demand forecasting refers to a scientific and creative
approach for anticipating the demand of a particular
commodity in the market based on past behaviour,
experience, data and pattern of related events
Forecasting Applications
Macroeconomic Applications
Predictions of economic activity at the national or
international level, e.g., inflation or employment.
Microeconomic Applications
Predictions of company and industry performance, e.g.,
business profits.
Forecast Techniques
Qualitative analysis.
Trend analysis and projection.
Exponential smoothing.
Econometric methods.
Need for demand forecasting
Production policy
Supply of materials
Best possible use of machines
Regular availability of labour
Price policy
Appropriate management of sales
Organising funds
Importance of demand forecast
Management decisions
Evaluation
Quality and Quality controls
Financial estimates
Avoiding surplus and inadequate production
Recommendations for the future.
Meaning of demand forecasting:
Demand forecasting is an estimate of sales in dollars or physical
units for a specified future period under a proposed marketing
plan- American Marketing Association
It is the tool to scientifically predict the likely demand of a product
in the future.
Methods of Estimating Demand
Consumer survey
Market experiment
Statistical methods
Consumer survey :Seeking information through
questionnaire , interviews etc.
Asking information about their consumption behavior
ie, buying habits , motives etc.
 .

Qualitative Analysis

Qualitative forecasting is based on judgements of individuals or groups. The

results of qualitative forecasts may be in numerical form but generally are not
based on a series of historical data.
Quantitative forecasting utilizes significant amounts of prior data as a basis for
prediction. Quantitative techniques can be
1. Naïve forecasting – projects past data without explaining future trends
2. Causal (explanatory ) forecasting attempts to explain the functional
relationships between the dependent variable and the independent variables.

Expert Opinion
Informed personal insight is always useful.
Panel consensus reconciles different views.
Delphi method seeks informed consensus.
Survey Techniques
Random samples give population profile.
Stratified samples give detailed profiles of population segments.
Expert opinion techniques: Jury of executive opinion- Forecasts generated by a
group of corporate executives assembled together. The major drawback is that
persons with strong personalities may exercise disproportionate influence.

Delphi method: A form of expert opinion forecasting that uses a series of

questions and answers to obtain a consensus forecast, where experts do not meet.

Merits:
Decisions are enriched with experience of competent experts
Firm need not spend time and resources in collection of data by survey
Very useful when the product is absolutely new to all the markets.

However, different results with different experts and ambiguity of questions are
major drawback.
Firm may be exposed to the risk of loss of confidential information to rival firms.
Opinion polls and market research
Opinion polls: Sample populations are surveyed to
determine consumption trends.
May identify changes in trends
Choice of sample is important
Questions must be simple and clear
Market research is closely related to opinion polling
Market research will indicate not only why the
consumer is or is not buying, but also who the
consumer is, how he or she is using the product, and
what characteristics the consumer thinks are most
important in the purchasing decision.
Direct methods of demand forecasts

Market studies & experiments- Market simulation

Firms create an artificial market, in which the
consumers are instructed to shop with some money. –
Laboratory experiment.
Market studies attempt to hold everything constant
during the study except the price of the good
Lab experiments use volunteers to simulate actual
buying conditions
Field experiments observe actual behavior of consumers
Test Marketing: the product is actually sold in certain
segments of the market, regarded as test market.
Merits:
Most reliable as it is based on real sales proceeds
Suitable for new products
Considered less risky than launching the product across a wide
region
Demerits:
Costly as it requires actual production of the product, and in the
event of failure of the product the entire cost of administering the
test is sunk.
Time consuming
Demand varies due to varying markets across geographical
regions.

Surveys of spending plans
Surveys of spending plans seek information about
macro-type data relating to the economy such as
1. consumer attitudes and their effect on spending
2. inventories and sales expectations
Economic Indicators:
A barometric method of economic indicators is
designed to alert business to changes in economic
conditions
The success of the indicator approach to forecasting
depends on the ability to identify one or more
historical economic series whose direction not only
correlates with, but also precedes that of the series to
be predicted.
Trend Projection
Trend is a general pattern of change in the long run
It is a powerful tool used to predict future values of a variable on the basis
of time series data.
Time series data are arrangement of the values of a variable in chronological
order of days, weeks, months, quarters or years. The basic assumption in
using time series is that past trend is likely to continue.
4 types of trends
Secular- increasing trend or decreasing trend.
Seasonal- seasonal variations of the data within a year
Cyclical- cyclical movement in demand for a product that have a tendency
to recur in a few years. These changes push economic activity in expansion
mode or recession.

Random events-natural calamities, social unrest, foreign aggression creating

war situation etc. , these events have no trend of occurrence hence they
create random variation in the series.
Trend Analysis and Projection
A naïve method of forecasting from past data by
using least squares statistical methods.
Secular trends show fundamental patterns of
growth or decline.
Constant unit growth is linear.
Constant percentage growth is exponential.
Cyclical fluctuations show variation according to
macroeconomic conditions.
 Cyclical normal goods have ε > 1, e.g., housing.
I
Seasonal variation due to weather or custom is
often important, e.g., summer demand for soda.
Random variation can be notable.
Methods of Trend projection: Graphical
Business Cycle
Barometric techniques
In barometric forecasting we construct an index of relevant
economic indicators and forecast future trends on the basis of
these indicators.
The Business Cycle is a rhythmic pattern of economic
expansion and contraction.
Economic indicators help forecast the economy.
Leading indicators, e.g., stock prices. – These are economic series
that typically go up or down ahead of other series; in the sense
they are leading and tell us where we are heading. Ex: interest
rates
Coincident indicators, e.g., production.
Lagging indicators, e.g., unemployment; demand for loans etc.
 Economic recessions are periods of declining economic
activity.
Least squares method

Least squares estimation is a powerful tool to estimate

the coefficients of a linear function.
Equation of a linear trend is
Y = a + bX
Where a is the intercept of the demand curve and b is
the slope of the curve (also termed as the regression
coefficient).
X is the deviation from mean of independent variable
(time in this case).
Least squares estimation is based on the minimisation
of squared deviations between the best fitting line and
the original observations given.
This method aligns macro with micro economics
It is less costly as it depends on past data
Demerits
Proper choice of indicator series may pose as a major
problem
It may not be applicable for long term forecasting.
Econometric Forecasting

Advantages of Econometric Methods

Models can benefit from economic insight.
Forecast error analysis can improve models.
Single Equation Models
Show how Y depends on X variables.
Multiple-equation Systems
Show how many Y variables depend on several X
variables.
Moving average
The simple moving average method forecasts on the
basis of demand values during the recent past.
This method is applicable to a time series that does not
have any pronounced behavioural pattern of
fluctuations.
Formula for computing simple moving average is
 n
Dn = ∑Di/n
 i=1
Where Di = demand in the ith period, n= number of
periods in the moving average.
Weighted Moving Average
Here we forecast the future value of sales on the basis
of weights of the most recent observations. The
formula for computing weighted moving average is
given as:
 5
Dn = ∑ wiDi
 i=1
Where Di=demand in the ith period, wi=weight for the
ith period, n=number of periods in the moving
average.
Always ∑ w=1.0
Empirical Demand Functions

Demand equations derived from actual market data

Useful in making pricing & production decisions
In linear form, an empirical demand function can
be specified as
Q  a  bP  cM  dPR
Where Q is quantity demanded, P is the price of the
good or service, M is consumer income, and PR is the
price of some related good R.
Empirical Demand Functions

In linear form

b = Q/P
c = Q/M
d = Q/PR
Expected signs of coefficients
b is expected to be negative
c is positive for normal goods; negative for inferior goods
d is positive for substitutes; negative for complements
Estimated elasticities of demand are computed as

ˆ P
 Ê  b
Q
ˆ M
 EM  c ˆ
Q

 ˆ PR
Ê XR d
Q
Time series Forecasts

A time series analysis is a naïve method of forecasting from

past data by using least squares statistical methods
Data collected of a number of periods usually exhibit certain
characterisitics:
A)Trends: direction of movement of data over a relatively
long period
B)Cyclical fluctuations: deviation from the trend due to
general economic conditions.
C) Seasonal fluctuations: a pattern that is repeated annually.
D) Irregular movements: departures from norm which may
be caused by special events or may be just noise in the series.

Advantages of time series analysis
Easy to calculate
Does not require much judgement or analytical skill
Describes the best possible fit for past data
Usually reasonably reliable in the short run.
Trend line:
Computation of the trend using least squares method