MEFA I UNIT MATERIAL

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

2. DEMAND ANALYSIS

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UNIT - I

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 EconomicsEconomics 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 EconomicsS.N Micro Macro1.

2.

3.

4.

5.

It is study of the behavior of the individual firms or units

It is individualistic.

It is concerned with the behavior of the micro variable such as individual demand, supply etc.,

Its scope is limited.

It deals with the data of individual firm.

It is study of the behavior of the economy as a whole.

It is aggregate.

It is concerned with the behavior of macro variables such as National Income, National Output, Total Savings.Its scope is vast.

It deals with the data of total industry.

1.2 Introduction to ManagementManagement 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.

MA --- The ManagerNAG --- KnowledgeEME --- The PeopleNT --- 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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Economic Principles, Concepts, Tools and Techniques

ManagerialEconomics, Application of Economics to solve the problems of business management

Solutions to business problems/ managers

Decision making problems of Business Management

1.3 Introduction to Managerial EconomicsEconomics 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.

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 follows1. 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:

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Micro Economics in NatureNormative EconomicsApplication OrientedTake the help of Macro EconomicsEvaluation of each alternativeAssumptionsGoal 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 firmManagerial economics is both conceptual and materialisticManagerial economics is concerned with managerial decision makingManagerial economics takes the help of other sources to make optimum use of scarce resourcesManagerial economics is goal oriented in its approachManagerial 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 organizationResource allocationsDemand analysis and ForecastingCost AnalysisProduction AnalysisMarketing StrategiesPricing PoliciesProfit ManagementCapital 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 EconomicsThe 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 DecisionsPricing DecisionsQuantity 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 supply2. Production planning at micro, macro levels.3. Capacity planning and product-mix-determination.4. Economic feasibility of new production process5. Assistance in preparation of overall development plan6. preparation of periodical economic reports7. Keeping management information at various national and international developments on

economic matters8. Preparing briefs, speeches, articles and papers for top management

1.11 Role

The managerial economist plays a very important role in an organizationThe objective of a managerial economist plays a very important role in an organizationThe managerial economist must try to maximize profits on their invested capitalManagerial 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 issuesThe managerial economist has to maintain contact with data sources. He has to obtain statistical data on national income, price level and tax policiesHe should identify new business opportunitiesHe should build micro and macroeconomic models to solve specific problems

1.12 Responsibilities of Managerial EconomistSales forecastingIndustrial market researchEconomic analysis of competing companiesPricing problems of industryCapital projectsProduction programmersSecurity analysis and forecastAdvice on trade and public relationsAdvice on primary commoditiesAdvice on foreign exchangeEconomic analysis on agriculture.Analysis of underdeveloped economiesEnvironmental 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 )WhereD = Quantity demanded for the product xF = Function ofY = Consumer’s incomePx = Price of good xPs = Price of substitute of xPc = Price of complements of xT = Measure of consumer tastes and preferencesEp = Consumer’s expectations above future prices.N = No of customers

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D = Distribution of consumersu = Other determinants of the demand for xa = advertisement

Factors Influencing the Demand for A Product

1. Price of the Product2. Income of the Consumers3. Tastes, Habits and Preference of the Consumer4. Relative price of Substitute Goods and Complement Goods5. Consumer Expectation6. Population7. Climate and Weather8. 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 types1. Substitutes which can replace each other in useE.g.: Tea, Coffee and bournvita are substitutes.2. Complementary goods are those which are jointly demandedE.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 DemandThe 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 DemandDemand schedule

Price in Rs. Quantity Demanded(units)

54321

10002000300040005000

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 CurveOn 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 curveIf 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 IncomeNo change in Consumer PreferenceNo change in the Tastes and FashionsNo change in the Price Related ProductNo change in the populationNo change in the Govt. PolicyNo 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 effectA commodity is utilized more when it become cheaperSubstitution effectMultiple 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 Demand1. Giffen Goods/ Inferior Goods2. Veblen Goods3. Consumer Expectation4. Consumer Psychological Bias5. Necessaries6. 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 Demand1. Price Demand and Income Demand2. Cross Demand and Joint Demand3. Demand for Consumer Goods and Producer Goods4. Durable Goods and Perishable Goods Demand

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5. Derived Demand and Autonomous Demand6. Industry Demand and Company Demand7. Short run Demand and Long run Demand8. New demand and Replacement Demand9. 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 demandPerishable 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 DemandWhen 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 DemandShort 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 demandTake 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 tablePrice Rs.

Goods Demanded by individual Total Demand in units

X in units

Y in units

Z in units

10095908580

1020304050

510121520

25101420

1735526990

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 OP 1, 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 D 1 D1. In this even though there is no change in price i.e. OP, the demand increases form OM to OM1.

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 DEMANDElasticity 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 demand2. Income elasticity of demand3. Cross elasticity of demand4. 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)

E p=Pr oportionatechange in the quantity demandedPr oportionate change in price or

E p=

Change inquantity demandedQuantity demandedChange in Pr icePr ice

E p=

(Q2−Q1)Q1

(P2−P1)P1

=

ΔQQ1

( ΔP )P1

=ΔQΔP

×P1

Q1

WhereQ1= Quantity demanded before price changeQ2= Quantity demanded after price changeP1= Price charged before price changeP2= 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 DemandWhen a small change in price may bring about a big change in demand then it represents elastic demandWhat 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 demandPerfect inelastic demandUnit elasticity demandRelative/Comparative Elasticity of demandRelative/ Comparative Inelasticity of demand

Perfect Elasticity of Demand (Ep=∞):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 OQ1 from OQ1 to OQ2 even though there is no change in price. The price is fixed at OP.

Perfect Inelastic Demand (Ep=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 OP0 to OP1 to OP2 there is no change in demand.

Unit Elasticity of Demand (Ep=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 OQ1, 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 OP0 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 OQ0 to OQ1 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 DemandThere are four methods for the measurement of price elasticity of demand.

1. Percentage Method / Proportionate Change Method2. Total Outlay Method3. Point Method4. Arc Method

1. Percentage Method/ Proportionate Change MethodIn 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

E p=Pr oportionatechange in the quantity demandedPr oportionate change in price or

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E p=

Change inquantity demandedQuantity demandedChange in Pr icePr ice

E p=

(Q2−Q1)Q1

(P2−P1)P1

=

ΔQQ1

( ΔP )P1

=ΔQΔP

×P1

Q1

WhereQ1= Quantity demanded before price changeQ2= Quantity demanded after price changeP1= Price charged before price changeP2= 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.

E p=Lower SegmentUpper Segment

E p=PMPL

Here Ep= Elasticity at Point PLower Segment = PMUpper Segment = PL

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

E p=QMQL

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

E p=PRPT

= Lower SegmentUpper 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.

Arc elasticity of demand =Q1−QQ1+Q

÷P1−PP1+P

In the above diagram P and P1 are 5 and 4 respectively and Q and Q1 are 100 and 110 respectively then Arc elasticity will be as given below

Arc e =Q1−QQ1+Q

÷P1−PP1+P

Arc e =110−100110+100

÷4−54+5

Arc e =10210

÷−19

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Arc e =−10210

×91

Arc e =−37

Arc e =37(Negtive Symbol is avoided )

So Arce = 3/7(or e<1)

Factors Determine Price elasticity of DemandThe price of elasticity of demand depends on the following factors:

1. Nature of goods2. Availability of substitutes3. Income level4. Variety of uses5. Proportion of income spent on the commodity6. Durability of a commodity7. 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 commodityIf 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 DemandThe 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 Product2. Decision Regarding to Price Changes3. Price discrimination4. Taxation Policy

1. Price Fixation of a ProductThe 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 ChangesPrice 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 discriminationDiscrimination 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 PolicyTax 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 FORECASTINGA 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 forecasts3. micro forecasting4. Short term Forecasting5. 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 analysisSales ForecastingControl of BusinessInventory ControlLong term Investment ProgramsMaintain StabilityHelpful 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.

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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-termSelect Appropriate method of forecastingIdentify the variables affecting the demand for the product and express them in appropriate formsGather all relevant date o represent the variable.It may be made either in terms of physical units or in terms of rupees of sales volumeIt may be in terms of product group or individual productsIt may be annual basis or moth wise or week wise on the basis of past records

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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 ways1. Census method2. 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.

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Least Square MethodThis 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 + dWhere

a= Trendb= Seasonc= Cycled= irregular fluctuationsa, 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. Simpleb. 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:AccuracySimple and Easy to ComputeEconomyAvailabilityMaintenance 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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