Business Economics 1st Year,
LESSON – 2
DEMAND ANALYSIS
OBJECTIVES
After going through this chapter, you should be able to
- Understand the Meaning of Demand
- Understand the Law of Demand
- Know the determinants of Demand
- Know the concept of elasticity of demand, its types, measurement and importance.
- understand the meaning and methods of demand forecasting.
STRUCTURE
2.1. MEANING OF DEMAND
2.2 LAW OF DEMAND
2.2.1 Assumptions of the Law of Demand
2.2.2 Demand Schedule
2.2.3 Why Demand Curve Slopes Downwards?
2.2.4 Exceptions TO the Law of Demand
2.3. Determinants of Demand
2.4. ELASTICITY OF DEMAND
2.4.1 ELASTICITY AND ITS KINDS
2.4.2 MEASUREMENT OF ELASTICITY
2.4.3 IMPORTANCE OF ELASTICITY
2.5. MEANING OF DEMAND FORECASTING
2.5.1 METHODS OF FORECASTING DEMAND
UNIT QUESTIONS
2.1. MEANING OF DEMAND
Demand is an important concept in Economics. In ordinary usage, demand means desire of individuals to buy a commodity. But in Economics it has a special meaning. Mere desire for a commodity is not considered demand in Economics. A commodity is said to be demanded when the individuals have desire or willingness to buy and ability to buy the commodities. Broadly speaking, the term ‘demand’ implies three elements. (a) desire for the commodity, (b) willingness to purchase the commodity, and (c) ability to purchase the commodity. Hence the desire backed by purchasing power of money is known as demand in Economics.
Demand always refers to a particular (a) price, (b) place, (c) time. Demand has no meaning when the price of a commodity, place of its purchase and time are not mentioned. The reason is that demand changes with a change in price, place and time. Hence demand has a special meaning and usage in Economics.
2.2. LAW OF DEMAND
The Law of Demand denotes the quantitative relationship between the quantity demanded of a commodity and its price. It explains the inverse relationship between quantity of a commodity and its price. In the words of Marshall
The law is based on an important assumption namely ‘Other conditions remaining constant”. That means this law assumes other conditions like availability of substitutes or complementaries, consumers tastes and fashions, income, price etc., remain constant. If these conditions change, this law does not hold good.
2.2.1 Assumptions of the Law of Demand
1. Tastes and Preferences
The Law of Demand assumes that consumer’s tastes and preferences remain the same. If consumer’s tastes and preferences change, quantity demanded of commodity by the consumers also change.
2. Population
Constancy in population is another assumption of the law of demand. In fact population and demand are directly related to each other. Demand for a commodity will be great, when population of a country increases. Similarly when the size of population is low, demand for commodities also remains less.
3. Discovery of Substitutes
Discovery of substitutes influence the quantity demanded of a commodity. Demand changes whenever a new substitute product is discovered. The law assumes that no new substitutes are discovered in the market.
4. Income
Demand and income are directly related to one another. Consumers purchase more quantity of a commodity with a rise in their income. Similarly they reduce their demand for a commodity when their income falls. The law assumes constancy in income.
5. Weather Conditions
Change in weather and seasons also affect the demand for a commodity. For example people demand cool drinks during summer season and hot drinks in winter season. The law assumes contancy in weather conditions.
6. Prices of other Goods
Demand for a good also depends on the prices of other goods. These goods may be substitutes or complementaries. Tea and coffee are examples of substitutes. If price of tea increases, the demand for coffee rises even though the price of the latter remains unchanged. Similarly car and petrol are considered complementaries. When price of cars decreases, the demand for petrol increases as new consumers buy cars and demand petrol for running their vehicles. A change in the price of other goods affects the demand of a good. This law assumes that prices of related goods do not change.
2.2.2 Demand Schedule
Demand schedule denotes the relationship between quantity demanded of a commodity and its price. Demand schedule is shown below:
DEMAND SCHEDULE
Price (Rs.) | Demand (in Quantity) |
5 | 10 |
4 | 20 |
3 | 30 |
2 | 40 |
1 | 50 |
The above Demand schedule denotes that more quantity of coffee is purchased when price is low.
The above demand schedule can be represented in the following figure.
In the diagram quantity demanded of a commodity is shown along OX axis and price on ‘OY’ axis. DD is the demand curve. It slopes downwards from left to right. It denotes that a consumer purchases more of a commodity at lower prices and less at higher prices.
2.2.3 Why Demand Curve Slopes Downwards?
The demand curve always slopes downwards from left to right. This is due to the fact that demand increases when price falls and decreases when price rises. Besides this reason, there are several other reasons or causes for the downward slope of the demand curve. They are mentioned as follows:
1. New Buyers: When price is high, only a few people can buy a commodity. When price falls, people who could not buy upto now can also buy the commodity. The fall in the price of a commodity encourages new persons to buy it. As a result, demand for it increases.
2. Income Effect: Demand curve slopes downwards due to the income effect. When the price of a commodity falls, the consumers get that commodity by paying less amount of money. Their money is saved to some extent. As a result, they can get more units of the same commodity with the same amount. This is known as income effect.
3. Substitution Effect: Substitution effect is another cause for the downward slope of the demand curve. Let us suppose that coffee and tea are close substitutes. When the price of coffee rises, the demand for tea increases. People reduce their demand for coffee and buy tea as tea became relatively cheaper. They substitute tea for coffee.
4. Different Uses: Demand curve slopes downwards because of the different uses of commodity. Certain commodities like electricity, sugar, wheat etc. have different uses. For instance, electricity can be used for domestic lighting, for running business enterprises or for street-lighting purposes. When the price of electricity is high, people use it for limited purposes only. When its price decreases, they use it for even minor purposes like heating water, cooking food etc. As a result, the demand for electricity increases to a great extent.
5. Demand curve slopes downwards to the right because the law of demand is based on the law of diminishing marginal utility. As the consumer buys more and more of a commodity, the marginal utility of the additional unit falls. Therefore, the consumer is willing to pay lower prices for additional units. That is why the demand curve slopes downwards.
6. The demand curve slopes downwards because of the operation of the principle of equi-marginal utility. The consumers will arrange their purchases in such a way that marginal utility is equal in all his purchases. Suppose if it is not equal, they will alter their purchases till the marginal utility is equal. When the price of one commodity falls, they will buy more, thus reaching a new equilibrium, at which marginal utilities are equal.
7. The law of demand operates because of people having different desires. People have different taste. For example, some people are fond of movies; others enjoy in a moderate scale; some find it monotonous. The first category is willing to pay any price. The second category will be willing to pay a lesser price and the third category still lower price.
8. Different income levels of the consumers is also responsible for the downward sloping demand curve. If the supply of the commodity is less, it can be sold to the rich people for a higher price, If the supply is more it can be sold to the poor people at a low price.
9. Psychologically people buy more of a commodity when its price falls. Hence the demand curve slopes downwards.
2.2.4 Exceptions TO the Law of Demand
The Law of Demand is not applicable under certain conditions. It has the following exceptions:
1. Prestige Goods
The Law of Demand is not applicable in the case of prestige goods. Rich
persons buy these goods for maintaining their prestige, status and dignity in society. Diamonds, pearls, gold etc. are some examples of prestige goods. Even though these goods do not possess use-value they carry prestige value. The demand for these goods increases when their price rises and decreases when their price falls. Rich persons buy more quantity of these goods at higher prices. They hesitate to buy them at lower prices, because they feel that everybody can buy these goods at lower prices. So, this is against the Law of Demand.
2. Giffen Paradox
This exception to the Law of Demand was explained by Sir Robert Giffen. He explained this paradox on the basis of the consumption behaviour of the British people. He stated that people demand more quantity of inferior goods when their price increases. He described this paradox with the help of two essential commodities used by the British people. The two commodities are potatoes and meat. He considered that the British people spent a major portion of their income on potatoes and a less portion on meat. When the price of potatoes increases, they buy less quantity of meat by spending less amount of money. They spend this amount for buying more quantity of potatoes. So the demand for potatoes increases. This is against the Law of Demand.
3. Speculation
The Law of Demand is not applicable in the case of speculative activities and speculative goods. Businessmen consider it profitable to buy more quantity of goods even though the prices increase. They speculate further rise in prices in the immediate future. Similarly if they expect any fall in the prices of goods, they like to reduce the demand for various goods as it is not profitable to buy more quantity of goods at failing prices. Such a tendency of business people in speculative activities is an exception to the Law of Demand.
Ignorance
Sometimes, the quality of the commodity is judged by it’s price. Consumers think that the product is superior if the price is high. As such they buy more at a higher price.
Fear of Shortage
During times of emergency or war, people may expect shortage of a commodity. At that time, they may buy more at a higher price to keep stocks for the future.
Necessaries
In the case of necessaries like rice, vegetables, etc., people buy more even at a higher price.
2.3. Determinants of Demand
The demand for a commodity is determined or influenced by several factors.
1. Price
The demand for a commodity is mainly determined by its price. The demand will be greater at lower price. Similarly the demand will be less at higher price.
2. Population
Size of population and changes in population act as a great determinant of demand. The demand for goods varies with the size of population. The demand will be greater when the population is high. It will be less when the population is less. Besides the size of population, composition of population also influences the demand.
3. Income
Demand also depends on the income of the people. The demand and income are directly related to each other. People buy more commodities when their income increases. Similarly they buy less commodities when their income is low.
4. Tastes and Fashions
Changes in tastes and fashions also determine the volume of demand for commodities. If people are well developed, they demand more commodities. For example, at present, people consider the purchase of polyster and terene clothes as fashion. Similarly the purchase of pocket- size and small size cell phones, DVD players etc. is considered as a fashion.
5. Discovery of Substitutes
Demand for commodities also depends on the discovery of substitutes. The discovery of new substitutes results in the fall in demand for the old commodities. For example, the discovery of plastic and hindaliam led to the decrease in demand for iron and copper utensils. Similarly the demand for jute bags was reduced due to the discovery of paper bags.
6. Prices of Substitutes and Complementaries
The demand for a commodity also depends on the price of its substitutes and complementaries. For example, tea and coffee are close substitutes. If the price of coffee falls, the demand for tea falls as people consider it profitable to buy more quantity of coffee. They also consider that the price of coffee is relatively cheaper when compared to tea. The demand for a commodity is also determined by the prices of complementary goods. Let us suppose that car and petrol are good complementaries. If price of cars decreases the demand for petrol increases. The reason is that more people will buy cars and more quantity of petrol is used by them.
7. Seasons
Change in seasons also determine the quantity demanded of a commodity. Demand changes with a charge in seasons. For example, people demand cool drinks during summer, umbrellas and hot drinks during rainy season. They demand woollen clothes during winter.
8. Distribution of Income
The nature of distribution of income between different sections of people also affects the demand for a commodity. If Government takes steps for distribution of income from the rich to the poor sections, then the income of the poor people will increase. As a result, demand for those commodities used by the poor people will increase.
9. Business Conditions
Business conditions are another determinant of demand for a commodity. Demand will be high during economic prosperity. It will be less during depression.
10. Savings
The level of savings determine the quantity demanded of a commodity. Level of savings and demand are inversely related to one another. If people save more, then the money income available at their disposal will be less. As a result they buy only a less quantity of commodities. If, on the other hand, they save a small portion of their income, they will be able to buy more quantity of commodities. Hence the more the level of savings, the less will be the demand for goods and vice-versa.
2.4. Elasticity of Demand
The Law of Demand explains that demand for a commodity increases with a fall in price and decreases with a rise in price. But it does not explain the exact change in the demand for commodities due to the changes in their prices. Due to a change in price, the demand for some commodities may increase to a great extent Demand may change slightly in the case of other commodities. Hence changes in demand for all commodities due to change in prices are not same. The proportionate change in demand for a commodity due to a proportionate change in its price is known as elasticity of demand. Elasticity of demand expresses the quantitative relationship between two variables, demand and price.
Elastic and Inelastic Demand
In the words of Marshall
Elastic or More Elastic Demand
In this case the demand expands greatly for a small fall in price and contracts greatly for a small rise in price. It is shown in the Table. In this table as the price of the cake rises and falls by 5 paise, the demand has halved and doubled. The demand is therefore more elastic.
Price of Cake in paise | Amount of Cakes demanded |
50 | 100 |
45 | 200 |
55 | 50 |
Inelastic or Less Elastic Demand
The demand that expands little for a great fall in price and contracts little for a great rise in price is inelastic demand.
Price | Quantity |
6 | 30 |
3 | 31 |
9 | 29 |
Here a large change in price leads to a small change in quantity demanded. Hence demand is inelastic.
2.4.1 Elasticity and its Kinds
Generally elasticity of demand refers to price elasticity. Marshall
1. Perfectly or Infinitely Elastic Demand: When an infinitesimal small change in price leads to an infinitely large change in the amount demanded, there will be perfectly or infinitely elastic demand. It may be stated as
It is illustrated in figure.
In this figure, at OD price the quantity demanded continues to increase infinitely. It is infinite elasticity of demand.
2. Perfectly Inelastic or Zero Elastic Demand: It is one in which whatever the change in price, there is absolutely no change in demand.
In this case 
It is exhibited in the figure.
It is exhibited in the figure.
In the Figure, for all changes in prices the demand does not change at all Hence it is perfectly inelastic demand.
3. Unitary Elastic Demand: When the change in demand is exactly proportionate to the change in price, price elasticity of demand is unity.
It may be expressed as 
It is shown in the Figure.
It is shown in the Figure.
In the Figure as price falls from OP1 to 0P2, the demand has proportionately increased from OM1 to OM2. So the price elasticity of demand is unity.
4. Relatively Elastic Demand : It is one which the demand changes more than proportionately to the change in price, It is stated as 
Elasticity of demand is thus greater than unity or 1. It is illustrated in the Figure.
Elasticity of demand is thus greater than unity or 1. It is illustrated in the Figure.
In the Figure the demand has changed more than proportionately from OM to 0M1 for the change of price ON to ON1. Elasticity of demand is therefore greater than 1.
5. Relatively Inelastic Demand: If the change in demand is less than proportionate to the change in price, price elasticity of demand is less than unity. It is stated as 
It is illustrated in the Figure.
It is illustrated in the Figure.
In the Fig. the changes in prices are comparatively greater than the changes in demand. Hence price elasticity of demand is less than 1.
Income Elasticity of Demand
Income elasticity of demand expresses the relationship between the proportionate change in quantity demanded of a commodity due to a proportionate change in income of the consumer. Income elasticity of demand is measured by the following equation:
Income elasticity is of three types. it is equal to one, if the percentage change in demand and percentage change in income are equal. It is less than 1, if a great percentage change in income brings a smaller percentage in change in demand. It is more than one, if a small percentage change in income brings about a great change in demand, In the case of superior goods, income elasticity of demand is positive. But it is negative in the case of inferior goods. When income increases, people demand more quantity of superior goods. They buy less quantity of inferior goods, with a rise in their income.
Cross Elasticity of Demand
Cross elasticity of demand indicates the relationship between percentage change in the demand for a commodity and percentage change in the price of a related commodity. The related commodities are either substitutes or complementaries. This type of elasticity of demand is measured by the following equation:
In the case of substitutes the cross elasticity of demand is positive. For example, if the price of tea increases, demand for coffee increases as it is relatively cheaper.
The cross elasticity of demand is greater than one, if a percentage change in the price of ‘Y’ leads to a more percentage change in the quantity demanded of ‘X’. The cross elasticity of demand is less than one if the percentage change in price of ‘Y’ leads to a less percentage change in the quantity of ‘X’. Lastly the cross elasticity of demand is unitary or equal to 1, if the percentage change in the price of ‘Y’ and the percentage change in the quantity demanded of X’ are equal. If two commodities are perfect substitutes, the cross elasticity of demand will be infinite.
2.4.2 MEASUREMENT OF ELASTICITY
1. Percentage Method
The comparison between the percentage change in price and percentage change in quantity demanded of a commodity is known as percentage method. Elasticity of demand, according to this method, is measured through the following formula:
If the co-efficient is one, it is called unitary elasticity. If the co-efficient is less than one, it is called inelastic demand. If the co-efficient is more than one, it is called elastic demand.
Total Outlay Method
This method was given by Alfred Marshall. In this method, we consider the change in expenditure on commodities due to a change in price. If a given change in price does not cause any change in the total amount of money spent on commodity, then elasticity of demand is equal to unity.
Price in Rs. | Quantity Demanded | Total outlay or expenditure (Rs.) |
4.50 | 4 | Rs. 18 |
4.00 | 4 ½ | Rs. 18 |
3.00 | 6 | Rs. 18 |
Demand Schedule Showing Unit Elasticity
As price falls, quantity demanded increases; but the total outlay remains constant at Rs. 18. Hence elasticity of demand is equal to unity.
If the total expenditure increases due to a fall in price, elasticity of demand is greater than unity.
Price in Rs. | Quantity Demanded | Total outlay in Rs. |
4.50 | 6 | Rs. 27 |
4.00 | 7 | Rs. 28 |
3.00 | 10 | Rs. 30 |
Demand Schedule Showing Elasticity Greater than Unity
When price falls, the total outlay increases. Therefore elasticity of demand is greater than unity.
If a given change in price results in a fall in the amount spent, then elasticity of demand is less than unity.
Price in Rs. | Quantity Demanded | Total outlay in Rs. |
4.50 | 4 | Rs. 18 |
4.00 | 4 ¼ | Rs. 17 |
3.00 | 5 | Rs. 15 |
Demand Schedule Showing Elasticity Less than Unity
Here the total outlay is declining even though quantity demanded is increasing. Hence demand is said to be inelastic and elasticity coefficient is less than one.
The relationship between total outlay and elasticity of demand may be shown diagrammatically.
Total outlay or expenditure is measured in X axis and price is shown in Y axis. When price falls from P1 to P2, total expenditure remains the same. Therefore, elasticity is equal to one. When price falls to P4 total expenditure decreases from E2 to E4. Hence elasticity is less than one. When price decreases from P3 to P1 total outlay increases from E3 to E2. In this case, elasticity is greater than one.
This method which is also known as total revenue method simply classifies demand into three types. It does not help us to measure eisticity in numerical terms. Therefore, to find out the exact numerical value, point method is suggested.
Arc Elasticity
This method is used to measure elasticity between two points on a demand curve. Any two points on a demand curve make an arc. The following equation is used for measuring elasticity under this method.
If the quotient is one, elasticity of demand is unitary or equal to one. If the quotient is greater than one, elasticity of demand is relatively elastic. If the quotient is less than one, elasticity of demand is relatively inelastic. Arc elasticity of demand may be explained from the following example:
Price Demand
Rs. 20/- 4,000 units
Rs. 4/- 20,000 units
In the above example change in price is Rs. 16/- (Rs. 20/-, Rs. 4/-). Initial price is Rs. 20/- and present price is Rs. 4/-. Initial demand is 4,000 units. Present demand is 20,000 units. Change in demand 16,000/- units. According to the above equation, elasticity of demand is:
Hence elasticity is equal to one.
Geometric Method or Point Method
The measurement of elasticity at any point on the demand curve is known as geometric method or point method. This method is diagramatically explained as follows:
Demand and price are represented along OX and QY axis respectively. AB is the demand curve. It represents the different points of elasticity between A and B. Elasticity of demand is different at different points on the demand curve AB. ‘P’ and ‘P1’are the two points on AB. If we want to measure elasticity at point P. We have to use the following equation:
Accordingly elasticity of demand at point P is 
where PB denotes lower segment and PA upper segment. If the quotient is one, elasticity of demand is equal to one or unitary. If, on the other hand, the quotient is greater than one, elasticity of demand is relatively elastic. If it is less than one, elasticity of demand is relatively inelastic.
where PB denotes lower segment and PA upper segment. If the quotient is one, elasticity of demand is equal to one or unitary. If, on the other hand, the quotient is greater than one, elasticity of demand is relatively elastic. If it is less than one, elasticity of demand is relatively inelastic. If the demand curve is not a straight line, we have to draw a tangent where elasticity of demand is to be known. This is shown from the following diagram :
In the diagram, DD is the demand curve. For knowing elasticity, at point ‘P’, a tangential line is drawn. AB is the tangent line, it is tangential to the demand curve at point P. At point P the elasticity of demand s equal to .
.2.4.3 IMPORTANCE OF ELASTICITY OF DEMAND
The concept of elasticity of demand is of much practical importance.
Price Fixation
Each seller under monopoly and imperfect competition has to take into account elasticity of demand while fixing the price for his product. If the demand for the product is inelastic, he can fix a higher price.
Production
Producers generally decide their production level on the basis of demand for the product. Hence elasticity of demand helps the producers to take correct decision regarding the level of output to be produced.
Distribution
Elasticity of demand also helps in the determination of rewards for factors of production. For example, if the demand for labour is inelastic, trade unions will be successful in raising wages. Same is applicable to other factors of production.
International Trade
Elasticity of demand helps in finding out the terms of trade between two countries. Terms of trade refers to the rate at which domestic commodity is exchanged for foreign commodities. Terms of trade depends upon the elasticity of demand of the two countries for each other’s goods.
Public Finance
Elasticity of demand helps the government in formulating tax policies. For example, for imposing tax on a commodity, the Finance Minister has to take into account the elasticity of demand.
Nationalisation
The concept of elasticity of demand enables the government to decide about nationalisation of industries.
DEMAND FORECASTING
2.5. MEANING OF DEMAND FORECASTING
Forecast is an estimation of future conditions. Demand forecasting refers to an estimate of future demand for the product.
2.5.1 METHODS OF FORECASTING DEMAND
Broadly the techniques of forecasting demand can be classified into
1. Opinion polling method
a) Consumer survey method Complete enumeration survey
Sample survey and test marketing
End-use
b) Sales force opinion method
c) Experts’ opinion method
2. Statistical methods
a) Trend projection method Fitting trend by observation
Least square method
Least square linear regression
Time series analysis
Moving average and annual difference
Exponential smoothing
b) Barometric technique Leading; lagging and coincident indicators
Diffusion indices
c) Regression method
d) Simultaneous equation method
1. Opinion polling method
This method depends on the mobilisation of the consumer’s opinion and then based on that to forecast the demand. This method is adopted in different ways to obtain the required information from the consumers so as to make the demand forecasting reliable.
a) Consumer Survey Method
i) Complete Enumeration Survey
In this method every consumer is contacted to obtain their opinion about the product, as well as their future purchase plans. This method has the advantage of obtaining the opinion from every consumer so that based on the information provided, any forecast is bound to be accurate. But the main difficulty is that at times this method may become unwieldy that it may not be possible to cover all the consumers as the time and financial resources required will be very high.
II) Sample Survey and test marketing
In this method, careful selection of a few elements from the population is made. Then the opinion is collected from the sample consumers. This is used as the base for obtaining the aggregate opinion of the population. If the sample elements are properly selected, then the conclusions and policies arrived at on the basis of the sample, will be applicable to the population. Considering the requirement of time and finance under the Complete Enumeration Survey Method, Sample Survey Method is preferable. Usually the marketing firms adopt a slightly variant method of this Sample Survey method called the Test Marketing. Under Test Marketing the firm would select carefully a few segments in a market and then the product is introduced to those segments among the consumers and their response is carefully analysed. This would help them to arrive at a conclusion about the product and consumers’ opinion.
Ill) End- use Method
In this method the sale of the product to be forecast is on the basis of demand survey of the industries using this product as an intermediate product But it should be carefully noted that the intermediate products may have several end-uses and the intermediate product may have domestic as we as international demand Hence, while forecasting the demand for such products the above points should be taken into account to make the forecasting accurate.
b) Sales Force Opinion Method
In this method, the first hand information about the consumers is collected from the persons who are very close to the consumers. Usually the ,sales representatives have the close contact with the consumers and so their opinion about the consumers’ reaction to the product is obtained. Their opinion is taken as the base for estimating the demand for the product. When the sales force opinion is aggregated, the firm would be able to obtain the accurate information to forecast the demand for the product The main advantages of this method are that it is very cheap and the first-hand information about the consumers’ opinion is collected. At the same time, salesmen are not free from optimism or pessimism, which may influence their report. Further salesmen may not be fully equipped to observe and study the changes in the environment which will have far reaching effect on the demand for the product.
c) Expert’s Opinion Method
In this method, the firm may approach the experts in a field connected with the particular product dealt with by the firm. Their opinion will be unbiased and give a clear cut picture about the prospects of a product. The experts normally consider various changes in the environment and then arrive at their opinion Hence, their view about the demand for the product is bound to be closer to reality. Usually while adopting the method, the firm would enlist a panel of members from whom the opinion is collected. The panel members are suggested to maintain anonymity. But their opinion will be aggregated and in case of consensus, all of them will be informed about it. In case of any dissent, the reason for dissent will be asked for. Hence, in this method; the experts’ opinion is collected and used as the base for demand projection.
2. Statistical Methods
The Statistical Method of demand projection includes various techniques. But the basic requirement under this method is that reliable quantitative information about the past should be available. This will then be analysed in various ways to obtain the forecast. The various statistical techniques are explained hereunder.
a) Trend Projection Method
i) Fitting trend by observation: Under this technique the actual sales data for the product is obtained for the past. This is plotted on a graph sheet. Based on the pattern emerging, a trend is fitted using observation technique. This is extended to understand the future pattern of demand for the product
ii). Trend through least square method: In this method a statistical formula is used to obtain the trend equation. The fundamental assumption under this method is that the rate of change in the sale will be constant. The formula used under this method is: Y = a + bX. In this linear equation, ‘a’ refers to the average sales over a period and ‘b’ refers to the rate at which the sales changes.
iii) Trend through least square linear regression: This is a slightly modified version of the least square method. In this method the time and the sales are taken as the independent variables and their relationship is explained through the linear regression equation of Y = a + bX.
iv) Time series analysis: In this method the statisticians study the different components of time series viz., trend, seasonal variation, cyclical fluctuations and the irregular fluctuations. By quantitatively measuring each one of these components, the statisticians will be able to exactly predict the extent to which each component will affect the original data. Based on this time series analysis, a more accurate prediction of demand is possible.
v) Moving average and annual difference method: In this method, the projection is based on the moving average of the sales in the past and not the simple average. The advantage of moving average is that it clearly reflects the changes that take place every time in the short period. In this method no excessive importance is given to any one particular period or data Hence, this method of predicting the demand is considered to be better than going by the simple average method.
vi) Exponential smoothing method: This is an improvement over the moving average method. Under the moving average method equal importance or weight is given to all the data but under the exponential method the weight is more for the latest data and it is less for the past data. By resorting to this differential weights the changes in the data are smoothened to a large extent thereby making the prediction more reliable.
b) Barometric Techniques
The Barometric techniques are based on the assumption that the study of the past events can lend certain indicators which when used can yield a more accurate prediction for the future. The trend method on the other hand is based on the assumption that the past would continue in the future also. Under the barometric techniques, the lead indicators are used for projecting the future demand for a product. For example, suppose we want to predict the demand for sweaters, then we should find out the rate at which the population grows over a period. Based on this it should be easy to obtain an estimate of growth of demand for sweaters Sometimes the coincident indicators are also used along with the lagging indicators to predict the demand. The former refers to the indicators which change according to the changes in the economic variables. For example, the economic development or growth is measured in terms of the changes in the national product, An increase in national product implies that the economy is growing at a higher rate. Then this could be used as base to estimate the demand for a product. An increase in national product means increase in income and other macro - aggregates which together forecast an increase in demand for the product. Similarly using the depletion in the stock level of the producers, predictions can be made about the demand. Such indicators are called lagging indicators.
Sometimes diffusion indices are also used which more clearly reflect the reliability of the lead and lagging indicators.
c) Regression Method:
In this statistical method, quantitative relationship is established between the variables under consideration. This method can deal with two or more variables which can determine the demand for a commodity. However, all the regression models are based on the assumption that the predicted changes based on the past data will hold good for the future. With increased use of computers, the predictions through regression method are found to be more accurate.
d) Simultaneous Equation Method
In this method, depending upon the number of variables, required number of equations are constructed and solved to obtain the effect of the various variables on the demand for a commodity. This method is supposed to be comprising the whole system in terms of various variables and equations. But this method is highly complex that its use is not widely found.
Each one of the methods of forecasting has its own merits and limitations. Hence, the producers select from among these available methods depending upon the task on hand.
UNIT QUESTIONS
1. State and explain the Law of Demand
2. Why does the demand curve slope downwards? Are there any exceptions?
3. Explain the determinants of demand.
4. Define elasticity of demand and explain its types.
5. Examine the methods of measuring elasticity of demand.
6. Bring out the importance of the concept of elasticity of demand.
7. What is meant by demand forecasting?
8. Describe the various techniques of demand forecasting.
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