Cardinal Utility 

Approach
The Cardinal Utility approach is propounded by neo-classical economists, who believe that
utility is measurable, and the customer can express his satisfaction in cardinal or quantitative
numbers, such as 1,2,3, and so on.

The neo-classical economist developed the theory of consumption based on the assumption
that utility is measurable and can be expressed cardinally. And to do so, they have introduced
a hypothetical unit called as “Utils” meaning the units of utility. Here, one Util is equivalent
to one rupee and the utility of money remains constant.

Over the passage of time, it was realized that the absolute measure of utility is not possible,
i.e. it was difficult to measure the feeling of satisfaction cardinally (in numbers). Also, it was
difficult to quantify the factors that cause a change in the moods of the consumer, their tastes
and preferences and their likes and dislikes. Therefore, the utility is not measurable in
quantitative terms. But however, it is being used as the starting point in the consumer
behavior analysis.

The cardinal utility approach used in analyzing the consumer behavior depends on the
following assumptions to find answers to the above-stated questions:

1. Rationality

It is assumed that the consumers are rational, and they satisfy their wants in the order of their
preference. This means they will purchase those commodities first which yields the highest
utility and then the second highest and so on.

2. Limited Resources (Money)

The consumer has limited money to spend on the purchase of goods and services and thus
this makes the consumer buy those commodities first which is a necessity.

3. Maximize Satisfaction

Every consumer aims at maximizing his/her satisfaction for the amount of money he/she
spends on the goods and services.

4. Utility is cardinally Measurable

It is assumed that the utility is measurable, and the utility derived from one unit of the
commodity is equal to the amount of money, which a consumer is ready to pay for it, i.e. 1
Util = 1 unit of money.

5. Diminishing Marginal Utility

This means, with the increased consumption of a commodity, the utility derived from each
successive unit goes on diminishing. This law holds true for the theory of consumer behavior.
6. Marginal Utility of Money is Constant

It is assumed that the marginal utility of money remains constant irrespective of the level of a
consumer’s income.

7. Utility is Additive

The cardinalists believe that not only the utility is measurable but also the utility derived from
the consumption of different commodities are added up to realize the total utility.

Thus, the cardinal utility approach is used as a basis for explaining the consumer behavior
where every individual aims at maximizing his/her utility or satisfaction for the amount of
money he spends on the consumption of goods and services.

Diminishing Marginal Utility

The Law of Diminishing Marginal Utility states that all else equal as consumption increases
the marginal utility derived from each additional unit declines. Marginal utility is derived as
the change in utility as an additional unit is consumed. Utility is an economic term used to
represent satisfaction or happiness. Marginal utility is the incremental increase in utility that
results from consumption of one additional unit.

Marginal utility may decrease into negative utility, as it may become entirely unfavourable to
consume another unit of any product. Therefore, the first unit of consumption for any product
is typically highest, with every unit of consumption to follow holding less and less utility.
Consumers handle the law of diminishing marginal utility by consuming numerous quantities
of numerous goods.

Example of Diminishing Marginal Utility

An individual can purchase a slice of pizza for $2; she is quite hungry and decides to buy five
slices of pizza. After doing so, the individual consumes the first slice of pizza and gains a
certain positive utility from eating the food. Because the individual was hungry and this is the
first food she consumed, the first slice of pizza has a high benefit. Upon consuming the
second slice of pizza, the individual’s appetite is becoming satisfied. She wasn’t as hungry as
before, so the second slice of pizza had a smaller benefit and enjoyment as the first. The third
slice, as before, holds even less utility as the individual is now not hungry anymore.

In fact, the fourth slice of pizza has experienced a diminished marginal utility as well, as it is
difficult to be consumed because the individual experiences discomfort upon being full from
food. Finally, the fifth slice of pizza cannot even be consumed. The individual is so full from
the first four slices that consuming the last slice of pizza results in negative utility. The five
slices of pizza demonstrate the decreasing utility that is experienced upon the consumption of
any good. In a business application, a company may benefit from having three accountants on
its staff. However, if there is no need for another accountant, hiring a fourth accountant
results in a diminished utility, as little benefit is gained from the new hire.

This law can be stated thus:

“The more one consumes of one commodity during any period of time the less satisfaction
one gets from consuming an additional unit of it”.

As one adds to his (her) weekly consumption of chocolate, each additional unit adds to his
TU or total satisfaction, but each unit adds less utility than the one before it.

Utility schedule presented in Table 4.1 can be represented diagrammatically. See Fig. 4.1. In
Fig. 4.1 our representative consumer Mr. John is seen to add to his total satisfaction as he
increases weekly purchase of chocolate until he is buying 5 units (bars) per day. A 6th bar per
week gives him disutility or dissatis¬faction.

Fig. 4.2 (which is derived from Fig. 4.1) illustrates the Law of Diminishing MU. This
indicates that the additions to TU of chocolate became less as more bars per day are
purchased. It is clear that the MU of the six bars per day is negative, i.e., the sixth bar causes
a decrease in TU

Assumptions of the Law

The Law of Diminishing Marginal Utility is based on the assumptions:

1. The utility that a consumer gets can be measured and expressed in numbers (utils).
Moreover, the units of the commodity must be properly defined.

2. The maximum price a consumer is ready to pay for the commodity depends on its
marginal utility to him.

3. The taste and preference of the consumer remain unchanged during the period of
purchases.

4. The initial amount of consumption is sufficient to give the consumer full

satis¬faction.

Causes of Diminishing Marginal Utility:

Three important causes of the diminishing marginal utility are:

1. Satisfaction of a Particular Want

Although human wants are unlimited, a particular want is limited. So it can be satisfied. As a
person consumes more and more of a commodity, his indication becomes less and less. So his
marginal utility from the successive units becomes gradually smaller. It means that too many
units of a commodity bring complete satisfaction.

2. Introspection

The validity of the law can be established through introspection (i.e., an examination of one’s
own thought or mental reaction). The classical economists used to look into their minds for
their own psychological reaction to the extra consumption of a particular thing (say, an apple,
an ice-cream, a chocolate, etc.) and tested the truth of the law.
3. Less Important Uses of Additional Quantities

Furthermore, marginal utility diminishes because a person, having several units of a

commodity capable of alternative uses, puts one unit to its most important use and the
additional units to the successively less important uses.

Limitations of the Law

The Law may not operate in certain circumstances and in those exceptional cases the
marginal utility of a thing may increase for some time.

Six important exceptional cases to the law are:

1. Change of Taste and Preferences

If a consumer’s taste changes so that he likes a commodity more, the marginal utility of any
quantity of that commodity rises. A person may not have initially any interest in eating egg
roll. But after taking one egg roll, he may form a good taste for it and may get a great
satisfaction from the 2nd or the 3rd one.

2. Inadequate Initial Consumption

If a person consumes a very small quantity of a particular thing at the initial stage, he may not
get full satisfaction from it. In such a case his satisfaction will be greater from the second
unit. Thus, coke in a small glass may not quench one’s thirst at all, as such, the satisfaction
from the second one is likely to be greater.

3. Emotional or Fancy Buying

The marginal utility of a thing does not diminish when a buyer purchases it in a larger
quantity out of sheer emotion or fancy. An example is the art work of a known painter or a
rare book of a dead author.

4. Miser’s Collections or Hobby Collections

A miser gets a greater satisfaction from the additional collection of money. Similarly, a
person gets more and more satisfaction as his hobby-collections (e.g., stamps, coins, works of
art, etc.) increase gradually.

5. Consumption at Different Time Periods

If a person consumes different units of a particular thing at different times, the marginal
utility from the successive units is not likely to be smaller. Thus, if he consumes the 1st ice-
cream in the morning, the 2nd in the afternoon and the 3rd at night, the marginal utility may
not diminish.

6. Stock with Other Persons

Sometimes the utility of a thing depends on its stock with the others. If in a locality all but
one have two cars, the second car to that man will not yield diminishing utility.
Law of Equi-Marginal Utility
The Law of equimarginal Utility is another fundamental principle of Economics.

This law is also known as the Law of substitution or the Law of Maximum Satisfaction.

We know that human wants are unlimited whereas the means to satisfy these wants are
strictly limited. It, therefore’ becomes necessary to pick up the most urgent wants that can be
satisfied with the money that a consumer has. Of the things that he decides to buy he must
buy just the right quantity. Every prudent consumer will try to make the best use of the
money at his disposal and derive the maximum satisfaction.

Explanation of the Law

In order to get maximum satisfaction out of the funds we have, we carefully weigh the
satisfaction obtained from each rupee ‘had we spend If we find that a rupee spent in one
direction has greater utility than in another, we shall go on spending money on the former
commodity, till the satisfaction derived from the last rupee spent in the two cases is equal.

It other words, we substitute some units of the commodity of greater utility tor some units of
the commodity of less utility. The result of this substitution will be that the marginal utility of
the former will fall and that of the latter will rise, till the two marginal utilities are equalized.
That is why the law is also called the Law of Substitution or the Law of equimarginal Utility.

Suppose apples and oranges are the two commodities to be purchased. Suppose further that
we have got seven rupees to spend. Let us spend three rupees on oranges and four rupees on
apples. What is the result? The utility of the 3rd unit of oranges is 6 and that of the 4th unit of
apples is 2. As the marginal utility of oranges is higher, we should buy more of oranges and
less of apples. Let us substitute one orange for one apple so that we buy four oranges and
three apples.

Now the marginal utility of both oranges and apples is the same, i.e., 4. This arrangement
yields maximum satisfaction. The total utility of 4 oranges would be 10 + 8 + 6 + 4 = 28 and
of three apples 8 + 6 + 4= 18 which gives us a total utility of 46. The satisfaction given by 4
oranges and 3 apples at one rupee each is greater than could be obtained by any other
combination of apples and oranges. In no other case does this utility amount to 46. We may
take some other combinations and see

We thus come to the conclusion that we obtain maximum satisfaction when we equalize marginal utilities by substituting
some units of the more useful for the less useful commodity. We can illustrate this principle with the help of a diagram.

Diagrammatic Representation:
In the two figures given below, OX and OY are the two axes. On X-axis OX are represented the units of money and on the
Y-axis marginal utilities. Suppose a person has 7 rupees to spend on apples and oranges whose diminishing marginal utilities
are shown by the two curves AP and OR respectively.

The consumer will gain maximum satisfaction if he spends OM money (3 rupees) on apples and OM’ money (4 rupees) on
oranges because in this situation the marginal utilities of the two are equal (PM = P’M’). Any other combination will give
less total satisfaction.

Let the purchase spend MN money (one rupee) more on apples and the same amount of money, N’M'( = MN) less on
oranges. The diagram shows a loss of utility represented by the shaded area LN’M’P’ and a gain of PMNE utility. As MN =
N’M’ and PM=P’M’, it is proved that the area LN’M’P’ (loss of utility from reduced consumption of oranges) is bigger than
PMNE (gain of utility from increased consumption of apples). Hence the total utility of this new combination is less.

Limitations of the Law of Equimarginal Utility

Like other economic laws, the law of equimarginal utility too has certain limitations or exceptions. The following are the
main exception.

(i) Ignorance
If the consumer is ignorant or blindly follows custom or fashion, he will make a wrong use of money. On account of his
ignorance he may not know where the utility is greater and where less. Thus, ignorance may prevent him from making a
rational use of money. Hence, his satisfaction may not be the maximum, because the marginal utilities from his expenditure
cannot be equalised due to ignorance.

(ii) Inefficient Organisation

In the same manner, an incompetent organiser of business will fail to achieve the best results from the units of land, labour
and capital that he employs. This is so because he may not be able to divert expenditure to more profitable channels from the
less profitable ones.

(iii) Unlimited Resources

The law has obviously no place where this resources are unlimited, as for example, is the case with the free gifts of nature. In
such cases, there is no need of diverting expenditure from one direction to another.

(iv) Hold of Custom and Fashion

A consumer may be in the strong clutches of custom, or is inclined to be a slave of fashion. In that case, he will not be able
to derive maximum satisfaction out of his expenditure, because he cannot give up the consumption of such commodities.
This is especially true of the conventional necessaries like dress or when a man is addicted to some intoxicant.

(v) Frequent Changes in Prices

Frequent changes in prices of different goods render the observance of the law very difficult. The consumer may not be able
to make the necessary adjustments in his expenditure in a constantly changing price situation.

Ordinal Utility Approach

The basic idea behind ordinal utility approach is that a consumer keeps number of pairs of
two commodities in his mind which give him equal level of satisfaction. This means that the
utility can be ranked qualitatively.

The ordinal utility approach differs from the cardinal utility approach (also called classical
theory) in the sense that the satisfaction derived from various commodities cannot be
measured objectively.

Ordinal theory is also known as neo-classical theory of consumer equilibrium, Hicksian

theory of consumer behavior, indifference curve theory, optimal choice theory. This approach
also explains the consumer’s equilibrium who is confronted with the multiplicity of
objectives and scarcity of money income.

The important tools of ordinal utility are:

• The concept of indifference curves.

• The slop of I.C. i.e. marginal rate of substitution.

• The budget line.

Assumptions of Ordinal Utility Approach

1. Rationality

It is assumed that the consumer is rational who aims at maximizing his level of satisfaction
for given income and prices of goods and services, which he wish to consume. He is expected
to take decisions consistent with this objective.

2. Ordinal Utility

The indifference curve assumes that the utility can only be expressed ordinally. This means
the consumer can only tell his order of preference for the given goods and services.

3. Transitivity and Consistency of Choice

The consumer’s choice is expected to be either transitive or consistent. The transitivity of

choice means, if the consumer prefers commodity X to Y and Y to Z, then he must prefer
commodity X to Z. In other words, if X= Y, Y = Z, then he must treat X=Z. The consistency
of choice means that if a consumer prefers commodity X to Y at one point of time, he will not
prefer commodity Y to X in another period or even will not consider them as equal.

4. Nonsatiety

It is assumed that the consumer has not reached the saturation point of any commodity and
hence, he prefers larger quantities of all commodities.

5. Diminishing Marginal Rate of Substitution (MRS)

The marginal rate of substitution refers to the rate at which the consumer is ready to
substitute one commodity (A) for another commodity (B) in such a way that his total
 satisfaction remains unchanged. The MRS is denoted as DB/DA. The ordinal approach
assumes that DB/DA goes on diminishing if the consumer continues to substitute A for B.

Indifference Curves
An indifference curve is a graph showing combination of two goods that give the consumer
equal satisfaction and utility. Each point on an indifference curve indicates that a consumer is
indifferent between the two and all points give him the same utility.

Indifference Map

An Indifference Map is a set of Indifference Curves. It depicts the complete picture of a

consumer’s preferences. The following diagram showing an indifference map consisting of
three curves:

We know that a consumer is indifferent among the combinations lying on the same
indifference curve. However, it is important to note that he prefers the combinations on the
higher indifference curves to those on the lower ones.

This is because a higher indifference curve implies a higher level of satisfaction. Therefore,
all combinations on IC1 offer the same satisfaction, but all combinations on IC2 give greater
satisfaction than those on IC1.

Properties of an Indifference Curve or IC

Here are the properties of an indifference curve:

1. An IC slopes downwards to the right

 This slope signifies that when the quantity of one commodity in combination is increased, the
amount of the other commodity reduces. This is essential for the level of satisfaction to
remain the same on an indifference curve.

2. An IC is always convex to the origin

From our discussion above, we understand that as Peter substitutes clothing for food, he is
willing to part with less and less of clothing. This is the diminishing marginal rate of
substitution. The rate gives a convex shape to the indifference curve. However, there are two
extreme scenarios:

 Two commodities are perfect substitutes for each other – In this case, the indifference
curve is a straight line, where MRS is constant.
 Two goods are perfect complementary goods – An example of such goods would be
gasoline and water in a car. In such cases, the IC will be L-shaped and convex to the origin.

3. Indifference curves never intersect each other

Two ICs will never intersect each other. Also, they need not be parallel to each other either.
Look at the following diagram:

Fig shows tow ICs intersecting each other at point A. Since A and B lie on IC1, the give the
same satisfaction level. Similarly, A and C give the same satisfaction level, as they lie on
IC2. Therefore, we can imply that B and C offer the same level of satisfaction, which is
logically absurd. Hence, no tow ICs can touch or intersect each other.

4. A higher IC indicates a higher level of satisfaction as compared to a lower IC

A higher IC means that a consumer prefers more goods than not.

5. An IC does not touch the axis

This is not possible because of our assumption that a consumer considers different
combinations of two commodities and wants both of them. If the curve touches either of the
axes, then it means that he is satisfied with only one commodity and does not want the other,
which is contrary to our assumption.
Marginal rate of Substitution
In economics, the marginal rate of substitution (MRS) is the amount of a good that a
consumer is willing to give up for another good, as long as the new good is equally
satisfying. It’s used in indifference theory to analyse consumer behaviour. The marginal rate
of substitution is calculated between two goods placed on an indifference curve, displaying a
frontier of equal utility for each combination of “good A” and “good B.”

• The marginal rate of substitution (MRS) is the amount of a good that a consumer is
willing to give up for another good, as long as the new good is equally satisfying.

• It forms a downward sloping curve, called the indifference curve.

• At any given point along an indifference curve, the MRS is the slope of the
indifference curve at that point.

What Does the Marginal Rate of Substitution Tell You?

The marginal rate of substitution is an economics term that refers to the point at which one
good is substitutable for another. It forms a downward sloping curve, called the indifference
curve, where each point along it represents quantities of good X and good Y that you would
be happy substituting for one another. It is always changing for a given point on the curve,
and mathematically represents the slope of the curve at that point.

At any given point along an indifference curve, the MRS is the slope of the indifference
curve at that point. Note that most indifference curves are actually curves, so their slopes are
changing as you move along them. If the marginal rate of substitution of X for Y or Y for X
is diminishing, the indifference’ curve must be convex to the origin. If it is constant, the
indifference curve will be a straight line sloping downwards to the right at a 45° angle to
either axis. If the marginal rate of substitution is increasing, the indifference curve will be
concave to the origin.

The law of diminishing marginal rates of substitution states that MRS decreases as one moves
down the standard convex-shaped curve, which is the indifference curve.

Limitations of Marginal Rate of Substitution

The marginal rate of substitution does not examine a combination of goods that a consumer
would prefer more or less than another combination but examines which combinations of
goods the consumer would prefer just as much. It also does not examine marginal utility –
how much better or worse off a consumer would be with one combination of goods rather
than another – because all combinations of goods along the indifference curve are valued the
same by the consumer.

Budget Line and Consumer Equilibrium

Budget Line

Definition: The Budget Line, also called as Budget Constraint shows all the combinations of
two commodities that a consumer can afford at given market prices and within the particular
income level.

We know that the higher the indifference curve, the higher is the utility, and thus, utility
maximizing consumer will strive to reach the highest possible Indifference curve. But, he has
two strong constraints: limited income and given the market price of goods and services. The
income in hand is the main constraint (budgetary) that decides how high a consumer can go
on the indifference map. In a two commodity model, the budgetary constraint can be
expressed in the form of the budget equation:

Px . Qx + Py . Qy =M

Where,

Px and Py are the prices of commodity X and Y and Qx, and Qy is their respective quantities.

M= consumer’s money income

The Budget equation states that the consumer’s expenditure on commodity X and Y cannot
exceed his money income (M). Thus, the quantities of commodities X and Y that a consumer
can buy from his income (M) at given prices Px and Py can be calculated through the budget
equation given below:
 The values of Qx and Qy are plotted on the X and Y axis, and a line with a negative slope is
drawn connecting the points so obtained. This line is called the budget line or price line.

Consumers Equilibrium

A consumer is in equilibrium when he derives maximum satisfaction from the goods and is in
no position to rearrange his purchases.

Assumptions of Consumers Equilibrium

 There is a defined indifference map showing the consumer’s scale of preferences

across different combinations of two goods X and Y.
 The consumer has a fixed money income and wants to spend it completely on the
goods X and Y.
 The prices of the goods X and Y are fixed for the consumer.
 The goods are homogenous and divisible.
 The consumer acts rationally and maximizes his satisfaction.

n order to display the combination of two goods X and Y, that the consumer buys to be in
equilibrium, let’s bring his indifference curves and budget line together.

We know that,

 Indifference Map: shows the consumer’s preference scale between various

combinations of two goods
 Budget Line: depicts various combinations that he can afford to buy with his money
income and prices of both the goods.

In the following figure, we depict an indifference map with 5 indifference curves – IC1, IC2,
IC3, IC4, and IC5 along with the budget line PL for good X and good Y.

From the figure, we can see that the combinations R, S, Q, T, and H cost the same to the
consumer. In order to maximize his level of satisfaction, the consumer will try to reach the
highest indifference curve. Since we have assumed a budget constraint, he will be forced to
remain on the budget line.

Theory of Demand, Law of Demand

Theory of Demand
Demand theory is a principle relating to the relationship between consumer demand for goods
and services and their prices. Demand theory forms the basis for the demand curve, which
relates consumer desire to the amount of goods available. As more of a good or service is
available, demand drops and so does the equilibrium price.

Demand is the quantity of a good or service that consumers are willing and able to buy at a
given price in a given time period. People demand goods and services in an economy to
satisfy their wants, such as food, healthcare, clothing, entertainment, shelter, etc. The demand
for a product at a certain price reflects the satisfaction that an individual expects from
consuming the product. This level of satisfaction is referred to as utility and it differs from
consumer to consumer. The demand for a good or service depends on two factors:

(1) Its utility to satisfy a want or need, and

(2) The consumer’s ability to pay for the good or service. In effect, real demand is when the
readiness to satisfy a want is backed up by the individual’s ability and willingness to pay.
Built into demand are factors such as consumer preferences, tastes, choices, etc. Evaluating
demand in an economy is, therefore, one of the most important decision-making variables
that a business must analyze if it is to survive and grow in a competitive market. The market
system is governed by the laws of supply and demand, which determine the prices of goods
and services. When supply equals demand, prices are said to be in a state of equilibrium.
When demand is higher than supply, prices increase to reflect scarcity. Conversely, when
demand is lower than supply, prices fall due to the surplus.

The law of demand introduces an inverse relationship between price and demand for a good
or service. It simply states that as the price of a commodity increases, demand decreases,
provided other factors remain constant. Also, as the price decreases, demand increases. This
relationship can be illustrated graphically using a tool known as the demand curve.

The demand curve has a negative slope as it charts downward from left to right to reflect the
inverse relationship between the price of an item and the quantity demanded over a period of
time. An expansion or contraction of demand occurs as a result of the income effect or
substitution effect. When the price of a commodity falls, an individual can get the same level
of satisfaction for less expenditure, provided it’s a normal good. In this case, the consumer
can purchase more of the goods on a given budget. This is the income effect. The substitution
effect is observed when consumers switch from more costly goods to substitutes that have
fallen in price. As more people buy the good with the lower price, demand increases.

Sometimes, consumers buy more or less of a good or service due to factors other than price.
This is referred to as a change in demand. A change in demand refers to a shift in the demand
curve to the right or left following a change in consumers’ preferences, taste, income, etc. For
example, a consumer who receives an income raise at work will have more disposable
income to spend on goods in the markets, regardless of whether prices fall, leading to a shift
to the right of the demand curve.

The law of demand is violated when dealing with Giffen or inferior goods. Giffen goods are
inferior goods that people consume more of as prices rise, and vice versa. Since a Giffen
good does not have easily available substitutes, the income effect dominates the substitution
effect.

Demand theory is one of the core theories of microeconomics. It aims to answer basic
questions about how badly people want things, and how demand is impacted by income
levels and satisfaction (utility). Based on the perceived utility of goods and services by
consumers, companies adjust the supply available and the prices charged.
 Law of Demand
The law of demand is one of the most fundamental concepts in economics. It works with the
law of supply to explain how market economies allocate resources and determine the prices
of goods and services that we observe in everyday transactions. The law of demand states that
quantity purchased varies inversely with price. In other words, the higher the price, the lower
the quantity demanded. This occurs because of diminishing marginal utility. That is,
consumers use the first units of an economic good they purchase to serve their most urgent
needs first, and use each additional unit of the good to serve successively lower valued ends.

 The law of demand is a fundamental principle of economics which states that at a

higher price consumers will demand a lower quantity of a good.
 Demand is derived from the law of diminishing marginal utility, the fact that
consumers use economic goods to satisfy their most urgent needs first.
 A market demand curve expresses the sum of quantity demanded at each price across
all consumers in the market.
 Changes in price can be reflected in movement along a demand curve, but do not by
themselves increase or decrease demand.
 The shape and magnitude of demand shifts in response to changes in consumer
preferences, incomes, or related economic goods, NOT to changes in price.

Understanding the Law of Demand

Economics involves the study of how people use limited means to satisfy unlimited wants.
The law of demand focuses on those unlimited wants. Naturally, people prioritize more
urgent wants and needs over less urgent ones in their economic behavior, and this carries over
into how people choose among the limited means available to them. For any economic good,
the first unit of that good that a consumer gets their hands on will tend to be put to use to
satisfy the most urgent need the consumer has that that good can satisfy.

For example, consider a castaway on a desert island who obtains a six pack of bottled, fresh
water washed up on shore. The first bottle will be used to satisfy the castaway’s most
urgently felt need, most likely drinking water to avoid dying of thirst. The second bottle
might be used for bathing to stave off disease, an urgent but less immediate need. The third
bottle could be used for a less urgent need such as boiling some fish to have a hot meal, and
on down to the last bottle, which the castaway uses for a relatively low priority like watering
a small potted plant to keep him company on the island.

In our example, because each additional bottle of water is used for a successively less highly
valued want or need by our castaway, we can say that the castaway values each additional
bottle less than the one before. Similarly, when consumers purchase goods on the market
each additional unit of any given good or service that they buy will be put to a less valued use
than the one before, so we can say that they value each additional unit less and less. Because
they value each additional unit of the good less, they are willing to pay less for it. So the
more units of a good consumers buy, the less they are willing to pay in terms of the price.

By adding up all the units of a good that consumers are willing to buy at any given price we
can describe a market demand curve, which is always downward-sloping, like the one shown
in the chart below. Each point on the curve (A, B, C) reflects the quantity demanded (Q) at a
given price (P). At point A, for example, the quantity demanded is low (Q1) and the price is
high (P1). At higher prices, consumers demand less of the good, and at lower prices, they
demand more.

Factors Affecting Demand

So what does change demand? The shape and position of the demand curve can be impacted
by several factors. Rising incomes tend to increase demand for normal economic goods, as
people are willing to spend more. The availability of close substitute products that compete
with a given economic good will tend to reduce demand for that good, since they can satisfy
the same kinds of consumer wants and needs. Conversely, the availability of closely
complementary goods will tend to increase demand for an economic good, because the use of
two goods together can be even more valuable to consumers than using them separately, like
peanut butter and jelly. Other factors such as future expectations, changes in background
environmental conditions, or change in the actual or perceived quality of a good can change
the demand curve, because they alter the pattern of consumer preferences for how the good
can be used and how urgently it is needed.

Movement along vs. Shift in Demand Curve

While understanding the meaning and analysis of a demand curve in the study of Economics,
it is also important to be able to make a distinction between the movement and shift of the
demand curve. In this article, we will look at ways by which you can understand the
difference between a movement along a demand curve and shift of the demand curve.

Movement along the Demand Curve and Shift of the Demand Curve

Every firm faces a certain demand curve for the goods it supplies. There are many factors that
affect the demand and these effects can be seen by observing the changes in the demand
curve. Broadly speaking, the factors can be categorized into two types:

(i) Change in demand

(ii) Change in the quantity demanded

Movement of the Demand Curve

When there is a change in the quantity demanded of a particular commodity, because of a

change in price, with other factors remaining constant, there is a movement of the quantity
demanded along the same curve.

The important aspect to remember is that other factors like the consumer’s income and tastes
along with the prices of other goods, etc. remain constant and only the price of the
commodity changes.

In such a scenario, the change in price affects the quantity demanded but the demand follows
the same curve as before the price changes. This is Movement of the Demand Curve. The
movement can occur either in an upward or downward direction along the demand curve.

We know that if all other factors remain constant, then an increase in the price of a
commodity decreases its demand. Also, a decrease in the price increases the demand. So,
what happens to the demand curve?
 In Fig. 1 above, we can see that when the price of a commodity is OP, its demand is OM
(provided other factors are constant). Now, let’s look at the effect of an increase and decrease
in price on the demand:

 When the price increases from OP to OP”, the quantity demanded falls to OL. Also,
the demand curve moves UPWARD.
 When the price decreases from OP to OP’, the quantity demanded rises to ON. Also,
the demand curve moves DOWNWARD.

Therefore, we can see that a change in price, with other factors remaining constant moves the
demand curve either up or down.

The shift of the Demand Curve

When there is a change in the quantity demanded of a particular commodity, at each possible
price, due to a change in one or more other factors, the demand curve shifts. The important
aspect to remember is that other factors like the consumer’s income and tastes along with the
prices of other goods, etc., which were expected to remain constant, changed.

In such a scenario, the change in price, along with a change in one/more other factors, affects
the quantity demanded. Therefore, the demand follows a different curve for every price
change.

This is the Shift of the Demand Curve. The demand curve can shift either to the left or the
right, depending on the factors affecting it.

Concept of Measurement of Elasticity

of Demand
The following points highlight the top five methods used for measuring the elasticity of
demand. The methods are:

1. Price Elasticity of Demand

2. Income Elasticity of Demand
3. Cross Elasticity of Demand
4. Advertisement or Promotional Elasticity of Sales
5. Elasticity of Price Expectations.

Method # 1. Price Elasticity of Demand

Price elasticity of demand is a measure of the responsiveness of demand to changes in the

commodity’s own price. It is the ratio of the relative change in a dependent variable (quantity
demanded) to the relative change in an independent variable (Price). In other words, price
elasticity is the ratio of a relative change in quantity demanded to a relative change in price.
Also, elasticity is the percentage change in quantity demanded divided by the percentage in
price.

Symbolically, we may rewrite the formula:

If percentages are known, the numerical value of elasticity can be calculated. The coefficient
of elasticity of demand is a pure number i.e. it stands by itself, being independent of units of
measurement. The coefficient of price elasticity of demand can be calculated with the help of
the following formula.

Where,

Q is quantity, P is price, ΔQ/Q relative change in the quantity demanded and ΔP/P Relative
change in price.

It should be noted that a minus sign (-) is generally inserted in the formula before the fraction
with a view to making the coefficient of elasticity a non-negative value.

The price elasticity can be measured between two finite points on a demand curve (called arc
elasticity) or on a point (called point elasticity).

Method # 2. Income Elasticity of Demand

The responsiveness of quantity demanded to changes in income is called income elasticity of

demand. With income elasticity, consumer incomes vary while tastes, the commodity’s own
price, and the other prices are held constant.

The income elasticity of demand for a good or service may be calculated by the formula:

where- e  stands for the coefficient of income elasticity, Y for income.

y
Whereas price-elasticity of demand is always negative, income-elasticity of demand is always
positive (except for inferior goods) as the relationship between income and quantity
demanded of a product is positive. For inferior goods the income elasticity of demand is
negative because as income increases, consumers switch over to the consumption of superior
substitutes.

Method # 3. Cross Elasticity of Demand

Demand is also influenced by prices of other goods and services. The cross elasticity
measures the responsiveness of quantity demanded to changes in price of other goods and
services. Cross elasticity of demand is defined as the percentage change in quantity
demanded of one good caused by a 1 percentage change in the price of some other good.

Cross elasticity is used to classify the relationship between goods. If cross elasticity is greater
than zero, an increase in the price of y causes an increase in the quantity demanded of x, and
the two products are said to be substitutes. When the cross- elasticity is greater than zero, the
goods or services involved are classified as complements Increases in the price of y reduces
the quantity demanded of that product. Diminished demand for y causes a reduced demand
for x. Bread and butter, cars and tires, and computers and computer programs are examples of
pairs of goods that are complements.

The coefficient is positive if A and B are substitutes because the price change and the
quantity change are in the same direction. The coefficient is negative if A and B are
complements, because changes in the price of one commodity cause opposite changes in the
quantity demanded of the other. Other things such as consumer taste for both commodities,
consumer incomes and the price of the other commodity are held constant.

Method # 4. Advertisement or Promotional Elasticity of Sales

The advertisement expenditure helps in promoting sales. The impact of advertisement on

sales is not uniform at all level of total sales. The concept of advertising elasticity is
significant in determining the optimum level of advertisement outlay particularly in view of
competitive advertising by rival firms. An advertising elasticity could be defined as the
percentage change in quantity demanded for a percentage change in advertising. Advertising
might be measured by expenditure.

Advertising elasticity may be measured by the following formula:

Method # 5. Elasticity of Price Expectations

People’s price expectations also play a significant role as a determinant of demand. J.R.
Hicks, the English economist, in 1939, devised the concept of elasticity of price expectations.
The elasticity of price expectations may be defined as the ratio of the relative change in
expected future prices to the relative change in current prices.
 Factors affecting Elasticity of Demand
9 Major Factors which Affects the Elasticity of Demand of a Commodity

1. Nature of commodity

Elasticity of demand of a commodity is influenced by its nature. A commodity for a person

may be a necessity, a comfort or a luxury.

(i) When a commodity is a necessity like food grains, vegetables, medicines, etc., its demand
is generally inelastic as it is required for human survival and its demand does not fluctuate
much with change in price.

(ii) When a commodity is a comfort like fan, refrigerator, etc., its demand is generally elastic
as consumer can postpone its consumption.

(iii) When a commodity is a luxury like AC, DVD player, etc., its demand is generally more
elastic as compared to demand for comforts.

(iv) The term ‘luxury’ is a relative term as any item (like AC), may be a luxury for a poor
person but a necessity for a rich person.

2. Availability of substitutes

Demand for a commodity with large number of substitutes will be more elastic. The reason is
that even a small rise in its prices will induce the buyers to go for its substitutes. For example,
a rise in the price of Pepsi encourages buyers to buy Coke and vice-versa.

Thus, availability of close substitutes makes the demand sensitive to change in the prices. On
the other hand, commodities with few or no substitutes like wheat and salt have less price
elasticity of demand.

3. Income Level

Elasticity of demand for any commodity is generally less for higher income level groups in
comparison to people with low incomes. It happens because rich people are not influenced
much by changes in the price of goods. But, poor people are highly affected by increase or
decrease in the price of goods. As a result, demand for lower income group is highly elastic.

4. Level of price
 Level of price also affects the price elasticity of demand. Costly goods like laptop, Plasma
TV, etc. have highly elastic demand as their demand is very sensitive to changes in their
prices. However, demand for inexpensive goods like needle, match box, etc. is inelastic as
change in prices of such goods do not change their demand by a considerable amount.

5. Postponement of Consumption

Commodities like biscuits, soft drinks, etc. whose demand is not urgent, have highly elastic
demand as their consumption can be postponed in case of an increase in their prices.
However, commodities with urgent demand like life saving drugs, have inelastic demand
because of their immediate requirement.

6. Number of Uses

If the commodity under consideration has several uses, then its demand will be elastic. When
price of such a commodity increases, then it is generally put to only more urgent uses and, as
a result, its demand falls. When the prices fall, then it is used for satisfying even less urgent
needs and demand rises.

For example, electricity is a multiple-use commodity. Fall in its price will result in substantial
increase in its demand, particularly in those uses (like AC, Heat convector, etc.), where it was
not employed formerly due to its high price. On the other hand, a commodity with no or few
alternative uses has less elastic demand.

7. Share in Total Expenditure

Proportion of consumer’s income that is spent on a particular commodity also influences the
elasticity of demand for it. Greater the proportion of income spent on the commodity, more is
the elasticity of demand for it and vice-versa.

Demand for goods like salt, needle, soap, match box, etc. tends to be inelastic as consumers
spend a small proportion of their income on such goods. When prices of such goods change,
consumers continue to purchase almost the same quantity of these goods. However, if the
proportion of income spent on a commodity is large, then demand for such a commodity will
be elastic.

8. Time Period

Price elasticity of demand is always related to a period of time. It can be a day, a week, a
month, a year or a period of several years. Elasticity of demand varies directly with the time
period. Demand is generally inelastic in the short period.

It happens because consumers find it difficult to change their habits, in the short period, in
order to respond to a change in the price of the given commodity. However, demand is more
elastic in long rim as it is comparatively easier to shift to other substitutes, if the price of the
given commodity rises.

9. Habits
Commodities, which have become habitual necessities for the consumers, have less elastic
demand. It happens because such a commodity becomes a necessity for the consumer and he
continues to purchase it even if its price rises. Alcohol, tobacco, cigarettes, etc. are some
examples of habit forming commodities.

Income Elasticity of Demand

Income elasticity of demand refers to the sensitivity of the quantity demanded for a certain
good to a change in real income of consumers who buy this good, keeping all other things
constant. The formula for calculating income elasticity of demand is the percent change in
quantity demanded divided by the percent change in income.

Income elasticity of demand measures the responsiveness of demand for a particular good to
changes in consumer income. The higher the income elasticity of demand in absolute terms
for a particular good, the bigger consumers’ response in their purchasing habits — if their
real income changes. Businesses typically evaluate income elasticity of demand for their
products to help predict the impact of a business cycle on product sales.

Calculation of Income Elasticity of Demand

Consider a local car dealership that gathers data on changes in demand and consumer income
for its cars for a particular year. When the average real income of its customers falls from
$50,000 to $40,000, the demand for its cars plummets from 10,000 to 5,000 units sold, all
other things unchanged. The income elasticity of demand is calculated by taking a negative
50% change in demand, a drop of 5,000 divided by the initial demand of 10,000 cars, and
dividing it by a 20% change in real income — the $10,000 change in income divided by the
initial value of $50,000. This produces an elasticity of 2.5, which indicates local customers
are particularly sensitive to changes in their income when it comes to buying cars.

Interpretation of Income Elasticity of Demand

Depending on the values of the income elasticity of demand, goods can be broadly
categorized as inferior goods and normal goods. Normal goods have a positive income
elasticity of demand; as incomes rise, more goods are demanded at each price level. Normal
goods whose income elasticity of demand is between zero and one are typically referred to as
necessity goods, which are products and services that consumers will buy regardless of
changes in their income levels. Examples of necessity goods and services include tobacco
products, haircuts, water and electricity. As income rises, the proportion of total consumer
expenditures on necessity goods typically declines. Inferior goods have a negative income
elasticity of demand; as consumers’ income rises, they buy fewer inferior goods. A typical
example of such type of product is margarine, which is much cheaper than butter.

Luxury goods represent normal goods associated with income elasticities of demand greater
than one. Consumers will buy proportionately more of a particular good compared to a
percentage change in their income. Consumer discretionary products such as premium cars,
boats and jewelry represent luxury products that tend to be very sensitive to changes in
consumer income. When a business cycle turns downward, demand for consumer
discretionary goods tends to drop as workers become unemployed.
Basically, a negative income elasticity of demand is linked with inferior goods, meaning
rising incomes will lead to a drop in demand and may mean changes to luxury goods. A
positive income elasticity of demand is linked with normal goods. In this case, a rise in
income will lead to a rise in demand.

Types of Income Elasticity of Demand

There are five types of income elasticity of demand:

(i) High

A rise in income comes with bigger increases in the quantity demanded.

(ii) Unitary

The rise in income is proportionate to the increase in the quantity demanded.

(iii) Low

A jump in income is less than proportionate than the increase in the quantity demanded.

(iv) Zero

The quantity bought/demanded is the same even if income changes

(v) Negative

An increase in income comes with a decrease in the quantity demanded.

Cross Elasticity of Demand

The cross elasticity of demand is an economic concept that measures the responsiveness in
the quantity demanded of one good when the price for another good changes. Also called
cross-price elasticity of demand, this measurement is calculated by taking the percentage
change in the quantity demanded of one good and dividing it by the percentage change in the
price of the other good.
Substitute Goods

The cross elasticity of demand for substitute goods is always positive because the demand for
one good increases when the price for the substitute good increases. For example, if the price
of coffee increases, the quantity demanded for tea (a substitute beverage) increases as
consumers switch to a less expensive yet substitutable alternative. This is reflected in the
cross elasticity of demand formula, as both the numerator (percentage change in the demand
of tea) and denominator (the price of coffee) show positive increases.

Items with a coefficient of 0 are unrelated items and are goods independent of each other.
Items may be weak substitutes, in which the two products have a positive but low cross
elasticity of demand. This is often the case for different product substitutes, such as tea versus
coffee. Items that are strong substitutes have a higher cross-elasticity of demand. Consider
different brands of tea; a price increase in one company’s green tea has a higher impact on
another company’s green tea demand.

Complementary Goods

Alternatively, the cross elasticity of demand for complementary goods is negative. As the
price for one item increases, an item closely associated with that item and necessary for its
consumption decreases because the demand for the main good has also dropped.

For example, if the price of coffee increases, the quantity demanded for coffee stir sticks
drops as consumers are drinking less coffee and need to purchase fewer sticks. In the
formula, the numerator (quantity demanded of stir sticks) is negative and the denominator
(the price of coffee) is positive. This results in a negative cross elasticity.

 Toothpaste is an example of a substitute good; if the price of one brand of toothpaste

increases, the demand for a competitor’s brand of toothpaste increases in turn.

KEY TAKEAWAYS
 The cross elasticity of demand is an economic concept that measures the
responsiveness in the quantity demanded of one good when the price for another good
changes.
 The cross elasticity of demand for substitute goods is always positive because the
demand for one good increases when the price for the substitute good increases.
 Alternatively, the cross elasticity of demand for complementary goods is negative.

Advertising Elasticity of Demand

Advertising elasticity of demand (AED) is a measure of a market’s sensitivity to increases
or decreases in advertising saturation. Advertising elasticity is a measure of an advertising
campaign’s effectiveness in generating new sales. It is calculated by dividing the percentage
change in the quantity demanded by the percentage change in advertising expenditures. A
positive advertising elasticity indicates that an increase in advertising leads to an increase in
demand for the advertised good or service.

The impact that an increase in advertising expenditures has on sales varies by industry.
Quality advertising will result in a shift in demand for a product or service. Advertising
elasticity of demand is valuable in that it quantifies the change in demand (expressed as a
percentage) by spending on advertising in a given sector. Simply put, how successful a 1%
rise in advertising spend is on raising sales in a specific sector when all other factors are the
same.

For example, a commercial for a fairly inexpensive good, such as a hamburger, may result in
a quick bump in sales. On the other hand, advertising a piece of jewelry may not see a
payback for a period of time because the good is expensive and is less likely to be purchased
on a whim.

Because a number of outside factors, such as the state of the economy and consumer tastes,
may also result in a change in the quantity of a good demanded, the advertising elasticity of
demand is not the most accurate predictor of advertising’s effect on sales. For example, in a
sector where all competitors advertise at the same level, additional advertising may not have
a direct effect on sales. A good example of this is when a specific beer company advertises
their product, which compels a consumer to buy beer, but not simply the specific brand they
saw advertised. Beer has an industry-wide elasticity of 0.0, which means that advertising has
little influence on profits. That said, AEDs can vary widely based on brand.

Advertising Elasticity of Demand Applied

The primary use for advertising elasticity of demand is making sure advertising expenses are
justified by their returns. A price comparison of AED and price elasticity of demand (PED)
can be used to calculate whether more advertising would maximize profit. PED applied
alongside AED can help determine what impact pricing changes may have on demand. For
maximum profit, a company’s advertising-to-sales ratio should be equal to minus the ratio of
the advertising and price elasticities of demand, or A/PQ = -(Ea/Ep). If a company finds that
their AED is high, or if their PED is low, they should advertise heavily.
 Limitations of the AED value

However, while the AED value may be very useful, a simple numerical interpretation of the
value may not be entirely appropriate for a number of reasons. These might include:

 The purpose of a lot of advertising may not be to directly boost demand, but to help
with building a brand image or brand loyalty – the AED value cannot show the effectiveness
of this strategy
 If dealing with a family of brands, it may be difficult to isolate the effect of the
advertising spending on a single product or service and this may distort the apparent
effectiveness of the expenditure
 It may be difficult to isolate the impact of advertising expenditure to a specific time
period – some campaigns are ongoing over a considerable period and other factors may also
influence demand over an extended period.

Demand Forecasting: Need, Objectives

and Methods
Some of the popular definitions of demand forecasting are as follows:

According to Evan J. Douglas, “Demand estimation (forecasting) may be defined as a process

of finding values for demand in future time periods.”

In the words of Cundiff and Still, “Demand forecasting is an estimate of sales during a
specified future period based on proposed marketing plan and a set of particular
uncontrollable and competitive forces.”

Demand forecasting enables an organization to take various business decisions, such as

planning the production process, purchasing raw materials, managing funds, and deciding the
price of the product. An organization can forecast demand by making own estimates called
guess estimate or taking the help of specialized consultants or market research agencies.

Need of Demand Forecasting

Demand plays a crucial role in the management of every business. It helps an organization to
reduce risks involved in business activities and make important business decisions. Apart
from this, demand forecasting provides an insight into the organization’s capital investment
and expansion decisions.

(i) Fulfilling objectives

Implies that every business unit starts with certain pre-decided objectives. Demand
forecasting helps in fulfilling these objectives. An organization estimates the current demand
for its products and services in the market and move forward to achieve the set goals.
 For example, an organization has set a target of selling 50, 000 units of its products. In such a
case, the organization would perform demand forecasting for its products. If the demand for
the organization’s products is low, the organization would take corrective actions, so that the
set objective can be achieved.

(ii) Preparing the budget

Plays a crucial role in making budget by estimating costs and expected revenues. For
instance, an organization has forecasted that the demand for its product, which is priced at Rs.
10, would be 10, 00, 00 units. In such a case, the total expected revenue would be 10*
100000 = Rs. 10, 00, 000. In this way, demand forecasting enables organizations to prepare
their budget.

(iii) Stabilizing employment and production

Helps an organization to control its production and recruitment activities. Producing

according to the forecasted demand of products helps in avoiding the wastage of the
resources of an organization. This further helps an organization to hire human resource
according to requirement. For example, if an organization expects a rise in the demand for its
products, it may opt for extra labor to fulfill the increased demand.

(iv) Expanding organizations

Implies that demand forecasting helps in deciding about the expansion of the business of the
organization. If the expected demand for products is higher, then the organization may plan to
expand further. On the other hand, if the demand for products is expected to fall, the
organization may cut down the investment in the business.

(v) Taking Management Decisions

Helps in making critical decisions, such as deciding the plant capacity, determining the
requirement of raw material, and ensuring the availability of labor and capital.

(vi) Evaluating Performance

Helps in making corrections. For example, if the demand for an organization’s products is
less, it may take corrective actions and improve the level of demand by enhancing the quality
of its products or spending more on advertisements.

(vii) Helping Government

Enables the government to coordinate import and export activities and plan international
trade.

Objectives of short-term demand forecasting :

1. Production policy: Short-term demand forecasting is used to evolve a suitable

production policy which can avoid the problems of over production and short supply.
2. Expenditure pattern: It helps the firm in purchasing. Knowledge of near future
economic conditions help the firm in reducing costs of purchasing raw materials and
controlling inventory.
3. Sales policy: Demand forecasting helps the firm in evolving a suitable sales policy.
4. Price policy: Sales forecasting is useful in determining pricing policy. When the
market conditions are expected to be weak, the firm can avoid an increase in price and vice-
versa.
5. Sales targets, controls and incentives: Short term demand forecasting is used to set
sales targets and for establishing controls and incentives.
6. Financial requirements: It is useful in forecasting short term financial requirements.
Cash requirement depends on production and sales levels. Hence sales forecasts help the firm
to make arrangements for necessary funds well in advance.

Objectives of long term demand forecasting :

1. New unit or expansion: Long term demand forecasting helps in planning of a new

unit or expansion of an existing unit of a business organization.
2. Financial requirements: It is useful in long term financial planning. Long-term sales
forecast is necessary to estimate long term financial requirements.
3. Man power planning: Long term demand forecasting enables the firm to make
arrangements for training and personnel development. Demand forecasting is also useful to
the Government in determining import and export policies.

Objectives Of Demand Forecasting In Business Economics is well recognized by the business

organizations who want to produce goods at optimum level. The objectives of short-term
demand forecasting are different from those of long term demand forecasting.

Methods of Demand Forecasting

There is no easy or simple formula to forecast the demand. Proper judgment along with the
scientific formula is needed to correctly predict the future demand for a product or service.
Some methods of demand forecasting are discussed below:

1. Survey of Buyer’s Choice

When the demand needs to be forecasted in the short run, say a year, then the most feasible
method is to ask the customers directly that what are they intending to buy in the forthcoming
time period. Thus, under this method, the potential customers are directly interviewed. This
survey can be done in any of the following ways:

 Complete Enumeration Method: Under this method, nearly all the potential buyers are
asked about their future purchase plans.
 Sample Survey Method: Under this method, a sample of potential buyers is chosen
scientifically and only those chosen are interviewed.
 End-use Method: It is especially used for forecasting the demand of the inputs. Under
this method, the final users i.e. the consuming industries and other sectors are identified. The
desirable norms of consumption of the product are fixed, the targeted output levels are
estimated and these norms are applied to forecast the future demand of the inputs.
 Hence, it can be said that under this method the burden of demand forecasting is on the
buyer. However, the judgments of the buyers are not completely reliable and so the seller
should take decisions in the light of his judgment also.

The customer may misjudge their demands and may also change their decisions in the future
which in turn may mislead the survey. This method is suitable when goods are supplied in
bulk to industries but not in the case of household customers.

2. Collective Opinion Method

Under this method, the salesperson of a firm predicts the estimated future sales in their
region. The individual estimates are aggregated to calculate the total estimated future sales.
These estimates are reviewed in the light of factors like future changes in the selling price,
product designs, changes in competition, advertisement campaigns, the purchasing power of
the consumers, employment opportunities, population, etc.

The principle underlying this method is that as the salesmen are closest to the consumers they
are more likely to understand the changes in their needs and demands. They can also easily
find out the reasons behind the change in their tastes.

Therefore, a firm having good sales personnel can utilize their experience to predict the
demands. Hence, this method is also known as Salesforce opinion or Grassroots approach
method. However, this method depends on the personal opinions of the sales personnel and is
not purely scientific.

3. Barometric Method

This method is based on the past demands of the product and tries to project the past into the
future. The economic indicators are used to predict the future trends of the business. Based on
the future trends, the demand for the product is forecasted. An index of economic indicators
is formed. There are three types of economic indicators, viz. leading indicators, lagging
indicators, and coincidental indicators.

The leading indicators are those that move up or down ahead of some other series. The
lagging indicators are those that follow a change after some time lag. The coincidental
indicators are those that move up and down simultaneously with the level of economic
activities.

4. Market Experiment Method

Another one of the methods of demand forecasting is the market experiment method. Under
this method, the demand is forecasted by conducting market studies and experiments on
consumer behavior under actual but controlled, market conditions.

Certain determinants of demand that can be varied are changed and the experiments are done
keeping other factors constant. However, this method is very expensive and time-consuming.

5. Expert Opinion Method

 Usually, the market experts have explicit knowledge about the factors affecting the demand.
Their opinion can help in demand forecasting. The Delphi technique, developed by Olaf
Helmer is one such method.

Under this method, experts are given a series of carefully designed questionnaires and are
asked to forecast the demand. They are also required to give the suitable reasons. The
opinions are shared with the experts to arrive at a conclusion. This is a fast and cheap
technique.

6. Statistical Methods

The statistical method is one of the important methods of demand forecasting. Statistical
methods are scientific, reliable and free from biases. The major statistical methods used for
demand forecasting are:

 Trend Projection Method: This method is useful where the organization has

sufficient amount of accumulated past data of the sales. This date is arranged chronologically
to obtain a time series. Thus, the time series depicts the past trend and on the basis of it, the
future market trend can be predicted. It is assumed that the past trend will continue in future.
Thus, on the basis of the predicted future trend, the demand for a product or service is
forecasted.
 Regression Analysis: This method establishes a relationship between the dependent
variable and the independent variables. In our case, the quantity demanded is the dependent
variable and income, the price of goods, price of related goods, the price of substitute goods,
etc. are independent variables. The regression equation is derived assuming the relationship
to be linear. Regression Equation: Y = a + bX. Where Y is the forecasted demand for a
product or service.