UNIT - II

DEMAND AND DEMAND FORECASTING

DEMAND ANALYSIS
Meaning of Demand: Conceptually, the term ‘demand’ implies a ‘desire’ for a commodity backed by
the ability and willingness to pay for it. Unless a person has adequate purchasing power or resources
and the preparedness to spend his resources, his desire for a commodity would not be considered as
his demand. For example, if a man wants to buy a car but he does not have sufficient money to pay for
it, his want is not his demand for the car. And, if a rich miserly person wants to buy a car but is not
willing to pay, his desire too is not his demand for a car. But if a man has sufficient money and is willing
to pay, his desire to buy a car is an effective demand.
The desires without adequate purchasing power and willingness to pay do not affect the market, nor do
they generate production activity.
Demand may be defined as the amount of a commodity purchased by a person at a given point of time
and at a given price.
Demand includes:
a) A desire to get a commodity
b) Ability to buy a commodity
c) Willingness to buy a commodity
According to Ferguson, “Demand refers to the quantities of a commodity that the consumers are
able and willing to buy at each possible price during a given period of time, other things being equal.”
Again it must consist,
a) Demand is always at a point of time
b) Demand is always at a price
DETERMINANTS OF DEMAND OR FACTORS AFFECTING DEMAND
1) Price of the Commodity : The most important factor affecting amount demanded is the price of
the commodity. The amount of a commodity demanded at a particular price is more properly
called price demand. The relation between price and demand is called the Law of Demand. It is
not only the existing price but also the expected changes in price which affect demand.
2) Price of Related Goods: Demand for a commodity is influenced by the change in the price of
related goods.
 There are two types of goods:
a) Substitute Goods: These are the goods which can replace each other in use like tea
and coffee.

b) Complementary Goods: These are those goods which are jointly demanded such as
petrol and car, pen and ink etc.

If the price of the car increases, demand for car will fall along with it the demand for petrol will
also fall and vice-versa.

3. Income of the Consumer: It is also another factor which influences the demand. There is a
direct relation between income of the consumer and its demand.

The demand for normal goods rises, with an increase in the income of the consumer and vice-
versa.

In case of Inferior goods, there is fall in demand with the increase in income and vice-versa.
That means there is an indirect relation in case of Inferior goods.

In case of necessities like salt, milk etc demand remains constant with the change in income.

4. Tastes and Preferences: Tastes and Preferences also influence the demand to a great extent.
This includes fashion, customs, advertisement, climate etc. Other things being equal, as the
taste of the commodity goes up, demand will also increase. And if the demand for the commodity
goes down that means the customers have no taste for that commodity.

5. Population: Increase in population increases demand for necessaries of life. The composition
of population also affects demand. Composition of population means the proportion of young
and old and children as well as the ratio of men to women.

Increase in Population leads to an increase in demand for all types of goods whereas decrease
in population means less demand for such commodities.

6. Government Policy: Government policy affects the demands for commodities through taxation.
Taxing a commodity increases its price and the demand goes down. Similarly, financial help for
the government increases the demand for a commodity while lowering its price.

7. Expectations Regarding the Future: If consumers expect changes in price of a commodity in

future, they will change the demand at present even when the present price remains the same.
Similarly, if consumers expect their incomes to rise in the near future they may increase the
demand for a commodity just now.

8. Climate and Weather: The climate of an area and the weather prevailing there has a decisive
effect on consumer’s demand. In cold areas woollen cloth is demanded. During hot summer
days, ice is very much in demand. On a rainy day, ice-cream is not so much demanded.

9. State of Business: The level of demand for different commodities also depends upon the
business conditions in the country. If the country is passing through boom conditions, there will
be a marked increase in demand. On the other hand, the level of demand goes down during
depression.

10 MEWAR INSTITUTE
DEMAND FUNCTION

The functional relationship between the demand for a commodity and its various

determinants may be expressed mathematically in terms of a demand function, thus:

Dx = f (Px, Py, I, T, E, U) where,

Dx = Quantity demanded for commodity X.

f = functional relation.

Px = The price of commodity X.

Py = The price of substitutes and complementary goods.

I = the income of the consumer.

E= Future expectations

T = The taste of the consumer.

U = Unknown variables or influences.

THE LAW OF DEMAND

The law of demand is one of the fundamental laws of economics. The law of demand states that the
demand for a commodity increases when its price decreases and falls when its price rises, other
things remaining constant. This is an empirical law, i.e., this law is based on observed facts and can be
verified with new empirical data. As the law states, there is an inverse relationship between the price
and quantity demanded. This law holds under the condition that “other things remain constant”. “Other
things” include other determinants of demand, viz., consumers’ income, price of the substitutes and
complements, tastes and preferences of the consumer, etc. These factors remain constant only in the
short run. In the long run they tend to change. The law of demand, therefore, holds only in the short run.

Assumptions:

1) There should be no change in the income of the consumer.

2) There should be no change in the taste and preferences of the consumer.

3) Price of related goods remains unchanged.

4) There should be no change in the size of the population.

5) There should be no expectation of rise in price of related goods.

Demand Schedule:

Demand Schedule refers to the response of amount demanded to change in price of a commodity. It
summarizes the information on prices and quantity demanded. It is of two types.

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1) Individual Demand Schedule

2) Market Demand Schedule

1) Individual Demand Schedule: Considering other things being equal individual demand schedule
refers to the quantities of the commodities demanded by the consumer at various prices. It can
be shown with the help of table given below:
Table – Individual Demand Schedule
Price of Mangoes Amount Demanded per Week
(Rs. per Kg.) (Quantities in kg.)
80 2
70 4
60 6
50 10
40 16

2) Market Demand Schedule: The demand side of the market is represented by the demand
schedule. It is tabular statement narrating the quantities of a commodity demanded in aggregate
by all the buyers in the market at different prices over a given period of time. A market demand
schedule, thus, represents the total market demand at various prices. Theoretically, the demand
schedule of all individual consumers of a commodity can be complied and combined to form a
composite demand schedule, representing the total demand for the commodity at various
alternative prices. The derivation of market demand from individual demand schedules is illustrated
in the table. Here is it is assumed that the market is composed only of three buyers, A, B and C.
Table – A Market Demand Schedule (Hypothetical Data)
Price (in Rs.) Units of Commodity X Demand per Day By Total or market demand
Individuals
A + B
4 1 1 2
3 2 3 5
2 3 5 8
1 5 9 14

Apparently, the market demand schedule is constructed by the horizontal additions of quantities
at various prices related in the individual demand schedules.

The Demand Curve

A demand curve is a graphical presentation of a demand schedule. When price quantity

information of a demand schedule is plotted on the graph, a demand curve is drawn. Demand
curve thus depicts the picture of the data contained in the demand schedule. It relates to the
amount the consumer is willing to pay at each alternative conceivable price for the commodity
over the given period of time.

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Derivation of Market Demand Curve
The market demand curve is derived by the horizontal summation of individual demand curves for a
given product. Following figure is drawn by plotting the data contained in the table.

It may be observed that the slope of the market demand curve is an average of the slopes of individual
demand curves.

Why the Demand Curve Slopes Downward?

The demand curve slopes downward due to following reasons:

1) Law of diminishing marginal utility:

A consumer always equalises marginal utility with price. The law states that a consumer derives less
and less satisfaction (utility) from the every additional increase in the stock of a commodity. When price
of a commodity falls the consumer’s price utility equilibrium is disturbed i.e. price becomes smaller
than utility.

The consumer in order to restore the new equilibrium between price and utility buys more of it so that
the marginal utility falls with the rise in the amount demanded. So long the price of a commodity falls,
the consumer will go on buying more amount of it so as to reduce the marginal utility and make it equal
with new price.

Thus the shape and slope of a demand curve is derived from the slope of marginal utility curve.

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(2) Income effect:

Another cause behind the operation of law of demand is income effect. As the price of a commodity
falls, the consumer has to buy the same amount of the commodity at less amount of money. After
buying his required quantity he is left with some amount of money.

This constitutes his rise in his real income. This rise in real income is known as income effect. This
increase in real income induces the consumer to buy more of that commodity. Thus income effect is
one of the reasons why a consumer buys more at falling prices.

(3) Substitution effect:

When the price of a commodity falls, it becomes relatively cheaper than other commodities. The
consumer substitutes the commodity whose price has fallen for other commodities which becomes
relatively dearer.

For example, with the fall in price of tea, coffee price being constant, tea will be substituted for coffee.
Therefore the demand for tea will go up.

(4) New consumers:

When the price of a commodity falls many other consumers who were deprived of that commodity at
the previous price become able to buy it now as the price comes within their reach. For example , the
units of colour TV. increases with a remarkable fall in price of it. The opposite will happen with a rise in
prices.

(5) Multiple use of commodity:

There are some commodities which have multiple uses. Their uses depend upon their respective,
prices. When their prices rise they are used only for certain selected purposes. That is why their
demand goes down.

For example electricity can be put to different uses like heating, lighting, cooling, cooking etc. If its price
falls people use it for other uses other than that. A rise in price of electricity will force the consumer to
minimise its use. Thus with a fall and rise in price of electricity its demand rises and falls accordingly.

Exceptions to the Law of Demand:

It is almost a universal phenomenon of the law of demand that when the price falls, the demand
extends and it contracts when the price rises. But sometimes, it may be observed, though of course,
very rarely, that with a fall in price, demand also falls and with a rise a price, demand also rises. This is
a paradoxical situation or a situation which apparently is contrary to the law of demand.

In this, demand curve slopes upward from the left to right. It appears that when there is increases in
price, the quantity demanded will also increase and vice-versa. It represents a direct functional relationship
between price and demand.

Such upward sloping demand curves are unusual and quite contradictory to the law of demand, as they
represent the phenomenon that ‘more will be at a higher price and vice versa. The upward sloping
demand curve thus, refers to the exceptions to the law of demand. There are a few such exceptional
cases, which may be categorized as follows:

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Giffen Goods

Giffen Goods is a concept that was introduced by Sir Robert Giffen. These goods are goods that are
inferior in comparison to luxury goods. However, the unique characteristic of Giffen goods is that as its
price increases, the demand also increases. And this feature is what makes it an exception to the law of
demand.

The Irish Potato Famine is a classic example of the Giffen goods concept. Potato is a staple in the Irish
diet. During the potato famine, when the price of potatoes increased, people spent less on luxury foods
such as meat and bought more potatoes to stick to their diet. So as the price of potatoes increased, so
did the demand, which is a complete reversal of the law of demand.

Veblen Goods

The second exception to the law of demand is the concept of Veblen goods. Veblen Goods is a concept
that is named after the economist Thorstein Veblen, who introduced the theory of “conspicuous
consumption”. According to Veblen, there are certain goods that become more valuable as their price
increases. If a product is expensive, then its value and utility are perceived to be more, and hence the
demand for that product increases. And this happens mostly with precious metals and stones such as
gold and diamonds and luxury cars such as Rolls-Royce. As the price of these goods increases, their
demand also increases because these products then become a status symbol.

The expectation of Price Change

In addition to Giffen and Veblen goods, another exception to the law of demand is the expectation of
price change. There are times when the price of a product increases and market conditions are such
that the product may get more expensive. In such cases, consumers may buy more of these products
before the price increases any further. Consequently, when the price drops or may be expected to drop
further, consumers might postpone the purchase to avail the benefits of a lower price.

For instance, in recent times, the price of onions had increased to quite an extent. Consumers started
buying and storing more onions fearing further price rise, which resulted in increased demand.

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Necessary Goods and Services

Another exception to the law of demand is necessary or basic goods. People will continue to buy
necessities such as medicines or basic staples such as sugar or salt even if the price increases. The
prices of these products do not affect their associated demand.

Change in Income

Sometimes the demand for a product may change according to the change in income. If a household’s
income increases, they may purchase more products irrespective of the increase in their price, thereby
increasing the demand for the product. Similarly, they might postpone buying a product even if its price
reduces if their income has reduced. Hence, change in a consumer’s income pattern may also be an
exception to the law of demand.

Consumer’s Psychological Bias or Illusion: When the consumer is wrongly biased against the quality
of the commodity with the price change, he may contract this demand with a fall in price.

ELASTICITY OF DEMAND

In law of Demand, we study the direction of change in demand and elasticity of demand has been
designed to measure the degree or speed of change in demand. The degree of responsiveness of
demand to the change in its determinants is called elasticity of demand.

The elasticity of demand is classified into three:

1) Price Elasticity of Demand

2) Income Elasticity of Demand

3) Cross Elasticity of Demand

Price Elasticity of Demand: The concept of price elasticity of demand was first of all introduced in
economics by Dr. Marshall. Price elasticity of demand is generally defined as the responsiveness or
sensitiveness of demand for a commodity to the changes in its price. More precisely, elasticity of
demand is the percentage change in demand as a result of percentage change in the price of the
commodity.

According to Alfred Marshall, “Elasticity of Demand may be defined as the percentage change in
quantity demanded to the percentage change in price.”

The formula for the Price Elasticity of Demand (ED) is:

ED = (% Change in Quantity Demanded)/(% Change in Price)

DEGREES OF PRICE ELASTICITY

1) Perfectly Elastic demand: It is said to happen when a little change in price leads to an infinite
change in quantity demanded. A small rise in price on the part of seller reduces the demand to
zero. In such a case the shape of the demand curve will be horizontal straight line. The elasticity
of demand in this case will be equal to infinity ( ed= )

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2) Perfectly Inelastic demand: Under the perfectly inelastic demand, irrespective of any rise or
fall in price of a commodity, the quantity demanded remains the same. The elasticity of demand
in this case is equal to zero. (ed=0)

3) Unitary Elastic Demand: The demand is said to be unitary elastic when a proportionate change
in the price level brings about an equal proportionate change in quantity demanded. The numerical
value of unitary elastic demand is exactly one i.e. ed = 1
This type of demand curve is also known as rectangular hyperbola.

4) Greater than Unitary Elastic Demand: It refers to a situation in which a small change in price
leads to a big change in quantity demanded. In such a case elasticity of demand is said be more
than one (ed > 1).

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5) Less than Unitary Elastic Demand: It refers to a situation in which a given percentage of
change in price produces a relatively less percentage change in quantity demanded. In such a
case elasticity of demand is said to be less than one (ed<1).

MEASUREMENT OF PRICE ELASTICITY OF DEMAND

Three methods have been devised by the economists to measure price elasticity. They are (a) Total
outlay method (b) Point method, and (c) Arc method.
a) Total Outlay Method: This method is associated with the name of Alfred Marshall. According to
this method, we may say that the elasticity of demand is one, if a small fall in price will cause an
equal proportionate increase in the quantity demanded; or as we may say roughly, a fall of one
percent in price will increase the sales by one percent; if a fall of one percent in price makes an
increase of two or one and a half percent respectively in the quantity demanded and so on. In
this method we consider the change in price and the consequent change in the outlay on the
purchase of the commodity. If for instance, a given change in price does not cause any change
in the total amount of money spent on the commodity (i.e., the total outlay on the commodity
remains constant), elasticity of demand said to be equal to unity. If as a result of a given change
in price the total outlay is increased, elasticity of demand is said to be greater than unity. On the
contrary, if as a result of a given change in price, the total outlay is diminished, then elasticity of
demand is said to be less than unity. In short, TQ = pq, where TQ stands for outlay, p and q for
price and quantity demanded respectively. This provides us with three different measurements
of the elasticity of demand which are as follows :
a) Less than unit elastic (< 1),
b) Unit elastic (= 1),

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 c) More than unit elastic (> 1).

1) Demand is less than unit elastic or inelastic when,

i) With a fall in price total outlay also falls; or

ii) With a rise in price, total outlay also rises.

2) Demand is unit elastic when total outlay does not vary with change in price of the
commodity as illustrated by demand schedule of cloth in table (B). With a fall in price,
demand for the commodity increases. The household continues to spend as much on
the commodity as before. With rise in price, demand contracts, but the total outlay
remains unchanged.

3) Demand is more than unit elastic when:

i) With a fall in price, total outlay increases; or

ii) With a rise in price, total outlay falls. Demand for butter in table (C) is of this
outlay.
We can tabulate these various results as follows :
Effect on Outlay
Change in price Type of elasticity of demand
=1 <1 >1
Fall in Price TQ remains TQ falls TQ rises
constant
Rise in Price TQ remains TQ rises TQ falls
Constant
The main weakness of the total outlay method is that it does not help us to measure elasticity in
numerical terms. It simply classifies price demand into elastic, inelastic and unitary elastic
demands.

B) Proportionate Method: This method is also associated with the name of Dr. Marshall. According
to this method, “price elasticity of demand is the ratio of percentage change in the amount
demanded to the percentage change in price of the commodity. It is also known as the Percentage
Method, Flux Method, and Ratio Method.

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a) Point Method: Measuring Elasticity Of Demand on a Linear demand Curve : Let a straight
line demand curve DD’ be given and we have to measure price elasticity of demand at the point
R on this demand curve.

The measure of price elasticity of demand is given by : Ep =(“q/”p) (p/q) The first term in this
formula ,(“q/”p) is the reciprocal of the slope of the demand curve DD’(slope of the demand
curve is equal to Change in price divided by change in quantity demanded and will be the same
all along the straight line demand curve). The second term is the original price divided by the
Original Quantity. Thus

Ep =(1/slope)(p/q)

Now at point R in the diagram, Original price p = OP and Original quantity q = OQ. Further,
slope of the demand curve DD’ is “p/”q = PD/PR

Substituting these in the above formula we have

Ep =[ 1/(PD/PR)](OP/OQ) = (PR/PD)(OP/OQ)

However PR =OQ and they will get cancelled and therefore

Ep = OP/PD

This represents the ratio of the distances on the vertical axis.

In a right angled triangle ODD’,PR is parallel to OD’.

Therefore

Ep = OP/PD =RD’/RD

RD’ is the lower segment of the demand curve DD’ at point R and RD is its upper segment.

Therefore,

Ep = RD’/RD =Lower segment/Upper segment.

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Measuring Price elasticity on a non –linear demand curve.

In order to measure elasticity in case of a non linear curve we draw a tangent at the given point R on
the demand curve DD’ and then measure price elasticity by finding out the value of RT’/RT.
On a Linear Demand curve price elasticity varies from Zero to infinity. This can be represented
diagrammatically as follows.In this diagram elasticity is being calculated at five points D,S,R,Land D’.

D) Arc Elasticity Method

Arc Elasticity of demand When price changes are large or we have to measure elasticity over an arc of
the demand curve rather than at a specific point on the demand curve, the point elasticity method does
not provide a true or correct measure of price elasticity of demand . Further, in such cases, the
elasticity would be different depending on whether we choose original price and original demand or the
subsequent price and quantity demanded as the basis for measurement of elasticity of demand. The
outcome would be different under the two situation . Hence , when the change in price is quite large

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then accurate measure of price elasticity can be obtained by taking the average of original price and
new price as well as average of the old quantity and new quantity as the basis of measurement of
percentage changes in price and quantity. Thus if the price of a good declines from p1 to p2 and as a
result the quantity demanded increases from q1 to q2 the average of the two prices is given by (p1+p2)/
2 and Average of the two quantities is given by (q1+q2)/2 . Thus the formula for measuring Arc elasticity
Is given by
E p = {“q/(p1+p2)/2} /{“p/(q1+q2)/2}
= { “q/(q1+q2)} {“p/(p1+p2)}
= ( “q/”p) {(p1+p2)/(q1+q2)}
FACTORS INFLUENCING ELASTICITY OF DEMAND
When the demand for a commodity is elastic or inelastic will depend on a variety of factors. The major
factors affecting elasticity of demand are :
1) Nature of Commodity : According to the nature of satisfaction the goods give, they may be
classified into luxury, comfort or necessary goods. In general, luxury and comfort goods are
price elastic, while necessary goods are price inelastic. Thus, for example, the demand for food
grains, cloth, salt etc. is generally inelastic while that for radio, furniture, car, etc. is elastic.
2) Availability of Substitutes : Where there exists a close substitute in the relevant price range,
its demand will tend to be elastic. But in respect of commodities having no substitutes, their
demand will be somewhat elastic. Thus, for example, demand for salt, potatoes, onions etc. is
highly inelastic as there are no close effective substitute for these commodities. On the other
hand, commodities like tea, coffee or beverages such as Thums - Up, Mangola, Gold Spot,
Fanta, Sosyo etc. having a wide rage of substitutes , have a more elastic demand in general.
3) Number of Uses : Single use goods will have generally less elastic demand as compared to
multi-use goods, e.g. for commodities like coal or electricity having a composite demand,
elasticity is relatively high. With the fall in price, these commodities may be demanded increasingly
for various uses. It may be elastic in some of the uses, and may be inelastic in some other
uses, e.g. coal is used by the railways and consumers as fuel. But the former’s demand is
inelastic as compared to the latter’s. Technically, thus the demand for a multi use commodity in
those uses where marginal utility is low, the demand will be elastic.
4) Height of Price and Range of Price Change : There are certain goods like costly luxury items
or bulky goods such as refrigerators, T.V. sets etc., which are highly priced in general. In their
case, a small change in price will have an insignificant effect on their demand. Their demand
will, therefore, be elastic. However, if the price change is large enough, then their demand will
be elastic. Similarly, there are perishable goods like potatoes, onions etc., which are relatively
low priced and bought in bulk, so a small variation in their prices will not have much effect on
their demand, hence their demand tends to be inelastic.
5) Proportion of Expenditure : Items that constitute a smaller amount of expenditure in a
consumer’s family budget tend to have a relatively inelastic demand, e.g., a cinegoer who sees
a film every fortnight is not likely to give it up when the ticket rates are raised. But one who sees
a film every alternate day perhaps may cut down his number of films. So is the case with
matches, sugar, kerosene, etc. Thus, cheap or small, expensive or large expenditure items
tend to have more demand inelasticity than expensive or large expenditure items.

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6) Durability of the Commodity : In the case of durable goods, the demand generally tends to be
elastic, in the short run,e.g.. furniture ,bicycle, radio, etc. In the case of perishable commodities
, on the other hand, demand is relatively elastic, e.g. milk, vegetables, etc.
7) Habit : There are certain articles which have demand on account of habit and in these cases,
elasticity is less than unity, e.g. cigarettes to a smoker have inelastic demand.
8) Complementary Goods : Goods which are jointly demanded have less elasticity e.g., ink, petrol
have inelastic demand for this reason.
9) Time : In the short period, demand in general will be less elastic, while in the long period, it
becomes more elastic. This is because it takes some time for the news of a price change to
become known to all the buyers. Consumers may expect a further change, so they may not
react to an immediate change in price . People are reluctant to change their habits all of a
sudden. When durable goods are worn out, these are demanded more . Demand for a certain
commodities may be postponed for sometime, but in the long run , it has to be satisfied.
10) Recurrence of Demand : It the demand for a commodity is of a recurring nature , its price
elasticity is higher than that of a commodity which is purchased only once. For instance,
bicycles, tape recorders, transistors, etc are purchased only once, hence their price elasticity
will be less. But the demand for the fast-food item such as pizza, burger etc. would be more
price elastic.
II) Possibility of Postponement : When the demand for a product is postponable, it will tend to be
price elastic. In the case of consumption goods which are urgently and immediately required, their
demand will be in elastic.
INCOME ELASTICITY OF DEMAND
Income elasticity of demand shows the way in which a consumer’s purchase of any good changes as
a result of change in his income. It means the ratio of percentage change in the quantity demanded to
the percentage in income.
Ie = %change in demand/ %change In income
Degrees of Income Elasticity of Demand:
1) Positive Income elasticity of demand: It is said to occur when with the increase in the income
of the consumer, his demand for goods and services also increases and vice-versa. Income
elasticity of demand is positive in case of normal goods.

2) Negative Income elasticity of Demand: It is said to occur when increase in the income of the

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 consumer is accompanied by fall in demand of goods and services and vice-versa. It is the
case of giffen goods.

3) Zero Income elasticity of Demand: It is said to exist when increase or decrease in income has
no impact on the demand of goods and services.

In short income elasticity is greater than one for luxuries but less than one for necessaries.
CROSS ELASTICITY OF DEMAND
The responsiveness of demand to changes in prices of related commodities is called cross elasticity of
demand. Prof. Watson defines it as, “Cross elasticity of demand is the rate of change in quantity
associated with a change in the price of related goods.” Thus cross elasticity of demand is the
responsiveness of demand for commodity X to change in price of commodity Y.

24 MEWAR INSTITUTE
Types of Cross Elasticity of Demand
1) Positive Cross Elasticity of Demand: When goods are substitute of each other, then cross
elasticity of demand is positive. In other words, when an increase in the price of Y leads to an
increase in the demand of X.

e ofX
Pric

2) Negative Cross Elasticity of Demand: In case of Complementary goods, cross elasticity of

demand is negative. A proportionate increase in the price of one commodity leads to a
proportionate fall in the demand of another commodity because both are demanded jointly.

3) Zero Cross elasticity of Demand: Cross elasticity of demand is zero when two goods are not
related to each other. For instance, increase in the price of car does not effect the demand for
cloth. Thus cross elasticity is zero.

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CONCEPT OF REVENUE
The term revenue refers to the income obtained by a firm through the sale of goods at different prices.
In the words of Dooley, “The revenue of a firm is its sales, receipts or income.”
Total Revenue: The income earned by a seller or producer after selling the output is called the total
revenue. In fact, total revenue is the multiple of price and output.
TR = AR X Q
Average Revenue: It refers to the revenue obtained by the seller by selling the per unit commodity. It
is obtained by dividing the total revenue by total output.
AR= TR/Q
Or
AR=P and p=f(Q) is an average curve which shows that price is a function of quantity demanded. It is
also a demand curve.
Marginal Revenue: It is the net revenue obtained by selling an additional unit of a commodity.
In the words of Ferguson,” Marginal revenue is the change in total revenue which results from the
sale of one more unit of output.”

Or
MR= TRn-TRn-1
Relation Between AR and MR Curves
1. Under Ideal Rivalry – The average revenue curve is a horizontal straight line parallel to X axis
and the marginal revenue curve coincides with it. This is since under ideal rivalry the number of

26 MEWAR INSTITUTE
 firms selling an identical product is very huge. The price is determined the market forces of
supply and demand so that only one price tends to prevail for the whole industry.

In the diagram 1, each firm can sell as much it wishes at the market price OP. Thus the
demand for the firm’s product becomes infinitely elastic.
In the diagram 2, since the demand curve is the firm’s average revenue curve, the shape of AR
curve is horizontal to the X axis at price OP and the MR curve coincides with it. Any change in
the demand and supply circumstances will change the market price of the product and
consequently the horizontal AR curve of the firm.
2. Under Monopoly or Imperfect Competition: The average revenue curve is the downward
inclining industry demand curve and its related marginal revenue curve lies below it. The marginal
revenue is lower than the average revenue. Given the demand for his product the monopolist
can increase his sales by lowering the price, marginal revenue also falls but the rate of fall in
marginal revenue is greater than that in average revenue.

In the diagram 3, the MR curve falls below the AR curve and lie half a way on the perpendicular
drawn from AR to Y axis. This relation will always exist amidst straight line downward sloping AR
and MR curves.
In diagram 4, AR curve is convex to the origin, the MR curve will cut any perpendicular from a
point on the AR curve at more than half –way to he Y axis. MR passes to the left of the mid point
B on the CA.

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 Alternatively, if the AR curve is concave to the origin, MR will cut the perpendicular at less than
half way towards y axis, in the diagram 5, MR passes to the right of the mid point B on the CA.
3. Monopolistic Competition : The relationship between AR and MR is the same as under
monopoly. But there is an exclusion that the AR curve is more elastic and it is represented in the
diagram 6. This is since products are close substitutes under monopolistic competition. The
firm can hikes sales by a reduction in its price.
Importance of Revenue Costs
The AR and MR curves form significant tool for economic analysis.
 Profit Determinants – The A curve is the price line for the producer in all market situations. By
relating the AR curve to the AC curve of a firm, it can ascertain whether it is earning supernormal
or normal profits or incurring losses. If the AR curve is tangent to the AC curve at the point of
equilibrium, the firm earns normal profits. If the AR curve is above AC curve, it makes super
normal profits. In case, AR curve is below the AC curve at the equilibrium point, the firm incurs
losses.
 Determination of Full capacity – It can also be known from their relationship whether the firm
is producing at is full capacity or under capacity. If the AR curve is tangent to the AC curve at its
minimum point, under perfect rivalry, the firm produces its full capacity. Where it is not so, under
monopolistic competition, the firm posses idle capacity.
 Equilibrium Determination – The MR curve when intersected by the MC curve determines the
equilibrium position of the firm under all market conditions. Their point of intersection in fact
determines price, output, and profit and loss of a firm.
 Factor Pricing Determination – The use of the average marginal revenue helps in determining
factor prices. In factor pricing they are inverted U shaped and the average and marginal revenue
curves become the average revenue productivity and marginal revenue productivity curves ARP
and MRP, also they are useful device in describing the equilibrium of the firm under different
market conditions.
DEMAND FORECASTING
Demand forecasting entails forecasting and estimating the quantity of a product or service that consumers
will purchase in future. It tries to evaluate the magnitude and significance of forces that will affect future
operating conditions in an enterprise. Demand forecasting involves use of various formal and informal

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forecast techniques such as informed guesses, use of historical sales data or current field data
gathered from representative markets. Demand forecasting may be used in making pricing decisions,
in assessing future capacity requirements, or in making decisions on whether to enter a new market.
Thus, demand forecasting is estimation of future demand.
According to Cardiff and Still, “Demand forecasting is an estimate of sales during a specified future
period based on a proposed marketing plan and a set of particular uncontrollable and competitive
forces”. As such, demand forecasting is a projection of firm’s expected future demands.
IMPORTANCE OF DEMAND FORECAST
1. Management Decisions: An effective demand forecast facilitates the management to take
appropriate steps in factors that are pertinent to decision making such as plant capacity, raw-
material requisites, space and building requirements and availability of labour and capital.
Manufacturing schedules can be drafted in compliance with the demand requisites; in this
manner cutting down on the inventory, production and other related costs.
2. Evaluation: Demand forecasting furthermore smoothes the process of evaluating the efficiency
of the sales department.
3. Quality and Quantity Controls: Demand forecasting is an essential and valuable instrument in
the control of the management of an organisation to provide finished goods of correct quality
and quantity at the correct time with the least amount of expenditure.
4. Financial Estimates: As per the sales level as well as production functions, the financial
requirements of an organisation can be calculated using various techniques of demand
forecasting. In addition, it needs a little time to acquire revenue on practical terms. Sales
forecasts will, as a result, make it possible for arranging adequate resources on practical terms
and in advance as well.
5. Avoiding Surplus and Inadequate Production: Demand forecasting is necessary for the old
and new organisations. It is somewhat essential if an organisation is engaged in large scale
production of goods and the development period is extremely time-consuming in the course of
production. In such situations, an estimate regarding the future demand is essential to avoid
inadequate and surplus production.
6. Recommendations for the future: Demand forecast for a specific commodity furthermore
provides recommendations for demand forecast of associated industries.
7. Significance for the government: At the macro-level, demand forecasting is valuable to the
government as it aids in determining targets of imports as well as exports for various products
and preparing for the international business
METHODS OF DEMAND FORECASTING
Broadly speaking, there are two approaches to demand forecasting- one is to obtain information
about the likely purchase behavior of the buyer through collecting expert’s opinion or by conducting
interviews with consumers, the other is to use past experience as a guide through a set of statistical
techniques. Both these methods rely on varying degrees of judgment. The first method is usually found
suitable for short-term forecasting, the latter for long-term forecasting. There are specific techniques
which fall under each of these broad methods

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Sample Survey Method
1) Experts Opinion Poll: In this method, the experts are requested to give their ‘opinion’ or ‘feel’
about the product. These experts, dealing in the same or similar product, are able to predict the
likely sales of a given product in future periods under different conditions based on their
experience. If the number of such experts is large and their experience-based reactions are
different, then an average-simple or weighted –is found to lead to unique forecasts. Sometimes
this method is also called the ‘hunch method’ but it replaces analysis by opinions and it can thus
turn out to be highly subjective in nature.
2) Reasoned Opinion-Delphi Technique: This is a variant of the opinion poll method. Here is an
attempt to arrive at a consensus in an uncertain area by questioning a group of experts repeatedly
until the responses appear to converge along a single line. The participants are supplied with
responses to previous questions (including seasonings from others in the group by a coordinator
or a leader or operator of some sort). Such feedback may result in an expert revising his earlier
opinion. This may lead to a narrowing down of the divergent views (of the experts) expressed
earlier. The Delphi Techniques, followed by the Greeks earlier, thus generates “reasoned opinion”
in place of “unstructured opinion”; but this is still a poor proxy for market behavior of economic
variables.
3) End-user Method of Consumers Survey: Under this method, the sales of a product are
projected through a survey of its end-users. A product is used for final consumption or as an
intermediate product in the production of other goods in the domestic market, or it may be
exported as well as imported. The demands for final consumption and exports net of imports
are estimated through some other forecasting method, and its demand for intermediate use is
estimated through a survey of its user industries.
Complex Statistical Methods
1) Time series analysis or trend method: Under this method, the time series data on the under
forecast are used to fit a trend line or curve either graphically or through statistical method of
Least Squares. The trend line is worked out by fitting a trend equation to time series data with
the aid of an estimation method. The trend equation could take either a linear or any kind of non-
linear form. The trend method outlined above often yields a dependable forecast
The advantage in this method is that it does not require the formal knowledge of economic
theory and the market, it only needs the time series data. The only limitation in this method is
that it assumes that the past is repeated in future. Also, it is an appropriate method for long-run
forecasts, but inappropriate for short-run forecasts. Sometimes the time series analysis may
not reveal a significant trend of any kind. In that case, the moving average method or exponentially
weighted moving average method is used to smoothen the series
2) Barometric techniques or lead or leg methods: This consists in discovering a set of series
of some variables which exhibit a close association in their movement over a period or time.
For example, it shows the movement of agricultural income (AY series) and the sale of tractors
(ST series). The movement of AY is similar to that of ST, but the movement in ST takes place
after a year’s time lag compared to the movement in AY. Thus if one knows the direction of the
movement in agriculture income (AY), one can predict the direction of movement of tractors’
sale (ST) for the next year. Thus agricultural income (AY) may be used as a barometer (a

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 leading indicator) to help the short-term forecast for the sale of tractors.
Generally, this barometric method has been used in some of the developed countries for
predicting business cycles situation. For this purpose, some countries construct what are
known as ‘diffusion indices’ by combining the movement of a number of leading series in the
economy so that turning points in business activity could be discovered well in advance. Some
of the limitations of this method may be noted however. The leading indicator method does not
tell you anything about the magnitude of the change that can be expected in the lagging series,
but only the direction of change. Also, the lead period itself may change overtime. Through our
estimation we may find out the best-fitted lag period on the past data, but the same may not be
true for the future. Finally, it may not be always possible to find out the leading, lagging or
coincident indicators of the variable for which a demand forecast is being attempted.
3) Simultaneous equations Methods : Here is a very sophisticated method of forecasting. It is
also known as the ‘complete system approach’ or ‘econometric model building’. In your earlier
units, we have made reference to such econometric models. Presently we do not intend to get
into the details of this method because it is a subject by itself. Moreover, this method is normally
used in macro-level forecasting for the economy as a whole; in this course, our focus is limited
to micro elements only. Of course, you, as corporate managers, should know the basic elements
in such an approach.The method is indeed very complicated. However, in the days of computer,
when package programmes are available, this method can be used easily to derive meaningful
forecasts. The principle advantage in this method is that the forecaster needs to estimate the
future values of only the exogenous variables unlike the regression method where he has to
predict the future values of all, endogenous and exogenous variables affecting the variable under
forecast. The values of exogenous variables are easier to predict than those of the endogenous
variables. However, such econometric models have limitations, similar to that of regression
method.
The method is indeed very complicated. However, in the days of computer, when package
programmes are available, this method can be used easily to derive meaningful forecasts. The
principle advantage in this method is that the forecaster needs to estimate the future values of
only the exogenous variables unlike the regression method where he has to predict the future
values of all, endogenous and exogenous variables affecting the variable under forecast. The
values of exogenous variables are easier to predict than those of the endogenous variables.
However, such econometric models have limitations, similar to that of regression method.
WHAT IS SUPPLY ANALYSIS?
Supply Analysis is a research and analysis done to understand the supply trends and responses to
changing market and production variables. Supply Analysis takes into account the production costs,
raw material costs, technology, labour wages etc. The analysis helps the manufacturers and companies
to understand the impact of these variables on supply and eventually demand.
The goal of demand-supply chain is to make sure that the supply and demand work properly. The
demand should be met and supply should not be more than what expected. There are lot of variables
which are considered in demand analysis and supply analysis.
Importance of Supply Analysis
Supply Analysis helps manufacturers to analyse the impact of production changes, policies on increase

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or decrease in supply of finished goods. e.g. newer upcoming technology can help produce more
goods in same amount of time. The analysis can help determine if this new technology should be
adopted or not. Also if this technology can help produce more, is the demand there for more products.
What impact will it have on the current labour and how would be it impact supply in the market.
Another example can be impact of increase in wages in the market on supply. The labour cost would go
up and it will drive the costs of product along with it. If the supply has to be kept constant, the costs
would go up and if costs have to be kept constant the supply would go down hence driving the prices
up if the demand is unchanged. These are some questions which the supply analysis tries to answer.

Supply Analysis Parameters

Some of the key parameter which determine supply are:
1. Product's own price
2. Input prices
3. Technology
4. Expectations of the market
5. Number of producers present
Supply and demand, in economics, relationship between the quantity of a commodity that producers
wish to sell at various prices and the quantity that consumers wish to buy. It is the main model of price
determination used in economic theory. The price of a commodity is determined by the interaction of
supply and demand in a market. The resulting price is referred to as the equilibrium price and represents
an agreement between producers and consumers of the good. In equilibrium the quantity of a good
supplied by producers equals the quantity demanded by consumers.

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Supply curve
The quantity of a commodity that is supplied in the market depends not only on the price obtainable for
the commodity but also on potentially many other factors, such as the prices of substitute products, the
production technology, and the availability and cost of labour and other factors of production. In basic
economic analysis, analyzing supply involves looking at the relationship between various prices and the
quantity potentially offered by producers at each price, again holding constant all other factors that
could influence the price. Those price-quantity combinations may be plotted on a curve, known as a
supply curve, with price represented on the vertical axis and quantity represented on the horizontal axis.
A supply curve is usually upward-sloping, reflecting the willingness of producers to sell more of the
commodity they produce in a market with higher prices. Any change in non-price factors would cause a
shift in the supply curve, whereas changes in the price of the commodity can be traced along a fixed
supply curve.

Decrease in Supply
Illustration of an increase in equilibrium price (p) and a decrease in equilibrium quantity (q) due to a shift
in supply (S).

IMPORTANT QUESTIONS
Q.1. What is Demand? Explain the factors affecting demand. Also explain the law of demand.
Q.2. What is Price Elasticity of Demand? How can Price Elasticity of Demand be measured?
Q.3. Explain the concept of Revenue. What is the Relationship beween AR and MR?
Q.4. What is Demand Forecasting? What are the various methods of demand forecasting?

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