CC-2 Economics Analysis for Business Decisions

UNIT-1 INTRODUCTION TO BUSINESS ECONOMICS AND DEMAND

ANALYSIS.

Q. Explain managerial economics its meaning, Nature & Scope?

:- Businesses run on various theories that are explained in Economics. Managerial Economics is
the stream of management studies that emphasizes solving problems in businesses using the
theories in micro and macroeconomics. This branch of economics is used by firms to not only
find a solution to problems in daily running but also for long-term planning. We can also say that
Managerial economics is a practical application of theories in economics.

“Managerial economics is concerned with the application of economic concepts and

economic analysis to the problems of formulating rational managerial decisions.”
- Edwin Mansfield, Economics Professor, University of Pennsylvania
We should also look here at What is economics? Economics is an inevitable part of any business.

All the business assumptions, forecasting, and investments are based on this one single concept.

“Economics is a social science concerned with the production, distribution, and

consumption of goods and services. It studies how individuals, businesses, governments,

and nations make choices about how to allocate resources.” So, theories in economics are not

just some statements written but rather they act as fuel for a firm. In the broader picture,

economics also helps nations in policy formation.

Definition of Managerial Economics

Managerial economics is defined as the branch of economics which deals with the

application of various concepts, theories, methodologies of economics to solve practical

problems in business management.
It is also reckoned as the amalgamation of economic theories and business practices to ease the

process of decision making. Managerial economics is also said to cover the gap between the

problems of logic and problems of policy.

Managerial economics is used to find a rational solution to problems faced by firms. These

problems include issues around demand, cost, production, marketing, and it is used also for

future planning. The best thing about managerial economics is that it has a logical solution to

almost every problem that may arise during business management and that too by sticking to the

microeconomic policies of the firm.

When we talk of managerial economics as a subject, it is a branch of management studies

that emphasizes solving business problems using theories of micro and macroeconomics.

Spencer and Siegelman have defined the subject as “the integration of economic theory with

business practice to facilitate decision making and planning by management.” The study of

managerial economics helps the students to enhance their analytical skills, developing a mindset

that enables them to find rational solutions.

Nature & Scope of Managerial Economics

Scope of Managerial Economics
Managerial Economics provides strategic planning tool that helps in analyzing the
problem and formulating rational managerial decisions. Decision making is a crucial
aspect in any business problem. It is an evolutionary science which correlates the
understanding and application of economic knowledge with the emerging business
problems in the economy. The basic business problems that arise in any decision
making or forward planning process involves operational and environmental
issues.

Resource Allocation- Managerial economics is First and foremost, like traditional

economic theory is concerned with the problem of optimum allocation of resources.
The problem of determining optimum level of output that maximizes profit is taken
care by the marginal analysis. On should ensure the most effective use of scare
resources to get the optimal results. Linear programming technique is the most
effective tool in decision making used to solve optimization problems.

Demand Estimation- It is very important for the Firm to accurately estimate the
market demand and to cater to the respective demand at the right time with right
quantity. The basic understanding of demand is crucial for demand forecasting or
demand estimation. Demand analysis helps to identify the factors responsible for
influencing the market demand. There are many factors that contribute in influencing
the market demand, namely, income of an individual, price of the commodity and
price of the related goods and many more. It has increasing becoming easy to forecast
the demand with the help of many computer software like SPSS, SAS etc.

Managing Inventory and handling Queuing problem- Managing inventory

requires the correct estimation about the holding of the inventory stocks of raw
material and also of the finished goods over time. These decisions are based upon
the demand analysis by considering the demand and supply conditions. For instance,
suppose a firm expects a rise in the future demand for its product, it has to plan
accordingly, whether it need to hire more labors or need to install more machinery, to
cope with the increased demand. Such problems are termed as queuing problems.

Cost Analysis – Cost analysis is a very crucial in decision making. Pricing policy
along with the cost analysis forms the base of profit planning. It also deals with the
concept of cost benefit analysis.

Pricing and Competitive strategy- Pricing plays a very crucial role when you are
not the only supplier of a good in the market. The pricing strategy depends on the
type of market structure, may be oligopolistic, monopolistic or monopoly market.
Price theory explains how the prices are determined in these different markets.
Competitive strategy anticipates price determination by taking into consideration
other players, strategies regarding pricing, advertising and marketing.

Profit Analysis – Economist defines profit as the reward for uncertainty bearing and
risk taking abilities. The manger is successful if it can reduce uncertainty and earn
higher profits. Profit estimating and measuring is the most challenging aspect of
managerial economics. Profit earning is the main yardstick to measure the success
of a firm in the long run.

The Nature of Managerial Economics:

1. It analyses towards solving business problems, constitutes the subject- matter of
Managerial Economics.
2. It helps in decision making and forward planning.
3. The problem of choice arises because resources are limited and the firm has to make the
most profitable use of these resources.
4. As future is unpredictable, a business manager’s task is to prepare the best possible plans
for the future depending on past experience and future outlook.
5. It assists the managers of the firm in a rotational solution of obstacles faced in the firm’s
activities.
6. It helps in formulating logical managerial decisions.
7. It lessens the gap between economics in theory and economics in practice.
8. It guides the managers in taking decisions relating to the firm’s customers, competitors,
supplier as well as relating to the internal function of the firm.
9. It makes use of statistical and analytical tools to assess economics theories in solving
practical business problem.
10. It helps in enhancement of analytical skills, assists in rational configuration as well as
solution of problems.
Q. What is the Role of managers in decision making?
: Business firms are a combination of manpower, financial and physical resources which helps in
making managerial decisions. Societies can be classified into two main categories – production
and consumption. Firms are the economic entities and are on the production side, whereas
consumers are on the consumption side.
The performance of firms gets analyzed in the framework of an economic model. The economic
model of a firm is called the theory of the firm. Business decision include many vital decisions
like whether a firm should undertake research and development program, should a company
launch a new product, etc.
Business decisions made by a managers are very important for the success and failure of a firm.
Complexity in the business world continuously grows making the role of a manager or a decision
maker of an organization more challenging! The impact of goods production, marketing and
technological changes highly contributes to the complexity of the business environment.

Steps for Decision-Making

The steps for decision making like problem description, objective determination, discovering
alternating, forecasting consequences are described below:

Define the Problem

Determine the Objective

Discover the Alternatives

Forecast the Consequences

Make a Choice
Business Decision Making Steps.
 Define the Problem: - What is the problem and how does it influence managerial
objectives are the main questions. Decisions are made in the firm’s planning process.
Managerial Decision are at times not very well defined and thus are sometimes source of
a problem.

 Determine the Objective: - The Goal of an organization or decision maker is very

important. In practice, there may be very problems while setting the objective of a firm
related to profit maximization and benefit cost analysis. Are the future benefits worth the
present capital? Should a firm make an investment for higher profits for over 8-10 years?
These are the questions asked before determining the objectives of a firm.

 Discover the Alternatives: - For a sound decision framework, there are many questions
which are needed to be answered such as – What are the alternatives? What factor are
under the decision maker’s control? What variables constrain the choice of options? The
manager needs to carefully formulate all such questions in order to weigh the attractive
alternatives.

 Forecast the Consequences: - Forecasting or predicting the consequences of each

alternative should be considered. Conditions could change by applying each alternative
action so it is crucial to decide which alternative action to use when outcomes are
uncertain.

 Make a Choice: - Once all the analysis and scrutinizing is completed, the preferred
course of action is completed. This step of the process is said to occupy the lion’s share in
analysis. In this, steep the objectives and the outcomes are directly quantifiable. It all
depends on how the decision maker puts the problem, how he formalize the objectives,
considers the appropriate alternatives, and find out the most preferable course of action.

 Sensitivity Analysis: - Sensitivity Analysis helps us in determining the strong features of

the optimal choice of action. It helps us to know how the optimal decision changes, if
conditions related to the solutions are altered. Thus, it proves that the optimal solution is
affected, if the important factors vary or are altered.
Managerial Economics is competent enough for serving the purposes in decision making.
It focuses on the theory of the firm which considered profit maximization as the main
objective.
Q. Explain Meaning and Definition of Demand?
The success of a business largely depends on sales. Sales depend on market demand behaviour
Market demand analysis is a core topic in managerial economics, for it seeks to search out and
measures the determinants of demand, thus, forces governing sales of a product.
Market Demand analysis serves the following managerial purposes
 It is an important technique for sales forecasting with a sound base and greater accuracy.
 It provides a guideline for demand manipulation through advertising and sales promotion
programmes.
 It shows direction to product planning and product improvement.
 It is useful in determining the sales quotas and appraisal of performance of the personnel
in Sales Department.
 It is an anchor for the pricing policy.
 It indicates the size of the market for given product and the market share of the concerned
firm.
 It thus, reflects the scope of business expansion and competitive position of the firm in
market trend.
For these reasons, demand analysis is essential for successful production planning and business
expansion in managerial decision making.
We shall, therefore, learn the basic concept, law and theory of demand to understand consumer
behaviour first, and then discuss the main ideas about demand elasticity, demand estimation and
demand forecasting as applied in business decision making.

MEANING OF DEMAND
Ordinarily, by demand is meant the desire or want for something. In economics, however,
demand means much more than that. The economics meaning of demand refers the effective
demand. tr., the amount the buyers are willing to purchase at a given price and over a given
period of time. From managerial economics point of view, thus, the concept of demand may be
looked upon as follows:
1. Demand is the Desire or Want Backed up by Money. Demand means effective desire
or want for a commodity, which is backed up by the ability (i.e., money or purchasing
power) and willingness to pay for it.

Obviously, to a businessman, a buyer's wish for the product without possessing money to
buy it or unwillingness to pay a given price for it will not constitute a demand for it. For
instance, a pauper's wish for a Maruti car will not constitute its potential market demand,
as he has no ability to pay for it Likewise, a miser's desire for the same, however rich he
may be, will not become an effective demand when he is unlikely to spend the money for
the fulfilment of that desire.
In short:
Demand Desire + Ability to pay (Le., Money or Purchasing Power) + Will to spend

2. Demand is Always Related to Price and Time. Demand is not an absolute term. It is a
relative concept. Demand for a commodity should always have a reference to price and time. For
instance, an economist would say that the demand for grapes by a household, at a price of Rs.40
per kg, is 10 kilograms per week.
Economists always mention the amount of demand for a commodity with reference to a
particular price and specific time period, such as per day, per week, per month or per year. They
are not concerned over with a single isolated purchase, but with a continuous flow of purchase".
In economics studies, therefore, demand is expressed 'as so much per period of time-one million
oranges per day, say, or seven million oranges per week, or 365 million per year'.
We may, thus, define demand as follows:
Definition of Demand. “The demand for a product refers to the amount of it which will be
bought per unit of time at a particular price”.

3. Demand may be Viewed Ex-Ante or Ex-Post. Demand for a commodity may be viewed as
ex-ante, i.e., intended demand or ex-post, i.e.. what is already purchased. The former denotes
potential demand, while the latter refers to the actual amount purchased.

Q. Explain 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 the 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 then they use each additional unit of the
good to serve successively lower-valued ends.

 The law of demand is a fundamental principle of economics that 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 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 that obtains a six-pack of bottled,
freshwater washed up onshore. 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.
Law of Demand Important
Together with the Law of Supply, the Law of Demand helps us understand why things are
priced at the level that they are, and to identify opportunities to buy what are perceived to be
underpriced (or sell overpriced) products, assets, or securities. For instance, a firm may boost
production in response to rising prices that have been spurred by a surge in demand.

Q. Explain Elasticity of Demand and its types?

Meaning of Elasticity

Elasticity can be defined as a measure of variable sensitivity to the change in another variable.
This sensitivity is the change in price, which is related to change in other factors. From a business
and economic point of view, it is a measure of how sensitive an economic factor is to another.

For example, changes in the prices of supply or demand, or changes in demand to changes in
income. Examples of elastic goods are clothing and electronics; inelastic goods include items like
prescribed drugs, food. It is used to measure the change in quantity demanded of goods or services
when compared to the price movements of those goods and services.

Elasticity of Demand.
As per the elasticity of demand definition, the demand contracts or extends with rising or fall in
the prices. This quality of demand is called Elasticity of Demand when the change in its virtue and
the price changes (low or high). The change sensitiveness may be small or less in the elasticity of
demand.
Let us take an example to have a better understanding of the concept. If we take salt, even a big
fall in demand cannot affect the fall of its appreciable extension in its demand. Similarly, if we
observe a slight fall in the prices of oranges, there will be a considerable change in its demand.
The elasticity of demand may be more or less, but it is always perfectly elastic or inelastic.

Types of Elasticity of Demand

There are four types of elasticity of demand mainly as given in the following.

1) Price Elasticity of Demand

It is defined as the responsiveness and sensitivity of a particular product along with the changes in
its price. It shows the relationship between price and quantity that provides a calculator of the price
effect in price quantity of demand.
The below equation calculates the price changes depending on the number of demands and the
revenue received by firms before and after any changes.

Ep= Proportionate change in Quantity Demanded

Proportionate change in Price

There are different types of price elasticity of demand i.e., 1) perfectly elastic demand, 2) perfectly
inelastic demand, 3) relatively elastic demand, 4) relatively inelastic demand, and 5) unitary elastic
demand.

2) Income Elasticity of Demand

Income is one of the factors that influence the demand for a product. The degree of responsiveness
of a change in demand for the product of the change in demand for the product due to change in
income is known as Income elasticity of demand.

Ey= Percentage Change in Demand for a product

Percentage change in Income

More income means more demand vice versa.
3) Cross Elasticity of Demand

It is defined as a change in the quantity of demand for one commodity to the change in the quantity
of demand for other commodities is called cross elasticity of demand. Usually, this type of demand
arises with the involvement of interrelated goods such as substitutes and complementary goods.

Ec= Proportionate Change in Purchase of Commodity X

Proportionate Change in Purchase of Commodity Y

For example, if two commodities are called substitutes, when the price of one commodity falls,
the demand for another commodity decreases. If the price of one commodity rises in demand, so
does the price of another commodity, such as tea and coffee.

4) Advertising Elasticity of Demand

It is defined as the responsiveness of the change in demand to the change in promotional expense
is known as the advertising elasticity of demand. It can be expressed by using below the elasticity
of demand formula.

Ec = Proportionate Change in Demand

Proportionate Change in Advertising Expenditure

Numerically,

Ea= Q2−Q1
(A2 + A1)
Q2+Q1

A2−A1

Where,
Q1 = Original Demand
Q2 = New Demand
A1 = Original Advertisement outlay
A2 = New Advertisement Outlay
Q. Explain Meaning and Definition of Supply?
MEANING OF SUPPLY
In economics, supply during a given period of time means the quantities of goods which are
offered for sale at particular prices. Thus, the supply of a commodity may be defined as the
amount of that commodity which the sellers (or producers) are able and willing to offer for
sale at a particular price during a certain period of time.
Supply is a relative term. It is always referred to in relation to price and time. A statement
of supply without reference to price and time conveys no economic sense. For instance, a
statement such as the supply of milk is 500 litres' is meaningless in economic analysis. One
must say, "the supply at such and such a price and during a specific period. Hence, the
above statement becomes meaningful if it is said at the price of Rs. 20 per litre, a dairy
farm's daily supply of milk is 500 litres. Here, both price and time are referred to with the
quantity of milk supplied.
Secondly, supply is what the seller is able and willing to offer for sale. The ability of a seller
to supply a commodity, however, depends on the stock available with him. Thus, stock is
the determinant of supply Similarly, another determining factor is the will of the seller. A
seller's willingness to supply a commodity, however, depends on the difference between the
reservation price and the prevailing. market price or the price which is offered by the
buyer for that commodity. If the ruling market price is greater than the seller's reservation
price, he (the seller) is willing to sell more. But at a price below the reservation price. the
seller refuses to sell. In short, supply always means supply at a given price At different
prices, the supply may be different. Normally, the higher the price, the greater the supply
and vice versa.

Definition:
“Supply is an economic term that refers to the amount of a given product or service
that suppliers are willing to offer to consumers at a given price level at a given
period”.
The factors of supply for a given product or service is related to:

 the price of the product or service

 the price of related goods or services
 the prices of production factors
 the price of inputs
 the number of production units
 production technology
 expectations of producers
 government policies
 random, natural or other factors
When the price of a product is low, the supply is low. When the price of a product is high, the
supply is high. This makes sense because companies are seeking profits in the market place.
They are more likely to produce products with a higher price and likelihood of producing profits
than not.
Supply and demand trends form the basis of the modern economy. Each specific good or service
will have its own supply and demand patterns based on price, utility and personal preference. If
people demand a good and are willing to pay more for it, producers will add to the supply. As
the supply increases, the price will fall given the same level of demand. Ideally, markets will
reach a point of equilibrium where the supply equals the demand (no excess supply and no
shortages) for a given price point; at this point, consumer utility and producer profits are
maximized.

Q. Explain Law of Supply?

The law of supply reflects the general tendency of the sellers in offering their stock of a
commodity for sale in relation to the varying prices.

It describes seller’s supply behaviour under given conditions. It has been observed that usually
sellers are willing to supply more with a rise in prices.

The law of supply may be written as follows:

“Other things remaining unchanged, the supply of a commodity rises i.e., expands with a rise in
its price and falls i.e., contracts with a fall in its price.

In other-words, it can be said that—”Higher the price higher the supply and lower the price
lower the supply.”

The law thus suggests that the supply varies directly with the change in price. So, a larger
amount is supplied at a higher price that at a lower price in the market.

Explanation of the Law:

This law can be explained with the help of a supply schedule as well as by a supply curve based
on an imaginary figures and data.
This can be shown by diagram as follows:

Here, in this diagram the supply curve SS is sloping upward. It suggests with the supply
schedule, that the market supply tends to expand with the rise in price and vice-versa. Similarly,
the upward slopping curve also depicts a direct co-variation between price and supply.

This law can be shown in this way also.

In the figure above OX axis shows quantity of demand and OY axis shows price. SS 1 line is the
line of supply when the price of the commodity is OP then quantity of supply is OQ.
When the price rises from OP to OP2 and then supply also rises from OQ to OQ2. Similarly, if
price is reduced from OP to OP1, then supply will reduce from OQ to OQ1.
By seeing the diagram the conclusion can be drawn that when price rises supply increases and
when the price reduces the supply reduces.
Assumptions Underlying the Law of Supply:
Important assumptions of the law of supply are as follows:
1. No change in the income:
There should not be any change in the income of the purchaser or the seller.

2. No change in technique of production:

There should not be any change in the technique of production. This is essential for the cost to
remain unchanged. With the improvement in technique if the cost of production is reduced, the
seller would supply more even at falling prices.

3. There should be no change in transport cost:

It is assumed that transport facilities and transport costs are unchanged. Otherwise, a reduction in
transport cost implies lowering the cost of production, so that more would be supplied even at a
lower price.

4. Cost of production be unchanged:

It is assumed that the price of the product changes, but there is no change in the cost of
production. If the cost of production increases along with the rise in the price of product, the
sellers will not find it worthwhile to produce more and supply more. Therefore, the law of supply
will be valid only if the cost of production remains constant. It implies that the factor prices such
as wages, interest, rent etc., are also unchanged.

5. There should be fixed scale of production:

During a given period of time, it is assumed that the scale of production is held constant. If there
is a changing scale of production the level of supply will change, irrespective of changes in the
price of the product.

6. There should not be any speculation:

The law also assumes that the sellers do not speculate about the future changes in the price of the
product. If, however, sellers expect prices to rise further in future, they may not expand supply
with the present price rise.

7. The prices of other goods should remain constant:

Further, the law assumes that there are no changes in the prices of other products. If the price of
some other product rises faster than that of the product in consideration, producers might transfer
their resources to the other product—which is more profit yielding due to rising prices. Under
this situation and circumstances, more of the product in consideration may not be supplied,
despite the rising prices.

8. There should not be any change in the government policies:

Government policy is also important and vital for the law of supply. Government policies like—
taxation policy, trade policy etc., should remain constant. For instance, an increase in or totally
fresh levy of excise duties would imply an increase in the cost or in case there is fixation of
quotas for the raw-materials or imported components of a product, then such a situation will not
permit the expansion of supply with a rise in prices.

Exceptions to the Law of Supply or Backward-Slopping Supply Curve:

As we have seen from the study above that supply of a commodity varies directly with its price.
But in some exceptional cases where supply may tend to fall with the rise in price or tend to rise
with the fall in price.

Such exceptional cases may be described as follows:

1. Exceptions about Future Price:
In this connection if the seller expects a rise in the price in future, he may withhold his stock of
the commodity. He will therefore reduce his supply in the market at the present price. Similarly,
if he expects a further fall in price in future, he will try to dispose of the commodity and will
supply more even at a lower price.

2. Supply of Labour:
Supply of labour after a certain point, when the wage rate rises, its supply will tend to diminish.
Why such situation because workers normally prefer leisure to work after receiving a certain
amount of wage.

3. Rate of Interest and Savings Position:

When there is rise in the interest rate, more savings are induced. But after a certain point of rise
in the rate of interest households may tend to save less than before due to high income from the
interest. In that case savings tend to decline even with a rise in the rate of interest.

From the points written above we can observe that the supply tends to fall with a rise in prices at
a point. This paradoxical situation of supply behaviour is represented by a backward sloping or
regressive supply curve over a part of its length as shown in the figure given below:
In this diagram SS’ shows the relationship of supply with price. Backward slopping supply curve
BS ‘ part represents supply curve is bending at B. This curve is also known as an “Exceptional
Supply Curve” as such a thing happens only in some exceptional cases like—labour supply or
savings.

Further, in this diagram SBS’ represents a backward slopping supply curve for labour as a
commodity. Here the wage rate has been regarded as the price of labour and the labour supply is
determined in terms of Labour-Hours the worker is willing to work at a given wage rate. It has
been observed that as wages increase, a worker might work for a lesser number of hours than
before.

For example:
When the wage rate is Rs. 5 per hour, the worker works for 50 hours per week and gets Rs. 250,
when it is Rs. 6 per hour, he works for 60 hours per week and gets Rs. 360 at Rs. 8 he works for
65 hours and gets Rs. 520 and at Rs. 10, he works 55 hours and gets Rs. 550.

Q. Explain Meaning & Types of Demand Forecasting?

Demand forecasting is a combination of two words; the first one is Demand and another forecasting.
Demand means outside requirements of a product or service. In general, forecasting means making
an estimation in the present for a future occurring event. Here we are going to discuss demand
forecasting and its usefulness.

Demand Forecasting

It is a technique for estimation of probable demand for a product or services in the future. It is based
on the analysis of past demand for that product or service in the present market condition. Demand
forecasting should be done on a scientific basis and facts and events related to forecasting should be
considered.

Therefore, in simple words, we can say that after gathering information about various aspect of
the market and demand based on the past, an attempt may be made to estimate future demand. This
concept is called forecasting of demand.
Accurate demand forecasting is essential for a firm to enable it to produce the required quantities
at the right time and arrange well in advance for the various factors of production.

According to Henry Fayol, “the act of forecasting is of great benefit to all who
take part in the process and is the best means of ensuring adaptability to
changing circumstances. The collaboration of all concerned lead to a unified
front, an understanding of the reasons for decisions and a broadened
outlook”.
For example, suppose we sold 200, 250, 300 units of product X in the month of January, February,
and March respectively. Now we can say that there will be a demand for 250 units approx. of product
X in the month of April, if the market condition remains the same.

Usefulness of Demand Forecasting

Demand plays a vital role in the decision making of a business. In competitive market conditions,
there is a need to take correct decision and make planning for future events related to business like a
sale, production, etc. The effectiveness of a decision taken by business managers depends upon the
accuracy of the decision taken by them.

Demand is the most important aspect for business for achieving its objectives. Many decisions of
business depend on demand like production, sales, staff requirement, etc. Forecasting is the
necessity of business at an international level as well as domestic level.

Demand forecasting reduces risk related to business activities and helps it to take efficient decisions.
For firms having production at the mass level, the importance of forecasting had increased more. A
good forecasting helps a firm in better planning related to business goals.

There is a huge role of forecasting in functional areas of accounting. Good forecast helps in
appropriate production planning, process selection, capacity planning, facility layout planning, and
inventory management, etc.

Demand forecasting provides reasonable data for the organization’s capital investment and
expansion decision. It also provides a way for the formulation of suitable pricing and advertisement
strategies.

Following is the significance of Demand Forecasting:

 Fulfilling objectives of the business

 Preparing the budget

  Taking management decision

 Evaluating performance etc.

Moreover, forecasting is not completely full of proof and correct. It thus helps in evaluating various
factors which affect demand and enables management staff to know about various forces relevant to
the study of demand behavior.

The Scope of Demand Forecasting

The scope of demand forecasting depends upon the operated area of the firm, present as well as
what is proposed in the future. Forecasting can be at an international level if the area of operation is
international. If the firm supplies its products and services in the local market then forecasting will
be at local level.

The scope should be decided considering the time and cost involved in relation to the benefit of the
information acquired through the study of demand. Cost of forecasting and benefit flows from such
forecasting should be in a balanced manner.

Types of Forecasting
There are two types of forecasting:

 Based on Economy

 Based on the time period

1. Based on Economy
There are three types of forecasting based on the economy:

i. Macro-level forecasting: It deals with the general economic environment relating to the
economy as measured by the Index of Industrial Production(IIP), national income and
general level of employment, etc.

ii. Industry level forecasting: Industry level forecasting deals with the demand for the
industry’s products as a whole. For example demand for cement in India, demand for clothes
in India, etc.

iii. Firm-level forecasting: It means forecasting the demand for a particular firm’s product. For
example, demand for Birla cement, demand for Raymond clothes, etc.
 2. Based on the Time Period
Forecasting based on time may be short-term forecasting and long-term forecasting

i. Short-term forecasting: It covers a short period of time, depending upon the nature of the
industry. It is done generally for six months or less than one year. Short-term forecasting is
generally useful in tactical decisions.

ii. Long-term forecasting casting: Long-term forecasts are for a longer period of time say, two
to five years or more. It gives information for major strategic decisions of the firm. For
example, expansion of plant capacity, opening a new unit of business, etc.

Q. Explain Importance of Demand Forecasting?

The importance of demand/sales forecasting can be understood by the following lines:

1. Helpful in deciding the number of salesmen required to achieve the sales objective.

2. Determination of sales territories.

3. To determine how much production capacity to be built up.

4. Determining the pricing strategy.

5. Helpful in deciding the channels of distribution and physical distribution decision.

6. To decide to enter a new market or not.

7. To prepare standard against which to measure performance.

8. To assess the effect of a proposed marketing programme.

9. To decide the promotional mix.

10. Helpful in the product mix decisions relating to width and length of product line.