Business Economics

December 2022 Examination

1. Demand forecasting in an organization plays a vital role in business organizations. It

provides reasonable data for the organization's capital investment and expansion
decision. Keeping the above statement in consideration. Discuss the various steps
involved in demand forecasting.

Introduction:

Demand Forecasting in an organization play an important role in business organizations.

Every business involves certain risks and uncertainties especially in today’s world.
Demand forecasting is a combination of two words; the first one is demand and another
forecasting, demand means outside requirement of a product or service. And normally
forecasting means making an estimation in the present for a future occurring event.
Demand forecasting is a process of predicting the demand for an organisation’s products
or services in a specified time period in the future. Demand forecasting is helpful for both
new as well as existing organization in the market. A new organization needs to anticipate
demand to expand its scale of production. On the other hand, an existing organization
requires demand forecasts to avoid problems such as overproduction and
underproduction. Demand forecasting enables an organization to arrange for the required
inputs as per the predicted demand, without any wastage of materials and time.

Concept:

Demand Forecasting can be defined as a process of predicting the future figures of an

organization. It helps an organization to take various business decisions such as planning
the production process, purchasing raw materials, managing funds, and deciding the price
of its products. Demand can be forecasted by organizations either internally by making
estimates called guess estimate or externally through specialized market research
agencies.

There are three bases for performing demand forecasting, they are:
1. Level of forecasting
 Firm level
 Industry Level
 Economy Level
2. Time period Involved
 Short-term forecasting
 Long-term forecasting
3. Nature of periods
 Consumer Goods forecasting
 Capital Goods forecasting

Level of forecasting: Demand forecasting can be done at the firm level, industry level, or
economy level. At the firm level, the demand is forecasted for the products and services of an
individual organization in the future. For example: Demand for cement in India, demand for
clothes in India etc. At the industry level, the collective demand for the products and services
of all organization in a particular industry is forecasted. For example: demand for Birla
cement, demand for Raymond clothes, etc.

Time period involved: There are two type of duration for demand forecast first one is short-
term forecasting and second one is long-term forecasting.

Short-term forecasting: It involves 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. For example: Arranging finance, formulating production
policy, making promotional strategies, etc. of an organization.

Long-term forecasting: 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:
deciding the production capacity, replacing machinery, etc. of an organization.

Nature of products: Products can be categorized into consumer goods or capital goods on the
basis of their nature.

Consumer Goods: The goods that are meant for final consumption by end users are called
consumer goods. These goods have a direct demand. It is good for demand forecasting while
introducing a new product or replacing the existing product with an improved one.

Capital Goods: These goods are required to produce consumer goods; For example, raw
material. These goods have a derived demand; the demand forecasting of capital goods
depends on the demand for consumer goods. For example, prediction of higher demand for
consumer goods would results in the anticipation of higher demand for capital goods too.

Need for Demand forecasting

There are some needs for demand forecasting into the organization’s capital investment and
expansion decisions and they are:

 Producing the desired output

 Assessing the probable demand
 Forecasting sales figures
 Better control
 Controlling inventory
 Assessing manpower requirement
 Ensuring stability
 Planning import and export policies

Steps in Demand forecasting

To achieve the desired results, it is important that demand forecasting is done systematically
and there are some steps in demand forecasting they are:
  Specifying the objective: The purpose of demand forecasting needs to be specified
before starting the process. The objective can be specified before starting the process.
The objective can be specified on the following basis:
 Short-term or long-term demand for a product
 Industry demand or demand specific to an organization
 Whole market demand or demand specific to a market segment

 Determining the time perspective: Depending on the objective, the demand can be
forecasted for a short period (up to one year) or long period (beyond 10 years).

 Selecting the method for forecasting: Depending on the objective, time period, and
availability of data, the organization needs to select the most suitable forecasting method.
The selection of demand forecasting method also depends on the experience and
expertise of the demand forecaster.

 Collecting and adjusting data: After selecting the demand forecasting method, the
data needs to be collected. Data can be gathered either from primary or secondary
sources or both. As data collected in raw form so need to analyses data in a meaningful
information out of it.

 Interpreting the outcomes: After data analyzed, it is used to estimate demand for the
predetermined years.

Conclusion:

Demand forecasting is like an array application in an organization. It takes various business

decisions, such as planning the production process, purchasing raw materials, managing
funds, and through demand forecasting we decide the price of its products. Like as above I
have mentioned there are some bases like Level of forecasting, Time period and nature of
product. There is some need for the demand forecasting and there are some techniques as
well as criteria to do demand forecast. Like when we do demand forecasting there are some
effects like, it depends on the selection of an appropriate demand forecasting technique. In
demand forecasting, some limitation also they are a lack of historical sales data, unrealistic
assumption, cost incurred, change in fashion, lack of expertise and psychological factors. As
you can see when have something that change the things, that thing have advantages and
disadvantages also. So 1for demand forecasting there are advantages and disadvantages so
need to implement according to the organization. And what is best for the organization.

2. From the given hypnotical table Calculate Total Cost, Average Fixed Cost, Average
Variable cost and Marginal Cost.
Quantity Total Total Total Average Average Average Marginal
Fixed Variable Cost Fixed Cost Variable Total Cost Cost
Cost Cost Cost
0 100 0
1 100 20
2 100 30
3 100 40
4 100 50
5 100 60

Introduction:

From above hypnotical table, we have quantity, Total fixed cost and total variable
cost.
Total fixed cost is the amount of money a business must pay to keep their operations
running regardless of how many products they make and sell. Even if the firm does
not produce anything, its fixed costs would still remain the same. For example:
depreciation, administrative costs, rent of land and buildings, taxes, etc. TFC of a firm
that remain unchanged even though the firm’s output changes. However, if the time
period under consideration is long enough to make alterations in the firm’s capacity,
the fixed costs may also vary.
Total variable cost is the costs that are directly dependent on the output level of the
firm. In the other words, variable costs vary with the changes in the volume or level of
output. For example: Variable costs are labour expenses, maintenance costs of fixed
assets, routine maintenance expenditure, etc. However, the change in variable costs
with changes in output level may not necessarily be in the same proportion.

Concept:

Total Cost is the sum of total fixed cost and total variable cost.

Total Cost ( TC ) = Total Fixed Cost ( TFC ) + Total Variable Cost ( TVC )

Average Fixed Cost ( AFC ): is the fixed cost that does not change with the change in
the number of goods and services produced by a company. It is the fixed cost per unit
and is calculated by dividing the total fixed cost by the quantity level.

AFC = TFC/ quantity

 Average variable cost: is the cost per unit of output. This is found by dividing total
variable cost ( TVC ) by total quantity ( Q ). Total variable cost is all the costs that vary
with the output, such as material and labor.

AVC = TVC/ quantity

Average total cost ( ATC ): The average cost is the combination of total fixed and
variable costs, which is divided by the total number of units that are produced by the
firm.

ATC = TC/ Quantity

Marginal Cost ( MC ): It is the change in the total cost that arises when the quantity
produced is incremented, the cos of producing additional quantity. Like to an
increment of one unit of output, and in other to the rate of change of total cost as
output is increased by an amount. Marginal cost is different from average cost, which
is the total cost divided by the number of units produced. If a firm produced zero units
than the TVC is equal to zero too. This is because it indicated with the number of units
produced.
The marginal cost can be either a short-run or long-run marginal cost.

Short-Run marginal Cost ( SRMC ): SRMC refers to the change in short-run total cost
due to change in the firm’s output. On the short-run, the firm has some costs that are
fixed independently of the quantity of output Example: Buildings, machinery. In this
when a producer moves from zero units produced to the 1 st unit then the MC of the
1st unit is equal to TVC. This is because, in the short run MC equals to the change in
TVC.

Long-Run marginal Cost ( LRMC ): LRMC is defined as the length of the time in which
no input is fixed. Everything, including building size and machinery, can be chosen for
the quantity of output that is desired.

MC = dC/dQ

MC = Marginal Cost
dC = Change in Cost
dQ = Change in quantity
Marginal cost = Change in total cost/ Change in quantity
Conclusion:

Quantity Total Total Total Average Average Average Marginal

Fixed Variable Cost Fixed Cost Variable Total Cost Cost
Cost Cost Cost
0 100 0 100 0 0 0
1 100 20 120 100 20 120 20
2 100 30 130 50 15 65 10
3 100 40 140 33.33 13.33 46.666 10
4 100 50 150 25 12.5 37.5 10
5 100 60 160 20 12 32 10

3. a. Suppose the monthly income of an individual increases from Rs 20,000 to Rs 25,000

which increases his demand for clothes from 40 units to 60 units. Calculate the income
elasticity of demand.

Introduction:

The income of consumers is also an important determinant of the demand for the product.
An increase in the income of consumers increases the demand for the product even if the
price remains constant. The responsiveness of the quantity demanded with respect to the
income of consumers is called the income elasticity of demand.

Concept:
In mathematically, the income elasticity of demand can be stated as:

Ey = percentage change in quantity demanded/ Percentage change in income

Where,
Percentage change in quantity demanded =
New quantity demanded – Original quantity demanded ( d Q ) / Original quantity demanded
(Q)

Percentage change in income = New income- Original income ( dY ) / Original income ( Y )

Thus, the formula for calculating the price elasticity of demand is as follow:
Ey = dQ/dY * Y/Q
Where
Q is original quantity demanded
Q1 is new quantity demanded
dQ = Q1- Q
Y is original income
Y1 is new income
dY = Y1 – Y
Types of Income Elasticity of Demand
There are three type of income elasticity of demand and they are:
 Positive Income elasticity of demand

 Namely unitary income elasticity of demand

 Less than unitary income elasticity of demand
 More than unitary income elasticity of demand

 Negative Income elasticity of demand

 Zero Income elasticity of demand

Factors Influencing Income Elasticity of Demand

 Income of consumers in a country
 Nature of commodity
 Consumption pattern

Conclusion:

Numerical:

Y= Rs 20,000
Y1 = Rs 25,000
dY = 25,000 – 20,000 = 5000
Q = 40 units
Q1 = 60 units
dQ = 60 – 40 = 20 units

The formula for calculating the income elasticity of demand is:

Ey = dQ/dY * Y/Q

Ey = 20/5000 * 20,000/40

Ey = 2

Ey > 1

b. Assume that a business firm sells a product at the price of Rs 500. The firm has decided to
reduce the price of the product to Rs 400. Consequently, the demand for the product is raised
from 20,000 units to 25,000 units. Calculate the price elasticity of demand.

Introduction:
Price elasticity of demand is a measure of a change in the quantity demanded of a product
due to change in the price of the product in the market. The ratio of the percentage changes
in quantity demanded to the percentage change in price. It can be mathematically expressed
as:

Concept:

Price elasticity of Demand = Percentage change in quantity demanded/ percentage change in

price
Thus, the formula for calculating the price elasticity of demand is as follow:

Ep = dQ/dP * P/Q
Where,
Ep = Price elasticity of demand
P = Initial price
dP = Change in price
Q = Initial quantity demanded
dQ = Change in quantity demanded

Types of Price elasticity

There are different type of price elasticity and they are:
 Perfectly Elastic Demand
 Perfectly Inelastic Demand
 Relatively Elastic Demand
 Relatively Inelastic Demand
 Unitary Elastic Demand

Factors Influencing Price Elasticity of Demand

 Relative Need for the product
 Availability of substitute goods
 Impact of income
 Time under consideration
 Perishability of the product
 Addiction

Conclusion:

Numerical:

P = Rs 500
dP = Rs 100 ( Rs 500 - Rs 400 = 100 )
Q = 20,000 units
dQ = 5000 (25,000 – 20,000 = 5000 )

Ep = dQ/dP * P/Q

Ep = 5000/100 * 500/20,000

Ep = 1.25