UNIT-I

INTRODUCTION TO BUSINESS ECONOMICS, DEMAND

ANALYSIS

DEFINITION OF ECONOMICS

According to Robbins defines-

"Economics is the science which studies human behavior as a relationship between ends
and scarce means which have alternative uses."

The above definition can be explained in the following:

• Economics is the science- which studies human behavior in a scientific manner.

Economics is a social science concerned with the production, distribution, and
consumption of goods and services.

• Relationship – it shows the relationship between ends and scarce.

• Ends- it refers to wants. Human wants are unlimited. When one want is satisfied then
another want is crop up.

• Scarce- it means resources being finite and limited. If resources are limited, an economic
problem arises. If resources are unlimited there is no economic problem.

• Alternative uses- alternative use of resources means simply the different ways in which

a resource can be used.

Example- the alternative uses of land are-

1. it can be used to grow crops.

2. it can be used to build school.

BRANCHES OF ECONOMICS

• Micro Economics
• Macro Economics
 MICRO ECONOMICS - which focuses on the behavior of individual consumers and
producers?

• The term micro economics is derived from the “Greek” word “Mikros” it means

“ Small”.

• Micro economics is very useful for a managers in taking so many decisions of a firm such
as demand analysis and estimation, demand forecasting, production analysis, cost
analysis, pricing under various market structures, profit management etc.

MACRO ECONOMICS - which examine overall economies on a regional, national, or

international scale.

• The term Macro Economics is derived from the “Greek” word “Makros” it means

“ Large”.

• In Macro Economics, we study the economic behaviour of the large aggregates such as
overall conditions of the economy like total savings, total investments, total production
and total consumption etc.

• MANAGEMENT- It is an art of getting things done by the others.

According to “W.F.Glueck” defined, “Management is effective utilization of

human and material resources to achieve the enterprise objectives.

• BUSINESS ECONOMICS –

Managerial Economics is defined as application of economic principles to solve

different management problems such as how to earn more profits with the given limited
resources.
NATURE OF BUSINESS ECONOMICS

• Art and Science: Managerial economics requires a lot of logical thinking and creative
skills for decision making or problem-solving. It is also considered to be a stream of
science by some economist claiming that it involves the application of different economic
principles, techniques and methods, to solve business problems.

• Micro Economics: In managerial economics, managers generally deal with the problems
related to a particular organization instead of the whole economy. Therefore it is
considered to be a part of microeconomics.

• Uses Macro Economics: A business functions in an external environment, i.e. it serves

the market, which is a part of the economy as a whole. Therefore, it is essential for
managers to analyze the different factors of macroeconomics such as market conditions,
economic reforms, government policies, etc. and their impact on the organization.

• Multi-disciplinary: It uses many tools and principles belonging to various disciplines

such as accounting, finance, statistics, mathematics, production, operation research,
human resource, marketing, etc.

• Prescriptive / Normative Discipline: It aims at goal achievement and deals with

practical situations or problems by implementing corrective measures.
 • Management Oriented: It acts as a tool in the hands of managers to deal with business-
related problems and uncertainties appropriately. It also provides for goal establishment,
policy formulation and effective decision making.

• Pragmatic: It is a practical and logical approach towards the day to day business
problems.

SCOPE OF BUSINESS ECONOMICS

• Micro-Economics Applied to Operational Issues

To resolve the organization’s internal issues arising in business operations, the various
theories or principles of microeconomics applied are as follows:

• Theory of Demand: The demand theory emphasizes on the consumer’s behavior towards
a product or service. It takes into consideration the needs, wants, preferences and
requirement of the consumers to enhance the production process.

• Theory of Production and Production Decisions: This theory is majorly concerned

with the volume of production, process, capital and labour required, cost involved, etc. It
aims at maximising the output to meet the customer’s demand.

• Pricing Theory and Analysis of Market Structure: It focuses on the price

determination of a product keeping in mind the competitors, market conditions, cost of
production, maximising sales volume, etc.
 • Profit Analysis and Management: The organisations work for a profit. Therefore they
always aim at profit maximisation. It depends upon the market demand, cost of input,
competition level, etc.

• Theory of Capital and Investment Decisions: Capital is the most critical factor of
business. This theory prevails the proper allocation of the organisation’s capital and
making investments in profitable projects or venture to improve organisational efficiency.

Macro-Economics Applied to Business Environment

Any organisation is much affected by the environment it operates in. The business
environment can be classified as follows:
• Economic Environment: The economic conditions of a country, GDP, economic
policies, etc. indirectly impacts the business and its operations.
• Social Environment: The society in which the organisation functions also affects it like
employment conditions, trade unions, consumer cooperatives, etc.
• Political Environment: The political structure of a country, whether authoritarian or
democratic; political stability; and attitude towards the private sector, influence
organizational growth and development.

DEMAND ANALYSIS

WHAT IS DEMAND?

• Demand in terms of economics may be explained as the consumers’ willingness and

ability to purchase or consume a given item/good. 

• As per Hibdon defines, “Demand means the various quantities of goods that would be
purchased per time period at different prices in a given market.” 

DEMAND FUNCTION

Demand function is a mathematical relationship between quantity demand and its determinants
Demand function can be expressed as follows.

D=F( Px, Py, T, Y )

Where,

D=Demand

F= Function

Px= Prices of substitutes goods

Py= Prices of complementary goods

T= Taste & preference of the consumers

Y= Income of the consumers

DETERMINANTS OF DEMAND

1. PRICE OF THE PRODUCT: The price of a product is the most important determinant

of market demand in the long-run and the only determinant in the short-run.

As per the law of demand, the price of a product and its quantity demanded are inversely
related, i.e. the quantity demanded increases when the price falls and decreases when the price
rises, other things remaining the same.
 2. PRICE OF THE RELATED GOODS: The market demand for a commodity is also
affected by the changes in the price of the related goods. 

The related goods may be the substitute and complementary goods.

• Substitute goods- Two commodities are said to be a substitute for one another if they
satisfy the same want of an individual.

Ex: tea and coffee, Maggi and Yippie, Pepsi and Coca-Cola are close substitutes for each
other. 

• Complementary goods- A commodity is said to be a complement for another if the use

of two goods goes together such that their demand changes (increases or decreases)
simultaneously.

Ex: bread and butter, car and petrol, mattress and cot, etc. are complementary goods.

3. CONSUMER’S INCOME: The income is the basic determinant of the quantity

demanded of a product as it decides the purchasing power of the consumers.

Thus, people with higher disposable income spend a larger amount of income on

consumer goods and services as compared to those with lower disposable income. 

4. CONSUMERS’ TASTES AND PREFERENCES: 

Consumer’s Tastes and preferences play a vital role in determining a demand for a
product. Tastes and preferences often depend on the lifestyle, culture, and hobbies of the
consumers and the religious sentiments attached to a commodity.

The change in any of these factors results in the change in the consumer’s tastes and preferences,
thereby resulting in either increase or decrease in the demand for a product.

5. ADVERTISEMENT EXPENDITURE: 

Advertisement is done to promote sales of a product. It helps in stimulating demand for a

product in four ways; by informing the prospective consumers about the availability of a product,
by showing its superiority over the competitor’s brand, by influencing the consumer’s choice
against the rival product and by setting new fashion and changing tastes of the consumers. 
6. CONSUMERS’ EXPECTATIONS: In the short run, the consumer’s expectation with
respect to the income, future prices of the product and its supply position plays a vital role in
determining the demand for a commodity. 

7. DEMONSTRATION EFFECT: Often, the new commodities or new models of an existing

product are bought by the rich people. Some people buy goods due to their genuine need for
them or have excess purchasing power. While some others do so because they want to exhibit
their affluence. 

8. CONSUMER-CREDIT FACILITY: 

The availability of credit to the consumer also determines the demand for a product. The
credit extended by sellers, banks, friends, relatives or from other sources induces a consumer to
buy more than what would have not been possible in the absence of the credit. 

9. POPULATION OF THE COUNTRY: 

The population of the country also determines the total domestic demand for a product of
mass consumption. For a given level of per capita income, tastes and preferences, price, income,
etc., the larger the size of the population the larger the demand for a product and vice-versa.

10. DISTRIBUTION OF NATIONAL INCOME: 

The national income is one of the basic determinants of the market demand for a product,
such as the higher the national income, the higher the demand for all the normal goods. 

LAW OF DEMAND

 The Law of Demand asserts that there is an inverse relationship between the price, and the
quantity demanded, such as when the price increases the demand for the commodity decreases
and when the price decreases the demand for the commodity increases, other things remaining
unchanged.

DEFINITION OF LAW OF DEMAND

According to Prof. Samuelson , defined as

"The law of demand states that people will buy more at lower prices and buy less at
higher prices, other things remaining the same".
 The law of demand can be further illustrated by the Demand Schedule and the Demand
Curve.

DEMAND SCHEDULE

The demand schedule is a tabular presentation of series of prices arranged in some chronological
order, i.e. either in ascending or descending order along with their corresponding quantities
which the consumers are willing to purchase per unit of time. A hypothetical daily demand
schedule for the commodity (Wheat) is given below:

PRICE OF WHEAT/KG WHEAT DEMANDED BY

FAMILY/DAY
(IN KG)

15 2

14 3

13 4

12 5

11 6

10 7

9 8

The table clearly illustrates the law of demand, i.e. the demand for wheat increases as its price
decreases. For example, at price Rs 14/kg only 3 kg of wheat is demanded, but as the price
decreases to Rs 13/kg the quantity demanded increased to 4 kg.
Demand Curve: Demand curve is formed when the demand and price data in the demand
schedule is plotted on a graph. Thus, the demand curve is the graphical representation of the
demand schedule. The above demand schedule is represented graphically in the figure below:

The DD’ is the demand curve that depicts the law of demand. The demand curve is downward
sloping towards the right, which shows that as the price of the wheat decreases the quantity
demanded increases.

LAW OF DEMAND – ASSUMPTIONS

While plotting the demand curve the following assumptions are to be taken into the
consideration:

• No change in price of related commodities.

• No change in income of the consumer.

• No change in taste and preferences, customs, habit and fashion of the consumer.

• No change in size of population

• No expectation regarding future change in price.

LAW OF DEMAND –EXCEPTIONS

• Giffen Goods

• Veblen Goods

• The expectation of Price Change

 • Speculative Demand

• Necessary Goods and Services

• Fear of shortage

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. 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. 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

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.
There are also times when consumers may buy and store commodities due to a fear of shortage.
Therefore, even if the price of a product increases, its associated demand may also increase as
the product may be taken off the shelf or it might cease to exist in the market.
SPECULATIVE DEMAND

In a speculative market (such as the stock market), a rise in the price of a commodity (such as,
share) creates an impression among buyers that its price will rise further. So people start buying
more of a share when its price rises.

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.

FEAR OF SHORTAGE

When people feel that a commodity is going to be scarce in the near future, they buy more of it
even if there is a current rise in price.

Ex: If the people feel that there will be shortage of L.P.G. gas in the near future, they will buy
more of it, even if the price is high.

ELASTICITY OF DEMAND

DEFINITION OF ELASTICITY OF DEMAND

• “Alfred Marshall” was the first economist to introduce the concept of elasticity of
demand into economic theory.

• “Elasticity of demand is the responsiveness of the quantity demanded of a commodity to

changes in one of the variables on which demand depends”.

• In other words, “it is the percentage change in quantity demanded divided by

the percentage in one of the variables on which demand depends.”

• Elasticity of demand Ed=

• Price Elasticity of Demand: The price elasticity of demand, commonly known as
the elasticity of demand refers to the responsiveness and sensitiveness of demand for a
product to the changes in its price. In other words, the price elasticity of demand is equal
to

• Income Elasticity of Demand: The income is the other factor that influences the
demand for a product. Hence, the degree of responsiveness of a change in demand for a
product due to the change in the income is known as income elasticity of demand.

• The formula to compute the income elasticity of demand is:

• Cross Elasticity of Demand: The cross elasticity of demand refers to the change in
quantity demanded for one commodity as a result of the change in the price of another
commodity. This type of elasticity usually arises in the case of the interrelated goods such
as substitutes and complementary goods.

• The cross elasticity of demand for goods X and Y can be expressed as:

• Advertising Elasticity of Demand:  

• The responsiveness of the change in demand to the change in advertising or rather
promotional expenses, is known as advertising elasticity of demand.

• In other words, the change in the demand as a result of the change in advertisement and
other promotional expenses is called as the advertising elasticity of demand. It can be
expressed as:
TYPES OF INCOME ELASTICITY OF DEMAND

1. High Income Elasticity Of Demand

2. Unitary Income Elasticity Of Demand
3. Low Income Elasticity Of Demand
4. Negative Income Elasticity Of Demand
5. Zero Income Elasticity Of Demand

1. HIGH INCOME ELASTICITY OF DEMAND

2. UNITARY INCOME ELASTICITY OF DEMAND

3. LOW INCOME ELASTICITY OF DEMAND

4. NEGATIVE INCOME ELASTICITY OF DEMAND

 5. ZERO INCOME ELASTICITY OF DEMAND

DEMAND FORECASTING AD METHODS OF DEMAND FORECASTING

• Demand Forecasting is the process in which historical sales data is used to develop an
estimate of an expected forecast of customer demand.

• To businesses, Demand Forecasting provides an estimate of the amount of goods and

services that its customers will purchase in the foreseeable future.

I. SURVEY METHOD
 Consumer’s survey method of demand forecasting involves direct interview of the
potential consumers.
 Consumers are simply contacted by the interviewer and asked how much they would be
willing to purchase of a given product at a number of alternative product price levels.
1. SURVEY OF BUYER’S INTENTION
• In survey of buyers intentions method, the buyers are contacted either directly or by post
with a questionnaire to elicit their opinions about a particular product or service.

A.CENSUS METHOD

• The Census Method is also called as a Complete Enumeration Survey Method wherein

each and every item in the universe is selected for the data collection.
• The census method is most commonly used by the government in connection with the
national population, housing census, agriculture census, etc. 

B.SAMPLE METHOD

• A sampling method is a procedure for selecting sample members from a population.

• A limited number of buyers chosen by sample are contacted, it is called sample method.

2. SURVEY OF SALES FORCE OPINION METHOD

• A sales forecasting technique that predicts future sales by analyzing the opinion of sales
people as a group.
• Sales people continuously interact with customers, and from this interaction they usually
develop a knack for predicting future sales.
• It is considered very valuable management tool and is commonly used in business and
industry throughout the world.

II. STATISTICAL METHODS

• Statistical methods are complex set of methods of demand forecasting.

• These methods are used to forecast demand in the long term.
• In this method, demand is forecasted on the basis of historical data and cross-sectional
data.
• Historical data refers to the past data obtained from various sources, such as previous
years’ balance sheets and market survey reports.
• On the other hand, cross-sectional data is collected by conducting interviews with
individuals and performing market surveys.
• Unlike survey methods, statistical methods are cost effective and reliable as the element
of subjectivity is minimum in these methods.

1. TREND PROJECTION METHOD

• Trend projection or least square method is the classical method of business forecasting.
• In this method, a large amount of reliable data is required for forecasting demand.
• In addition, this method assumes that the factors, such as sales and demand, responsible
for past trends would remain the same in future.
• In this method, sales forecasts are made through analysis of past data taken from previous
year’s books of accounts.
• In case of new organizations, sales data is taken from organizations already existing in
the same industry.
• This method uses time-series data on sales for forecasting the demand of a product.

2. BAROMETRIC TECHNIQUES

• In barometric method, demand is predicted on the basis of past events or key variables
occurring in the present.
• This method is also used to predict various economic indicators, such as saving,
investment, and income. This method was introduced by Harvard Economic Service in
1920 and further revised by National Bureau of Economic Research (NBER) in 1930s.
• This technique helps in determining the general trend of business activities.
• For example, suppose government allots land to the XYZ society for constructing
buildings. This indicates that there would be high demand for cement, bricks, and steel.
3. SIMULTANEOUS EQ UATIONS METHOD
• Under simultaneous equation model, demand forecasting involves the estimation of
several simultaneous equations.
• Thus, simultaneous equation model is a systematic and complete approach to forecasting.
• This method employs several mathematical and statistical tools of estimation.
• In the simultaneous equations method, all variables are simultaneously considered as it is
assumed that every variable influences the other variables in an economic environment.
 4. CORRELATION AND REGRESSION METHODS

• Correlation and regression n methods are statistical techniques.

• Correlation describes the degree of association between two variables such as sales and
advertisement expenditure.
• For example, if the sales have gone up as a result of increase in advertisement
expenditure, we can say that the sales and advertisement are positively correlated.
• For example, if the price of a product has come down and as a result there is increase in
its demand, the demand and the price are negatively correlated.

REGRESSION ANALYSIS

• Past data is used to establish a functional relationship between two variables.

• For Example, demand for consumer goods has a relationship with income of Individuals
and family; demand for tractors is linked to the agriculture income and demand for
cement, bricks etc. are dependent upon value of construction contracts at any time.
• Forecasters collect data and build relationship through co-relation and regression analysis
of variables.
II. OTHER METHODS
1. EXPERT OPINION METHOD
2. TEST MARKETING
3. CONTROLLED EXPERIMENTS
4. JUDGEMENTAL APPROACH

1.EXPERT OPINION METHOD

• An expert is good at forecasting and analysing the future trends in a given product or
service at a given level of technology.
• An expert, who is associated with the insights of the industry as a whole, is invited to
suggest about the future of a particular product or service.

2.TEST MARKETING
• The test marketing is the most reliable method of sales forecasting wherein the product
is launched in a few selected cities/town to check the response of customers towards the
product.
• On the basis of such response, the firm decides whether to commercialize the product on
a large scale or not.

3. CONTROLLED EXPERIMENTS

• Controlled experiments, as the name itself suggests, the company can experiment
different homogeneous markets releasing its product with different types of appeal such
as different prices, packaging, models and so on in different markets or same markets to
assess which combination appeals to the customer most.

4. JUDGEMENTAL APPROACH

• In the judgmental approach where none of the above methods are suitable to assess
demand for a particular product or service, the only alternative is to use one’s judgment.
• Also, that different methods have different assumptions and criteria, it is desirable that
management should supplement its judgement to the results of every method of demand
forecasting.