MANAGERIAL ECONOMICS NOTES

MBA 1stSemester

Unit- 2 By- Ruba Nasim

DEMAND ANALYSIS

What is Demand

Demand is an economic principle referring to a consumer's desire to purchase goods and

services and willingness to pay a price for a specific good or service. Holding all other
factors constant, an increase in the price of a good or service will decrease the quantity
demanded, and vice versa. Market demand is the total quantity demanded across all
consumers in a market for a particular good at a given time.

What is Supply

Supply is a fundamental economic concept that describes the total amount of a specific
good or service that is available for consumers. Supply can relate to the amount of goods
available at a specific price. The supply provided by producers will rise if the price rises
because all firms look to maximize profits.

Supply is the willingness and ability of producers to create goods and services to take them
to market. Supply is positively related to price given that at higher prices there is an
incentive to supply more as higher prices may generate increased revenue and profits.

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.

Difference between Goods & Service

1) Goods are tangible & services are intangible.

2) Goods are produced before they are consumed, while in case of services production and
consumption happen at the same time.
3) Goods can be stored in inventory while services cannot be stored for later use.
4) Quality assurance in goods is objective and is measurable, while the same for services is
very subjective.
Definition of 'Law Of Demand'

Definition: The law of demand states that other factors being constant (cetrisperibus), price
and quantity demand of any good and service are inversely related to each other. When the
price of a product increases, the demand for the same product will fall.

Description: Law of demand explains consumer choice behavior when the price changes. In
the market, assuming other factors affecting demand being constant, when the price of a
good rises, it leads to a fall in the demand of that good and vive-versa. This is the natural
consumer choice behavior. This happens because a consumer hesitates to spend more for
the good with the fear of going out of cash.

The above diagram shows the demand curve which is downward sloping. Clearly when the
price of the commodity increases from price p3 to p2, then its quantity demand comes
down from Q3 to Q2 and then to Q1 and vice versa.

Key determinants of demand

1. Income
When an individual's income rises, they can buy more expensive products or
purchasing power increases. As a result, this causes an increase in demand. On the
other hand, if incomes drop, then demand is likely to decrease.
2. Price
If the cost of a particular product rises, demand will decrease. For example, if the price
of crude oil goes up, the cost of petrol will rise in gas stations. Therefore, depending on
the income of the consumer, they will drive less to conserve gas. This tendency is
demonstrated during public holidays, when people will drive shorter distances to visit
family or for vacations.

3. Expectations, tastes, and preferences

If consumers suspect that the price of a product will rise in future, the demand for
said product will increase in the present. Equally, customers’ attitudes, tastes, and
preferences can impact demand in ways less directly associated with cost.

4. Customer base
One of the most important determinants of demand is the size of the market. The more
consumers want to purchase a product, the faster demand will rise.

5. Economic conditions
If consumers are confident their jobs are secure, they are more likely to spend. This
tendency is known as consumer confidence. Defined as consumers' feelings about
economic conditions, consumer confidence indicates the overall state of the economy.
However, if consumer confidence is low, individuals are more likely to put their
money into savings accounts – especially if interest rates are high.

6. Government Taxes

When there is increase in government taxes, then demand decreases, because no one
wants to pay high taxes to government. And when government taxes are low, demand
increases.

7. Population

When there is increase in population, then demand also increases because all the
needs are to fulfilled. And when population is low, demand also reduces.

8. Savings

When customer wants to save more, he will spend less so demand will reduce, and
when he don’t want to save, demands will increase.
Demand Forecasting
Definition:

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.
Demand Forecasting refers to the process of predicting the future demand for the firm’s
product. In other words, demand forecasting is comprised of a series of steps that involves
the anticipation of demand for a product in future under both controllable and non-
controllable factors.

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 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.

Objectives of Demand Forecasting

Objectives of Demand Forecasting include Financial planning, Pricing policy, Manufacturing

policy, Sales, and Marketing planning, Capacity planning and expansion, Manpower
planning and Capital expenditure.
Short-Term Objectives:

 Formulation of Production Policy: Demand forecasting aims at meeting the demand

by ensuring uninterrupted production and supply of goods and services.
 Formulation of Price Policy: It helps in formulating an effective price mechanism to
deal with the market fluctuations and conditions like inflation.
 Maximum Utilization of Machines: It streamlines the production process and
operations such that there is the optimum utilisation of machines.
 Proper Control of Sales: Forecasting the regional sales of a particular product or
service provides a base for setting a sales target and evaluating the performance.
 Regular Supply of Material: Sales forecast determines the level of production, leading
to the proper estimation of raw material.
 Arrangement of Finance: To maintain short-term cash in the organisation it is
essential to forecast the sales as well as liquidity requirement accordingly.
 Regular Availability of Labor: Estimation of the production capacity provides for the
acquisition of suitable skilled and unskilled labour.

Long-Term Objectives:

 Long-Term Finance Management: Forecasting sales for the long-term contributes to

long-term financial planning and acquisition of funds at reasonable rates and suitable
terms and conditions.
 Decisions Regarding Production Capacity: Demand forecast determines the
production level, which provides a base for decisions related to the expansion of the
production unit or size of the plant.
 Labour Requirement: Demand forecasting initiates the expansion of business, thus
leading to the estimation of required human resource to accomplish business goals
and objectives.

Process of Demand Forecasting

Demand forecasting is not based on assumptions but is a systematic and scientific process
of estimating future sales and performance as well as directing the resources accordingly.

The steps involved in a standard demand forecasting process are as follows:

1. Setting the Objectives: The purpose for which the demand forecasting is being done
must be clear. Whether it is for short-term or long-term, the market share of the product,
the market share of the organization, competitors share, etc. By all these aspects, the
objectives for forecasting are framed.

2. Determining the Time Perspective: The defined objectives are supported by the period
for which the forecasting is being done. The demand for a commodity varies with the
change in its determinants over the period of time.

3. Selecting a Suitable Demand Forecasting Method: Demand forecasting is based on

specific evidence and is determined using a particular technique or method. The method of
prediction must be selected wisely. It is dependent on the information available, the
purpose of predicting and the period it is done for.

4. Collecting the Data: Forecasting is based on past experiences and data. This data or
information can be primary or secondary. Primary data comprises of the information
directly collected by the analysts and researchers; whereas secondary data includes the
physical evidence of the past performance, sales trend in the past years, financial reports,
etc.

5. Estimating the Results: The data so collected is arranged in a systematic and meaningful
manner. The past performance of a product in the market is analysed on this basis.
Accordingly, future sales prediction and demand estimation are done. The results
decidedmust be in a format which is easy to understand and apply by the management.
Methods of Demand Forecasting
Demand forecasting is the art as well as the science of predicting the likely demand for a
product or service in the future. This prediction is based on past behavior patterns and the
continuing trends in the present.

There are various methods of demand forecasting..

Methods

1] Survey of Buyer’s Choice

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

a. Complete Enumeration Method: Under this method, nearly all the potential buyers are
asked about their future purchase plans.
b. Sample Survey Method: Under this method, a sample of potential buyers are chosen
scientifically and only those chosen are interviewed.
c. End-use Method: It is especially used for forecasting the demand of the inputs. Under
this method, the final users i.e. the consuming industries and other sectors are
identified. The desirable norms of consumption of the product are fixed, the targeted
output levels are estimated and these norms are applied to forecast the future demand
of the inputs.
2] Collective Opinion Method
Under this method, the salesperson of a firm predicts the estimated future sales in their
region. The individual estimates are aggregated to calculate the total estimated future sales.
These estimates are reviewed in the light of factors like future changes in the selling price,
product designs, changes in competition, advertisement campaigns, the purchasing power of
the consumers, employment opportunities, population, etc.

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

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

4] Market Experiment Method

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

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

5] Expert Opinion Method

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

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

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

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

What Is Price Elasticity of Demand?

Price elasticity of demand is an economic measure of the change in the quantity demanded
or purchased of a product in relation to its price change. Expressed mathematically, it is:

Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price

If the quantity demanded of a product exhibits a large change in response to changes in its
price, it is termed "elastic," that is, quantity stretched far from its prior point. If the quantity
purchased has a small change in response to its price, it is termed "inelastic"; or quantity
didn't stretch much from its prior point.
5 Types of Price Elasticity of Demand – Explained!
1. Perfectly Elastic Demand (EP = ∞)
The demand is said to be perfectly elastic if the quantity demanded increases infinitely (or
by unlimited quantity) with a small fall in price or quantity demanded falls to zero with a
small rise in price. Thus, it is also known as infinite elasticity. It does not have practical
importance as it is rarely found in real life.

In the given figure, price and quantity demanded are measured along the Y-axis and X-axis
respectively. The demand curve DD is a horizontal straight line parallel to the X-axis. It
shows that negligible change in price causes infinite fall or rise in quantity demanded.
2. Perfectly Inelastic Demand (EP = 0)
The demand is said to be perfectly inelastic if the demand remains constant whatever may
be the price (i.e. price may rise or fall). Thus it is also called zero elasticity. It also does not
have practical importance as it is rarely found in real life.

In the given figure, price and quantity demanded are measured along the Y-axis and X-axis
respectively. The demand curve DD is a vertical straight line parallel to the Y-axis. It shows
that the demand remains constant whatever may be the change in price.

3. Relatively Elastic Demand (EP> 1)

The demand is said to be relatively elastic if the percentage change in demand is greater
than the percentage change in price i.e. if there is a greater change in demand there is a
small change in price. It is also called highly elastic demand or simply elastic demand. For
example:

If the price falls by 5% and the demand rises by more than 5% (say 10%), then it is a case of
elastic demand. The demand for luxurious goods such as car, television, furniture, etc. is
considered to be elastic.
In the given figure, price and quantity demanded are measured along the Y-axis and X-axis
respectively. The demand curve DD is more flat, which shows that the demand is elastic.
The small fall in price from OP to OP1 has led to greater increase in demand
from OM to OM1. Likewise, demand decrease more with small increase in price.

4. Relatively Inelastic Demand (Ep<1 )

The demand is said to be relatively inelastic if the percentage change in quantity demanded
is less than the percentage change in price i.e. if there is a small change in demand with a
greater change in price. It is also called less elastic or simply inelastic demand.

For example: when the price falls by 10% and the demand rises by less than 10% (say 5%),
then it is the case of inelastic demand. The demand for goods of daily consumption such as
rice, salt, kerosene, etc. is said to be inelastic.
In the given figure, price and quantity demanded are measured along the Y-axis and X-axis
respectively. The demand curve DD is steeper, which shows that the demand is less
elastic.The greater fall in price from OP to OP1 has led to small increase in demand
from OM to OM1. Likewise, greater increase in price leads to small fall in demand.

5. Unitary Elastic Demand ( Ep = 1)

The demand is said to be unitary elastic if the percentage change in quantity demanded is
equal to the percentage change in price. It is also called unitary elasticity. In such type of
demand, 1% change in price leads to exactly 1% change in quantity demanded. This type of
demand is an imaginary one as it is rarely applicable in our practical life.
In the given figure, price and quantity demanded are measured along Y-axis and X-axis
respectively. The demand curve DD is a rectangular hyperbola, which shows that the
demand is unitary elastic. The fall in price from OP to OP1 has caused equal proportionate
increase in demand from OM to OM1. Likewise, when price increases, the demand
decreases in the same proportion

Law of SUPPLY
The law of supply is a microeconomic law. It states that, all other factors being equal, as
the price of a good or service increases, the quantity of that good or service that suppliers
offer will increase, and vice versa.

In plain terms, this law means that as the price of an item goes up, suppliers will attempt
to maximize their profits by increasing the number of that item that they sell.
In the above diagram when prices are increase then quantity supply is increase. SS’ is the
supply curve moving upward.

Price Elasticity of Supply

The quantitative relation between the price of a commodity and the quantity supplied of
that commodity is known as the elasticity of supply.
1. Relatively Greater-Elastic supply:
Relatively greater elastic supply occurs when the change in supply is relatively greater as
compared to the change in price. In this case, the value of price elasticity of supply is
greater than 1.

2. Unit Elastic Supply:

If the change amount supplied is exactly equal to the change in its price, then it is termed as
unit elastic supply or unitary elastic supply. In the above-mentioned scenario, the price
elasticity of supply is equal to 1.

3. Relatively Less-Elastic supply:

Relatively Less Elastic supply occurs when the change in supply is relatively lesser as
compared to the change in price. In this case, the value of price elasticity of supply is less
than 1.

4. Perfectly Inelastic Supply

A service or commodity is termed as perfectly inelastic when a certain quantity of the said
commodity can be supplied irrespective of the price. The value of the price elasticity of
supply is zero

5. Perfectly Elastic Supply:

If there is infinite elasticity, then it is considered a perfectly elastic supply. In this scenario,
with a minor fall in the price level, the supply will become zero and with a minor rise in the
price, the supply will become infinite.
What is Indifference Curve?
An indifference curve is a graphical representation of a combined products that gives
similar kind of satisfaction to a consumer thereby making them indifferent.Every point on
the indifference curve shows that an individual or a consumer is indifferent between the
two products as it gives him the same kind of utility.

Indifference Map
The Indifference Map refers to a set of Indifference Curves that reflects an understanding
and gives an entire view of a consumer’s choices. The below diagram shows an indifference
map with three indifference curves.

Here, we understand that all three products resting in the indifferent curve give him the
same satisfaction. However, higher indifference curve gives higher satisfaction.
PROPERTIES OF AN INDIFFERENCE CURVE

1. They Slope Negatively or Slope Downwards from the Left to the Right:
2. They are Convex to the Origin of Axes:
3. Every higher Indifference Curve represents Higher Level of Satisfaction than that of the
Previous One:
4. Indifference Curves can neither touch nor Intersect each other,
5. Indifference Curves are Parallel to each other.
6. In reality, Indifference Curves are like Bangles: