PRINCIPLES OF MANAGERIAL ECONOMICS

- The theory of the firm is a microeconomic concept that states that a firm exists and

make decisions to maximize profits. While managerial theories are collections of ideas

that recommend general rules how to manage an enterprise.

Economics Tools in Managerial Economics

- Managerial economics involves the use of theories and principles to make decisions

in the allocation of the firm’s resources. It guides managers in making

decisions.

- It facilitates the preparation of a robust decision.

Here are the list of useful economic tools:

1. Opportunity cost - the idea behind opportunity cost is that the cost of one item is

the lost opportunity to do or consume something else. In short, opportunity cost

is the value of next alternative value.

2. Incremental principle - states that a decision is profitable if revenue increases

more than the costs. If costs reduce more than the revenues; if increase in some revenues is more than
the decrease in others; and if decrease in some costs is greater than increase in others.

3. Principle of time perspective - states that a decision by the firm should take

into account of both short-run and long-run effects on revenues and costs and

maintain the right balance between the long and short run.

4. Discounting principle - states that the present value of future cash

flows is always less than the future values of cash flows. This is because

money has time value – it is worth more than today than it will be in the future.

5. Equi-marginal principle - states that consumers will choose a combination of goods to maximize their
total utility.

6. Risk and uncertainty - in making decisions under risk, managers can predict the

possibility of a future outcome. While when making decisions under uncertainty, it cannot be predicted.

7. Risk and return - The greater the risk that an investment may lose money, the

greater its potential for providing a substantial return. By the same token, the
smaller the risk an investment poses, the smaller the potential return it will

provide.

Basic Principles of Managerial Economics

1. Incremental Principle - The incremental concept is probably the most important

concept in economics and is certainly the most frequently used in Managerial

Economics. Incremental concept is closely related to the marginal cost and

marginal revenues of economic theory.

2 Major Concepts of Incremental Principle

- Incremental Cost denotes change in total cost.

- Incremental Revenue means change in total revenue.

The incremental principle may be stated as follows - A decision is clearly profitable

one if:

• It increases revenue more than costs.

• It reduces costs more than revenues.

• It decreases some costs to a greater extent than it increases others.

• It increases some revenues more than it decreases others.

2. Marginal Principle - Marginal analysis implies judging the impact of a unit change

in one variable on the other. Marginal generally refers to a small refers to small

changes.

- Marginal Cost refers to change in total costs per unit in output produced.

- Marginal Revenue is change in total revenue per unit in output sold.

3. Opportunity Cost Principle - the opportunity cost concept is useful in

decision involving a choice between different alternative courses of action.

- Resources are scarce, we cannot produce all the commodities. For the production

of one commodity, we have to forego the production of another commodity. We

cannot have everything we want. We are, therefore, forced to make a choice.

- Sacrifice of alternatives is involved when carrying out a decision

requires using a resource that is limited in supply with the firm.

- Opportunity cost, therefore, represents the benefits or revenue forgone by pursuing one course of

action rather than another. The concept of opportunity cost implies three things:

• The calculation of opportunity costs involves the measurement of

sacrifices.

• Sacrifices may be monetary or real.

• The opportunity cost is termed as the cost of sacrificed alternatives.

In managerial decision making, the concept of opportunity cost occupies an

important place. The economic significance of opportunity cost are as follows:

• It helps in determining relative prices of different goods.

• It helps in determining normal remuneration to a factor of production.

• It helps in proper allocation of factor resources.

4. Discounting Principle - This concept is an extension of the concept of time

perspective.

- It is simply that in the intervening period a sum of money can earn a return which

is ruled out if the same sum is available only at the end of the period.

- The mathematical technique for adjusting for the time value of money and computing present value is
called ‘discounting’.

5. Concept of Time Perspective - states that the decision maker must give due consideration both to the
short run and long run effects of his decisions. He must give due emphasis to the various time periods.
- It was Marshall who introduced time element in economic theory.

6. Equi-Marginal Principle - states that an input should be allocated so that value added by the last unit
is the same in all cases. This generalization is popularly called the equi-marginal.

Economics

- Is the study of the production, distribution, and consumption of goods and services.

- Is the study of choice related to the allocation of scarce resources.

- The purpose of managerial economics is to provide economic terminology and reasoning for the
improvement of managerial decisions.

Microeconomics - studies phenomena related to goods and services from the perspective of individual
decision-making entities—that is, households and businesses.

Macroeconomics - approaches the same phenomena at an aggregate level, for example,

the total consumption and production of a region.

Managerial Economics

- The purpose of managerial economics is to apply economics for the improvement of managerial
decisions in an organization, most of the subject material in managerial economics has a microeconomic
focus.

- it applies economic theory and methods to business and administrative decision making.

- Managerial economics is applicable to different types of organizations.

- The organization providing goods and services is often called as “business” or “firm” that

connote a for-profit organization. However, managerial economics is relevant to

nonprofit organizations and government agencies as well as conventional, for-profit

businesses.

-It identifies ways to achieve goals efficiently.

Role of Managerial Economics in Managerial Decision-Making

- it helps managers how economic forces affect organizations and describes the economic consequences
of managerial behavior.

What are the Characteristics of Managerial Economics?

1. Managerial economics is microeconomic in nature – It deals with the economic problems of

individual business firms in an economy, it is microeconomic in nature.

2. Prescriptive in nature - prescribes the ways through which a business firm can achieve its goal within
its constraints.

3. Pragmatic in its approach - it emphasizes on the real-life problems faced by any business firm

and their possible solutions, rather than concentrating only on some abstract

economic theories.

4. Emphasizes on quantitative analysis - is mainly concerned with some of the quantitative aspects of
business decisions.

Why Managerial Economics is Relevant to Managers?

- We rely on others in the society to produce and distribute nearly all the goods and

services we need.

- The responsibility for overseeing and making decisions for these organizations is the role of

executives and managers.

How is Managerial Economics Useful?

Evaluating Choice Alternatives

1. It helps managers recognize how economic forces

affect organizations and describes the economic consequences of managerial

behavior.

2. It identifies ways to achieve goals efficiently.

3. It provides production and marketing rules that permit the company to maximize net profits once it
has achieved growth or market share objectives.

4. It has application in both profit and non-profit sectors.

Making the Best Decisions

- To establish appropriate decision rules, managers must understand the economic

environment in which they operate.

What is the Scope of Managerial Economics?

1. Demand Analysis and Forecasting – It helps in analyzing the various types of demand which enables
the manager to arrive at reasonable estimates of demand of the product of his firm.

2. Production Function - Conversion of inputs into an output is known as production

function.

3. Cost Analysis - It takes into account all costs incurred while producing a particular

product.

4. Inventory Management - The question is – how much of the inventory is ideal stock. Both high and
low inventory is not good for the firm. Managerial economics uses such methods as ABC Analysis, simple
simulation exercises, and some mathematical models, to minimize inventory cost. It also helps in
inventory controlling.

5. Advertising – It is a promotional activity. It is through advertising only that the message about the
product should reach the consumer before he thinks to buy it. Advertising forms the integral part of
decision making and forward planning.

6. Pricing System - a concept was developed by economics and it is widely used in managerial
economics. A complete pricing knowledge of the price system is quite essential to determine the price.

7. Resource Allocation - Resources are allocated according to the needs only to achieve the level of
optimization.

THEORY OF THE FIRM

Expected Value Maximization

- People directly involved include customers, stockholders, management, employees, and

suppliers. Society is also involved because businesses use scarce resources, pay taxes,

provide employment opportunities, and produce much of society’s material and services

output.

- The model of business is called as the theory of the firm. In its simplest version, the firm

is thought to have profit maximization as its primary goal.

- In this more model, primary goal of the firm is long-term expected value maximization.

- The value of the firm is the present value of the firm’s expected future net cash flows.
Constraints and the Theory of the Firm

- Organization frequently face limited availability of essential inputs, such as skilled labor,

raw materials, energy, specialized machinery and warehouse space.

- Managers often face limitations on the amount of investments funds available for a

particular project or activity.

- Decisions can also be constrained by contractual requirements. For example, labor

contracts limit flexibility in worker scheduling and job assignments. Contract sometimes

require that a minimum level of output be produced to meet delivery requirements.

- In most instances, outputs must also meet quality requirements.

- Legal restrictions, which affect both production and marketing activities, can also play

an important role in managerial decisions.

Limitations of the Theory of the Firm

- Research shows that vigorous competition typically forces managers to seek value

maximization in their operating decisions. Competition in the capital markets forces

managers to seek value maximization in their financing decisions as well.

- Stockholders are interested in value maximization because it affects their rates of

return on common stock investments. Managers who pursue their own interest instead

of stockholder’s interest run the risk of losing their job.

- the value maximization model also offer insight into a firm’s voluntary ‘socially

responsible’ behavior. The criticism that the traditional theory of the firm emphasizes

profits and value maximization while ignoring the issue of social responsibility is

important.

- it equates utility maximization with profit maximization, but in the real world it is much more complex
and there are many things that determine a manager’s utility.

PROFIT MEASUREMENT
Business Profit versus Economic Profit

Business Profit

- it is the profit after subtracting explicit costs.

Economic Profit

- is a business profit minus the implicit costs and it is known as a loss.

Variability of Business Profits

- Business profit is often measured in money terms or as a percentage of sales revenue,

called as profit margin.

- The economist’s concept of normal rate of profit is typically

assessed in terms of the realized rate of return on stockholder’s equity (ROE).

- Return on stockholder’s equity is defined as accounting net income divided by the book value of

the firm.

- Reported profit rates can overstate differences in economic profits if accounting error

or bias causes investments with long-term benefits to be omitted from the balance

sheet.

WHY DO PROFITS VARY AMONG FIRMS?

Disequilibrium Profit Theories

Frictional profit theory

- One explanation of economic profits or losses is frictional profit theory.

- It states that markets are sometimes in disequilibrium because of unanticipated changes in demand or
cost conditions. Unanticipated shocks produce positive or negative economic

profits for some firms.

Monopoly profit theory

- A further explanation is the monopoly profit theory, an extension of frictional profit

theory.

- It states that the firm restricts the output and charge higher prices for its products and services, than
under perfect completion.
Innovation Profit Theory

- It describes above-normal profits that arise following successful invention or modernization.

Compensatory Profit Theory

- it describes above-normal rates of return that reward efficiency.

Role of Profits in the Economy

- Above-normal profits serve as a valuable signal that firms or industry output should be increased.

- Expansion by established firms or entry by new competitors occurs quickly during high- profit periods.

- Economic profits are one of the most important factors affecting the allocation of scarce resources.

- Profits play a pivotal role in providing incentives for innovation and productive efficiency and in
allocating scarce resources.

ROLE OF BUSINESS IN SOCIETY

- Business makes a big contribution to economic betterment in the country and around

the globe.

Why Firms Exist

- It exists because they are useful. They survive by public consent to serve social needs.

Social Responsibility of Business

- When such issues are considered, the economic model of any firm provides useful

insights. This model emphasizes the close relation between the firm and the society, and

indicates the importance of business participation in the development and achievement

of social objectives.

ECONOMIC OPTIMIZATION PROCESS

- Effective managerial decision-making is the process of arriving at the best solutions to

a problem.

Optimal Decisions
- Just as there is no single ‘best’ decision for all customers at all times, there is no single ‘best’
investment decision for all managers at all times. When alternative courses of actions are available, the
decision that produces a result most consistent with managerial objectives is the optimal

decision.

- Decision-makers must recognize all available choices and portray them in terms of appropriate costs
and benefits.

- Optimization techniques are helpful because they offer a realistic means for dealing with complexities
of goal-oriented managerial activities.

Maximizing the Value of the Firm

- In managerial economics, the primary objective of management is assumed to be

maximization of the value of the firm.

- Maximizing value of the firm is a complex task that

involves consideration of future revenues, costs and discount rates.

Total revenues are determined by the quantity sold and the prices obtained.

Factors that affect prices and the quantity sold include:

• choice of products made available for sale

• marketing strategies

• pricing and distribution policies

• competition, and

• general sate of the economy.

Cost analysis includes a detailed examination of the prices and availability of various

input factors and so on.

- The value maximization model provides an attractive basis for such integration. Using

the principles of economic analysis, it is also possible to analyze and compare the higher

costs or lower benefits of alternatives, suboptimal courses of actions.

Demand and Total Revenue

Concepts of Demand, Price and Revenue

- Demand is the quantity of a good that consumers are willing and able to buy products at various

prices during a given period of time.

Three Characteristics of Effective Demand: Desire, Willingness, and Ability to pay for a product.

Three key factors: Price, Point in time, and market place.

- Price is the amount of money that has to be paid to acquire a given product.

- The Law of Demand states that a higher price leads to a lower quantity demanded and

that a lower price leads to a higher quantity demanded.

- The Law of Supply states that a higher price leads to a higher quantity supplied and that

a lower price leads to a lower quantity supplied.

- The Theory of Price is an economic theory that states that the price of a specific good or

service is determined by the relationship between its supply and demand at any given

point in time.

- Revenue is the total amount of income generated by the sale of goods or services related

to the company’s primary operations. In accounting, revenue is also known as gross sales.

- Total revenue is the sum of revenues from all products and services that a company

brings from selling its goods and services. It determines how well a company is bringing

money from its core operations based on the demand and price.

- Marginal revenue is the increase in revenue that results from the sale of one additional

unit of output.

- The Law of Diminishing Returns is an economic principle stating that as investment in a

particular area increases, the rate of profit from that investment, after a certain point,

cannot continue to increase if other variables remain constant.

Tables, Spreadsheets, Graphs, Charts and Equations

- These are visual representations of data. They are important and useful because they are powerful
tools that can be used for things like analyzing data, emphasizing a point, or comparing multiple sets of
data in a way that is easy to understand and remember.
- Tables are the simplest and most direct form for presenting economic data. It is an arrangement of
information or data, typically in rows and columns, or possibly in a more complex structure.

- A spreadsheet is an electronic document in which data is arranged in rows and columns

of a grid and can be manipulated and used in calculation. Spreadsheets are one of the

most popular tools available with personal computers.

- A graph in economics is a visual illustration of numerical data in economics. They

simplify numerical data to improve readability and understanding.

- A chart is a graphical representation for data visualization, in which the data is

represented by symbols, such as bars in a bar chart, lines in a line chart, or slices in a

pie chart.

- An equation is an expression of the functional relationship or connection among economic

variables.

COSTS RELATIONS

Total Costs

- Total costs comprise fixed and variable expenses. Fixed costs do not vary with output.

These costs include interest expense, rent on leased plant and equipment, depreciation

charges associated with the passage of time, property taxes, and salaries for employees not laid off
during periods of reduced activity.

Two Basic Cost Functions:

1. Short-run cost functions are cost relations when fixed costs are present and

used for day-to-day operating decisions.

2. Long-run cost functions are cost relations when all costs are variable and used

for long term planning.

In economic analysis:

• The short-run - Is the operating period during which the availability of at least one input is

fixed; operating decisions are typically constrained by prior capital expenditures.

• In the long-run – The firm has complete flexibility with respect to input use; no such restrictions exist.

Marginal and Average Cost

- Marginal Cost (MC) is the rate of change in total costs associated with a change in

quantity.

- Average Cost (AC) is simply total cost divided by the number of units produced.

PROFIT RELATIONS

Total and Marginal Profit

- Total profit (TP) is the difference between total revenue and cost.

- Marginal profit is the rate of change in quantity.

INCREMENTAL CONCEPTS IN ECONOMIC ANALYSIS

Marginal vs. Incremental Concept

- Marginal Relations measure the effect associated with unitary changes in output.

- The incremental concept is the economist’s generalization of the marginal concept. The incremental
change is the change resulting from a given managerial decision.

- The incremental profit is the profit gain or loss associated with a given managerial

decisions.

BASIS OF DEMAND

Direct Demand

- Direct demand is the demand for a final good.

- For managerial decision-making, a prime focus is on market demand. Market demand

is the aggregate of individual, personal, demand. Insight into market demand relations

requires an understanding of the nature of individual demand.

- Individual demand is determined by the value associated with acquiring and using any

good or service and the ability to acquire it.

Two basic models of individual demand

1. Theory of Consumer Behavior - relates to the direct demand for personal consumption of products.

2. The value or worth of good or service - is the prime

determinants of direct demand. Individuals are viewed as attempting to maximize the

total utility or satisfaction provided by the goods and services they acquire and consume.

Derived Demand

- It is the demand for the products they are used to provide. Input demand is called as derived demand.

- Key components in the determination of derived demand are marginal benefits and

marginal costs associated with using a given input or factor of production.

- In short, derived demand is related to the profitability of using a good or service.

Regardless of whether a good or service is demanded by individuals for final

consumption (direct demand) or as an input used in providing other goods and services

(derived demand), the fundamentals of economic analysis offer a basis for investigating

demand characteristics.

• For final consumption products, utility maximization as described by the theory

of consumer behavior explains the basis for direct demand.

• For inputs used in production of other products, profit maximization provides the

underlying rationale for derived demand.

MARKET DEMAND FUNCTION

- The demand function for a product is a statement of the relation between the aggregate

quantity demanded and all factors that affect this quantity.

Demand Function and Demand Curve

- is a mathematical equation which expresses the demand of a product

or service as a function of the its price and other factors such as the prices of the

substitutes and complementary goods, income, etc.

- Demand is a dependent variable, while Price is independent variable.

Determinants of Demand
- The quantity demanded of a consumer is the amount of goods or services consumers

are willing and able to buy/purchase as a given price, place, and at a given period of time.

1. Price of the good itself – as the price of certain goods and services increases,

the demand for these goods and services decreases or vice versa.

2. Consumers’ income – a change in income will cause a change in demand.

Consumer tends to buy more goods and acquire more services when their

income increases. On the hand, demand for such goods and services declines

once their income decreases.

Types of Goods:

a) Normal Good – refers to a good for which quantity demand at every

price increase when income rises.

b) Inferior Good – refers to a good for which quantity demand falls when income rises.

3. Consumers’ expectation of Future Prices – the quantity of a good demanded

within any period depends not only on prices in that period but also on prices

expected in future periods.

4. Prices of Related Commodities/Goods – the quantity demanded for any

particular good will be affected by changes in the prices of related good.

All other commodities may be either:

a) Substitute goods are goods that can be used in place of other goods. They are related in such a way
that an increase in the price of one good, will cause an increase in the demand for the other good or vice
versa.

For example, coffee substitute for tea.

b) Complementary goods are goods that go together. They are related in such a way that an increase in
the price of one good will cause a decrease the demand for the other good. For example: gasoline and
car.

5. Consumers’ Taste and Preferences – consumers’ tastes and preferences are

a major factor determining the quantity of any good demanded.

6. Population – an increase in the population means more demand for goods and
services. Inversely, less population means less demand for goods and services.

The Demand Curve

- shows graphically the relationship between the quantity of good

demanded and its corresponding price, with other variables held constant.

- A demand curve is shown in the form of graph, all variables in the demand function except the

price and quantity of the product are held fixed.

- The demand curve is typically downward sloping. It describes the negative relation between the price
of a good and the quantity that consumers want to buy a given price.

Changes Involving Demand

1. Change in quantity demanded is the movement along a demand curve, which indicates movement
from one point to another point of the same demand curve. This is due to a change in the price of goods
and services.

2. Change in demand - a shifting from one demand curve to another is known as change in demand. This
is brought by the changes in all or other determinants of demand (non-price) except price.

Relationship Between Demand Curve and Demand Function

- The demand function specifies relationship between quantity demanded of a product with many
independent variables, whereas, demand curve of a product is a graphic representation of only a part of
the demand function with price of the product as the only independent variable.

- A change in quantity demanded is defined as a movement along a single demand curve.

- A shift in demand reflects a change in one or more non- price variables in product demand function.

Industry Demand versus Company Demand

Demand is classified into two types:

a) Company demand - refers to the demand for the products of a particular company

in an industry.

b) Industry demand - means the total or aggregate demand for the products of a

particular industry.
THE CONCEPT OF SUPPLY

Supply Function

- It is a tool used by economists to measure the relationship between price and quantity of goods
supplied.

- Supply function can be described with three variables: Price, Quantity Supplied, and Marginal Cost.

- The supply function is also known as Supply Curve.

Importance of Supply Function

- It is important to study because it shows the relationship between two variables. It can be used to
illustrate how demand changes when the price is altered, and vice versa.

Supply Curve

- It expresses the relation between price charged and quantity supplied, holding constant the effects of
all other variables.

- The quantity supplied refers to the amount or quantity and services producers are willing

and able to supply at a given price, at a given period of time.

The Determinants of supply are the following:

1. Change in technology – state of the art technology that uses high-tech machines increases the
quantity supply of goods which causes the reduction of cost of production.

2. Costs of inputs used – an increase in the price of an input or the cost of

production decreases the quantity supplies because the profitability of certain

business decreases.

3. Expectation of future price – when producers expect higher prices in the

future commodities, the tendency is to keep their good and release them when

the price rises.

4. Change in the price of related goods – changes in the price of goods have a

significant effect in the supply of such goods.

5. Government regulation and taxes – it is expected that taxes imposed by the government increases
cost of production which in turn discourages production because it reduces producers’ earnings.

6. Government subsidies – subsidies or the financial assistance given by the

government reduces cost of production which encourages more supply.

7. Number of firms in the market – an increase in the number of firms in the

market leads to an increase in supply of goods and services.

Changes involving Supply:

1. Change in quantity supplied – movement along a supply curve is known as a

change in quantity supplied, which shows the movement from one point to

another point on the same supply curve.

2. Change in supply – shifting from one supply curve to another is known as

change in supply. This is brought about by a change in any or of the all determinants.

Market Supply versus Individual Supply

- Market supply depends on all those factors that influence the supply of individual sellers, such as the
prices of inputs used to produce the good, the available technology, and expectations. In addition, the
supply in a market depends on the number of sellers.

THE MARKET EQUILIBRIUM

- Market equilibrium is a state which implies a balance between the opposing forces, a

situation in which quantity demanded and quantity supplied are equal.

The Equilibrium of Supply and Demand

- The equilibrium is found where the supply and demand curves intersect. At the equilibrium price, the
quantity supplied equals the quantity demanded.

- The price at which these two curves cross is called the equilibrium price, and the quantity is called the
equilibrium quantity.

- The equilibrium price is sometimes called the market-clearing price because, at this price, everyone in
the market has been satisfied.

THE MARKET FORCES OF SUPPLY AND DEMAND

Surplus

- Suppose first that the market price is above the equilibrium price - There is a surplus of the good:
Suppliers are unable to sell all they want at the going price.

- it is a situation in which quantity supplied is greater than quantity demanded.

Shortage

- Suppose now that the market price is below the equilibrium price - There is a shortage of the good:
Demanders are unable to buy all they want at the going price.

- is a situation in the market in which quantity demanded is greater than quantity supplied.

- Law of Equilibrium of Supply and Demand: The price of any good adjusts to bring the supply and

demand for that good into balance.

Demand Estimation and Demand Forecasting

- Demand estimation and forecasting means predicting future demand for the product under given
conditions.

- In Demand estimating manager attempts to quantify the links or relationship between the level of
demand and the variables which are determinants to it and is generally used in designing pricing
strategy of the firm.

- In demand estimation manager analyze the impact of future change in price on the quantity
demanded.

- In demand estimation data is collected for short period usually a year or less and analyzed in relation to
various variables to know the impact of each variables mainly the price on the demand behavior of the
customers. It is for a short period.

- Demand forecasting is generally used for short term estimation as well as long term forecasting.

Features of Demand Forecasting

1. Demand Forecasting is a process to investigate and measure the forces

that determine sales for existing and new products.

2. It is an estimation of most likely future demand for a product under given

business conditions.

3. It is basically an educated and well thought out guesswork in terms of specific quantities.

4. Demand Forecasting is done in an uncertain business environment.

5. Demand Forecasting is done for a specific period of time (i.e. the sufficient

time required to take a decision and put it into action).

6. It is based on historical and present information and data

7. It tells us only the approximate expected future demand for a product based

on certain assumptions and cannot be 100% precise.

Why Demand Forecasting?

- This will help up to certain extent in managing the future risks caused due to varied

business conditions as well as in optimum utilization of available business

resources.

- In short run demand forecasting helps in determining the optimum level of output

at various periods to avoid under or over production.

- It helps the company to set realistic sales targets for each individual salesman and for the firm as a
whole.

- In long run, the demand for a product of a firm is forecasted generally for a period

of 4 to 6 or 10 years

- Demand forecasting can play a significant role in controlling over total costs and revenues of a
company and determining the value and volume of business, estimating future profits of the firm and
regulating business effectively to meet the challenges of the market.

Demand Forecasting Process

1. Specifying the objective of Demand Forecasting

- the objective for which demand is to be estimated must be clearly defined at first stage.

2. Determining the nature of goods

- identification of type of goods as different type of goods such as consumer goods, capital goods,
industrial goods, durable and nondurable goods.

3. Determining the time perspective

- Depending upon the nature of goods and firm’s objective, the demand can be forecasted for short
term as well as for long term.

4. Determining the level of forecasting

Demand forecasting may be undertaken at micro or firm level, industry level, macro level or
international level.
5. Selection of proper method or technique of forecasting

- One has to select an appropriate method for demand forecasting to achieve stated objectives.

6. Data Collection and modification

- There are different method of collection of primary data like observation, interview, survey or
questionnaire, focus group discussion methods etc. Data can also be collected from various secondary
sources but, this data required modification as it may not be available in the required mode.

7. Data analysis and estimations

- The Efficiency of estimation depends upon the efficiency with which it has been analyzed and
interpretive. Sometimes, estimation required support from background factors which has not been used
in estimation process. One mist frequently revised the estimates depending upon the changed business
conditions.

Determinants of Demand Forecasting

- Broadly goods can be classified as Capital goods, Durable and Non-durable consumer goods.

Capital Goods

- factory building, machinery, equipment, tools etc.,

Demand for Consumer Durable goods

- residential building, car, refrigerators, furniture, readymade garments, TV, Computer etc. depend upon
social status, prestige, level of money income, obsolescence rate, maintenance costs, availability of
road, petrol, supply of electricity, family size, age-sex distribution and credit facilities.

Non-durable consumer goods

- are consumed once only i. e. milk, food, vegetables, fruits, medicines etc.

Methods of Demand Forecasting

1. Survey methods

- are generally used in short run and estimating the demand for new products.

The different approaches under survey methods are:

A. Consumers’ Survey method

- Under this method, efforts are made to collect the relevant information directly from the consumers
with regard to their future purchase plans.
- It is also called as “Opinion surveys”.

There are two type of consumer survey, namely:

i) Under Complete Enumeration Method all potential customers are contacted

in the market are surveyed.

ii) In Sample Survey Method different cross sections of customers that make

up the bulk of the market are carefully chosen.

B. Collective Opinion Method (Sale Force Opinion or Reaction Survey Method)

- also known as “Reaction Survey Method”.

- In this method, instead of customers, salesmen, marketing manager, production manager, professional
experts and the market consultants and others are asked to express their considered opinions about the
volume of sales expected in the future.

C. Experts Opinion Method or Delphi Method

- It is a variant of opinion poll and survey method of demand forecasting.

- Under this method, outside experts are appointed.

D. Market Studies and Experiments

- Under this method, companies first select some markets or cities having similar features i.e.
population, income culture, social or religious factors etc., then carry out the market experiments by
changing prices, quality, packing, advertisement expenditure or other controllable demand
determinants under the assumption that other things remain contestant.

2. Statistical methods

- are used to forecast the future probable demand of a particular product by applying statistical models
and mathematical, equations.

The important statistical methods used in demand estimation are:

A. Trend Projection Method

-In this method a data set of past sales are taken at specified time, generally at equal intervals to depict
the historical pattern under normal conditions.

The main aspect of this method lies in the use of time series and changes in time

series occur due to following reasons:

1. Secular Trend: also known as long term trend indicate the general tendency and direction in which
graph of a time series move in relatively over a long period of time.
2. Seasonal Trends: This trend reflects the changes in sales a company due to change in various seasons
or climates or due to festival season or sales clearance season etc.

3. Cyclical Trends: These trends reflect the change in the demand for a product during diverse phases of
a business cycle i.e growth, boom, maturity, depression, revival, etc.

4. Random or irregular trends: These changes arise randomly or irregularly due to unforeseen events
such as famines, earth quakes, floods, natural calamities, strikes, elections and crises.

- In trend projection method real problem is to separate and measure each of these trends separately. In
order to estimate the future demand of the product the impact of seasonal, cyclical and irregular trends
are eliminated from the data and only secular trend is used.

The trend in the time series can be eliminated by using any of the following method:

I. Graphical Method: It is simplest method of trend projection. In this method periodical sales data is
plotted on a graph paper and a line is drawn through the plotted points.

II. The Semi average method - In this method, first of all time series data of sale is divided into two
equal parts and thereafter, separate average sale is calculated for each half.

III. Moving average Method - Moving average method is very widely used in practice. Under this
method, moving average is calculated.

IV. The least square method - In this method a trend line is fitted with the help of straight-line
regression equation i.e.

B. Barometric or Economic Indicators Method

- In this method forecasting follows the method adopted by meteorologists in weather forecasting and a
few economic indicators become the basis for forecasting the sales of a company.

Demand Forecasting for a New Product

- Professor Joel Dean, however, has suggested a few guidelines to make forecasting of

demand for new products.

1. Evolutionary approach

- The demand for the new product may be considered as an outgrowth of an existing product.

- Thus, when a new product is evolved from the old product, the demand conditions of the old product
can be taken as a basis for forecasting the demand or the new product.

2. Substitute Approach - If the new product developed serves as substitute for the existing product, the
demand for the new product may be worked out on the basis of a ‘market share’.
3. Opinion Poll Approach - Under this approach the potential buyers are directly contacted, or through
the use of samples of the new product and their responses are found out.

4. Sales Experience Approach - Offer the new product for sale in a sample market; say supermarkets or
big bazaars in big cities, which are also big marketing centers.

5. Growth Curve Approach - According to this, the rate of growth and the ultimate level of demand for
the new product are estimated on the basis of the pattern of growth of established products.

6. Vicarious Approach - A firm will survey consumers’ reactions to a new product indirectly through
getting in touch with some specialized and informed dealers who have good knowledge about the
market, about the different varieties of the product already available in the market, the consumers’
preferences etc.