Demand

• The demand for a commodity is the amount of it that

a consumer will purchase or will be ready to take off
from the amount at various given prices during a
specified time period.
• The time period may be a day, a week, a month, a
year or any given time period.
• This demand in economies implies both the desire to
purchase, the ability and the willingness to pay for a
good.
• Example- If a poor man who hardly makes both ends
meet wishes to have a car, his wish or desire for a car
will not constitute the demand for the car because he
cannot afford to pay for it, that is he has no
purchasing power to make his wish or desire effective
in the market.
• Thus in economics, unless demand is backed by
purchasing power or ability to pay it does not
constitute demand.
• Demand for a good is determined by the several
factors, such as price of a commodity, the goods,
substitutes or compliments.
• When there is a change in any of these factors,
demand of the consumer changes.
 Importance of Demand
• The importance of demand analysis in business
decisions can be explained under following headings:
• Sales forecasting :The demand is a basis the sales of
the production of a firm. Hence, sales forecasting can
be made on the basis of demand. For example, if
demand is high, sales will be high and if demand is
low, sales will be low.
• The firms can make different arrangements to
increase or reduce production or push up sales on the
basis of sales forecast.
• Pricing decisions :The analysis of demand is the
basis of pricing decisions of a firm. If the demand for
the product is high, the firm can charge high price,
other things remaining the same. On the contrary, if
the demand is low, the firm cannot charge high price.
The demand analysis also helps the firm in profit
budgeting.
• Marketing decisions: The analysis of demand helps
a firm to formulate marketing decisions. The demand
analysis analyses and measure the forces that
determine demand. The demand can be influenced by
manipulating the factors on which consumers base
their demand on attractive packaging.
• Production decisions: How much a firm can produce
depends on its capacity. But how much it should
produce depends on demand. Production is not
necessary if their no demand. But continuous
production schedule is necessary if the demand for
the production is relatively stable. If the demand is
less than the quantity of production, new demand
should be created by means of promotional activities
such a advertising.
• Financial decisions :The demand condition in the
market for firm's product affects the financial
decisions as well. If the demand for firm's product is
strong and growing, the needs for additional finance
will be greater. Hence, the financial manager should
make necessary financial arrangement to finance the
growing need of the capital.
 Determinants of Demand
• Following are the determinants of demand for a product:
• i. Price of a Product or Service:
• Affects the demand of a product to a large extent. There is an
inverse relationship between the price of a product and
quantity demanded. The demand for a product decreases with
increase in its price, while other factors are constant, and vice
versa.
• For example, consumers prefer to purchase a product
in a large quantity when the price of the product is
less. The price-demand relationship marks a
significant contribution in oligopolistic market where
the success of an organization depends on the result
of price war between the organization and its
competitors.
• ii. Income:
• The income of a consumer affects his/her purchasing power,
which, in turn, influences the demand for a product. Increase
in the income of a consumer would automatically increase the
demand for products by him/her, while other factors are at
constant, and vice versa.

• For example, if the salary of Mr. X increases, then he may

increase the pocket money of his children and buy luxury
items for his family. This would increase the demand of
different products from a single family. The income-demand
relationship can be analyzed by grouping goods into four
categories, namely, essential consumer goods, inferior goods,
normal goods, and luxury goods.
• iii. Tastes and Preferences of Consumers:
• Play a major role in influencing the individual and market
demand of a product. The tastes and preferences of consumers
are affected due to various factors, such as life styles, customs,
common habits, and change in fashion, standard of living,
religious values, age, and gender.

• A change in any of these factors leads to change in the tastes

and preferences of consumers. Consequently, consumers
reduce the consumption of old products and add new products
for their consumption. For example, if there is change in
fashion, consumers would prefer new and advanced products
over old- fashioned products, provided differences in prices
are proportionate to their income.
• Apart from this, demand is also influenced by the habits of
consumers. For instance, most of the South Indians are non-
vegetarian; therefore, the demand for non- vegetarian products
is higher in Southern India. In addition, sex ratio has a relative
impact on the demand for many products.

• For instance, if females are large in number as compared to

males in a particular area, accordingly the demand for
feminine products, such as make-up kits and cosmetics, would
be high in that area.
• iv. Price of Related Goods:
• Refer to the fact that the demand for a specific product is
influenced by the price of related goods to a greater extent.
• Related goods can be of two types, namely, substitutes and
complementary goods, which are explained as follows:
• a. Substitutes:
• Refer to goods that satisfy the same need of consumers but at a
different price. For example, tea and coffee, jowar and bajra,
and groundnut oil and sunflower oil are substitute to each
other. The increase in the price of a good results in increase in
the demand of its substitute with low price. Therefore,
consumers usually prefer to purchase a substitute, if the price
of a particular good gets increased.
• b. Complementary Goods:
• Refer to goods that are consumed simultaneously or in
combination. In other words, complementary goods are
consumed together. For example, pen and ink, car and petrol,
and tea and sugar are used together.
• Therefore, the demand for complementary goods changes
simultaneously. The complementary goods are inversely
related to each other. For example, increase in the prices of
petrol would decrease the demand of cars.
• v. Expectations of Consumers:
• Imply that expectations of consumers about future changes in
the price of a product affect the demand for that product in the
short run. For example, if consumers expect that the prices of
petrol would rise in the next week, then the demand of petrol
would increase in the present.
• On the other hand, consumers would delay the purchase of
products whose prices are expected to be decreased in future,
especially in case of non-essential products. Apart from this, if
consumers anticipate an increase in their income, this would
result in increase in demand for certain products. Moreover,
the scarcity of specific products in future would also lead to
increase in their demand in present.
• Downward Sloping Demand Curve- Following are
the two factors due to which quantity demanded
increases with price falls-
• Income Effect
• Substitution Effect
• Income Effect- When the price of a commodity falls,
the consumer can buy more quantity of the
commodity with his given income. Or, if he chooses
to buy the same amount of quantity as before, some
money will be left with him because he has to spend
less on the commodity due to its lower price.
• In other words, as the result of the fall in the price of
a commodity, consumer’s real income or purchasing
power increases.
• This increase in real income induces the consumer to
buy more of that commodity. This is called the
income effect of the change in price of the
commodity.
• This is one reason why a consumers buys more of a
commodity whose price falls.
• Substitution Effect- When the price of a commodity
falls, it becomes relatively cheaper than other
commodities.
• This induces the consumer to substitute the
commodity whose price has fallen for other
commodities which have now become comparatively
dearer.
• As a result of this substitution effect, the quantity
demanded of the commodity whose price has been
fallen, rises.
• The substitution effect is more important than the
income effect. Marshall explained the downward-
sloping demand curve with the aid of this substitution
effect alone, since he ignored the income effect of the
price change is very significant and cannot be
ignored.
 Comparison between Income Effect and
Substitution Effect
BASIS FOR COMPARISON INCOME EFFECT SUBSTITUTION EFFECT

Meaning Income effect refers to the change Substitution effect means an

in the demand of a commodity effect due to the change in price
caused by the change in of a good or service, leading
consumer's real income. consumer to replace higher priced
items with lower prices ones.

Reflected by Movement along income- Movement along price-

consumption curve consumption curve

Effect of Income being freed up. Relative price changes.

Expresses Impact of rise or fall in Change in quantity demanded of a

purchasing power on good due to change in prices.
consumption.
Rise in price of a good Reduces disposable As alternative goods are
income, which in turn comparatively cheaper and
decrease quantity so customers will switch to
demanded. other goods.

Fall in price of a good Increases real spending Will make it cheaper than
power of a consumer, that its substitutes, which will
allows customers to buy attract more customers and
more, with the given result in higher demand.
budget.
 Elasticity of Demand
• The law of demand tells us that when the price of a
commodity falls, its quantity demanded rises and
when the price of its rises, its quantity demanded
falls.
• But it does not tells us by how much or to what
extend the quantity demand of the good will change
in response to a change in its price.
• This information as to how much or to what extend
the quantity demanded of a good will change as the
result of a change in its price is provided by the
concept of elasticity of demand.
• The term elasticity of demand is used to denote a
measure of the rate at which demand changes in
response to the change in prices.
• In other words we can say that, it is the percentage
change in quantity demanded divided by the
percentage in one of the variables on which demand
depends.
• Definition- According to Lipsey:

“Demand elasticity is measured by a ratio: the

percentage change in quantity demanded divided by the
percentage change in price that brought it about; for
normal, negatively sloped demand curves, elasticity is
nega­tive”.
 Various Elasticity's of Demand

• Price Elasticity of Demand

• Income Elasticity of Demand
• Cross Elasticity of Demand
• Advertising Elasticity of Demand
• Arc Elasticity of Demand
•
& %change in prices = x 100

Ep = x

Ep = x =

Where, Ep stands for price elasticity

P = Price
∆P = Change in price
Q = Quantity
∆Q = Change in quantity demanded
Types/Degree of Price Elasticity
• Perfectly Elastic Demand- When a small
change or sometimes without any change in
price of a product causes a major change in its
demand, it is said to be perfectly elastic
demand.
• In perfectly elastic demand, a small rise in
price results in fall in demand to zero, while a
small fall in price causes increase in demand to
infinity. In such a case, the demand is perfectly
elastic or ep = ∞.
• In perfectly elastic demand, the demand
curve is represented as a horizontal straight
line, as-
• 2. Perfectly Inelastic Demand:
• A perfectly inelastic demand is one when there
is no change produced in the demand of a
product with change in its price. The
numerical value for perfectly inelastic demand
is zero (ep=0).
• In case of perfectly inelastic demand,
demand curve is represented as a straight
vertical line, as-
• In case of essential goods, such as salt, the
demand does not change with change in price.
Therefore, the demand for essential goods is
perfectly inelastic.
• Relatively Elastic Demand:
• Relatively elastic demand refers to the demand when
the proportionate change produced in demand is
greater than the proportionate change in price of a
product. The numerical value of relatively elastic
demand ranges between one to infinity.
• Relatively elastic demand is known as more than unit
elastic demand (ep>1). For example, if the price of a
product increases by 20% and the demand of the
product decreases by 25%, then the demand would be
relatively elastic.
• The demand curve of relatively elastic
demand is gradually sloping,
• Relatively Inelastic Demand:
• Relatively inelastic demand is one when the
percentage change produced in demand is less than
the percentage change in the price of a product. For
example, if the price of a product increases by 30%
and the demand for the product decreases only by
10%, then the demand would be called relatively
inelastic.
• The numerical value of relatively elastic demand
ranges between zero to one (ep<1). Marshall has
termed relatively inelastic demand as elasticity being
less than unity.
• The demand curve of relatively inelastic
demand is rapidly sloping,
• Unitary Elastic Demand:
• When the proportionate change in demand produces
the same change in the price of the product, the
demand is referred as unitary elastic demand. The
numerical value for unitary elastic demand is equal to
one (ep=1).

• The demand curve for unitary elastic demand is

represented as a rectangular hyperbola,
 Income Elasticity of Demand
• Income elasticity of demand- It measures the
responsiveness of the quantity demanded for a good
or service to a change in the income of the people
demanding the good keeping other things constant.
• It is calculated as the ratio of the percentage change
in quantity demanded to the percentage change in
income.
• For example, if in response to a 10% increase in
income, the quantity demanded for a good increased
by 20%, the income elasticity of demand would be
20%/10% = 2.0
• The income elasticity of demand is defined as
the percentage change in quantity demanded
due to certain percent change in consumer’s
income.
• Where, EY = Elasticity of demand
• q = Original quantity demanded
• ∆q = Change in quantity demanded
• y = Original consumer’s income
• ∆y= Change in consumer’s income
Types of Income Elasticity of Demand

• High: A rise in income comes with bigger increases in the

quantity demanded.
• Unitary: The rise in income is proportionate to the increase in the
quantity demanded.
• Low: A jump in income is less than proportionate than the
increase in the quantity demanded.
• Zero: The quantity bought/demanded is the same even if income
changes.
• Negative: An increase in income comes with a decrease in the
quantity demanded.
Uses of Income Elasticity of Demand
• Estimation of demand
• Identifying the market for the product
• Forecasting changes in demand
 Cross Elasticity of Demand
• It is the ratio of proportionate change in the
quantity demanded of Y to a given
proportionate change in the price of the related
commodity X.
• It is a measure of relative change in the
quantity demanded of a commodity due to a
change in the price of its
substitute/complement. It can be expressed as:
 Ec =
Ec = x
where, Ec = Cross Elasticity
Py = Original Price of Good Y
∆Py = Small change in Price of Y
Qx = Original Quantity demanded of Good X
∆Qx = Change in quantity demanded of good X
 Types of Cross Elasticity of Demand
• Positive: When goods are substitute of each
other then cross elasticity of demand is
positive. ...
• Negative: In case of complementary
goods, cross elasticity of demand is negative.
• Zero: Cross elasticity of demand is zero
when two goods are not related to each other.
 Arc Elasticity
• Arc elasticity is the elasticity of one variable
with respect to another between two given
points. It is used when there is no general
function to define the relationship between the
two variables.
• Arc elasticity is also defined as the elasticity
between two points on a curve. The concept is
used in both mathematics and economics.
• The Formula for the Arc Price Elasticity of
Demand Is
•
PEd = % Change in Qty /% Change in Price
 Advertising Elasticity
• Advertising elasticity of demand (AED) is a measure
of a market's sensitivity to increases or decreases in
advertising saturation. Advertising elasticity is a
measure of an advertising campaign's effectiveness
in generating new sales. It is calculated by dividing
the percentage change in the quantity demanded by
the percentage change in advertising expenditures. A
positive advertising elasticity indicates that an
increase in advertising leads to a rise in demand for
the advertised good or services.
• Good advertising will result in a positive shift
in demand for a good. AED is used to measure
the effectiveness of this strategy in increasing
demand versus its cost. Mathematically, then,
AED measures the percentage change in the
quantity of a good demanded induced by a
given percentage often change in spending on
advertising in that sector
• AED = % change in quantity demanded / %
change in spending in advertisement
• = ^Qd / Qd / ^A/ A
 Uses of Elasticity of Demand in
Managerial Decision Making
• Price distribution: A monopolist adopts a price discrimination policy only when the
elasticity of demand of different consumers or sub-markets is different. Consumers
whose demand is inelastic can be charged a higher price than those with more elastic
demand.

• Public utility pricing: In case of public utilities which are run as monopoly
undertakings e.g. elasticity of water supply railways postal services, price discrimination
is generally practiced, charging higher prices from consumers or users with inelastic
demand and lower prices in case of elastic demand.

• Joint supply: Certain goods, being products of the same process are jointly supplied,
e.g. wool and mutton. Here if the demand for wool is inelastic compared to the demand
for mutton, a higher price for wool can be charged with advantage.
• Super Markets: Super-markets are a combined set of shops run by a
single organization selling a wide range of goods. They are supposed to
sell commodities at lower prices than charged by shopkeepers in
the bazaar. Hence, price policy adopted is to charge slightly lower price
for goods with elastic demand.

• Use of machine: Workers often oppose, use of machines out of fear of

unemployment. Machines need not always reduce demand for labor as
this depends on price elasticity of demand for the commodity produced.
When machines reduce costs and hence price of products, if the
products’ demand is elastic, the demand will go up, production will
have to be increased and more workers may be employed for the
product is inelastic, machines will lead to unemployment as lower
prices will not increase the demand.
• Factor pricing: The factors having price inelastic demand can obtain
a higher price than those with elastic demand. Workers producing
products having inelastic demand can easily get their wages raised.

• International trade: (a) A country benefits from exports of products

as have price inelastic demand for a rise in price and elastic demand
for a fall in price. (b) The demand for imports should be inelastic for a
fall in price and elastic for a rise in price. (c) While deciding whether
to devalue a country’s currency or not, price elasticity of demand for
a country’s exports would be an important factor to be taken into
consideration. If the demand is price elastic, it would lead to an
increase in the country’s exports and devaluation would fail to
achieve its objective.
• Shifting of tax burden: It is possible for a business
to shift a commodity tax in case of inelastic demand to his
customers. But if the demand is elastic, he will have to
bear the tax burden himself, otherwise demand for his
goods will go down sharply.

• Taxation policy: Government can easily raise tax

revenue by taxing commodities which are price inelastic.
 Revenue
• The term revenue refers to the income obtained by a firm
through the sale of goods at different prices.
• In the words of Dooley, 'the revenue of a firm is its sales,
receipts or income'.
• The revenue concepts are concerned with Total
Revenue, Average Revenue and Marginal Revenue.
 Revenue Types : Total, Average and
Marginal Revenue
• 1. Total Revenue:
• The income earned by a seller or producer after selling the
output is called the total revenue. In fact, total revenue is the
multiple of price and output. The behavior of total revenue
depends on the market where the firm produces or sells.
• Definitions-
• “Total revenue is the sum of all sales, receipts or income of a
firm.” Dooley
• Total revenue may be defined as the “product of planned
sales (output) and expected selling price.” Clower and Due
• “Total revenue at any output is equal to price
per unit multiplied by quantity sold.” Stonier
and Hague.
• 2. Average Revenue:
• Average revenue refers to the revenue obtained
by the seller by selling the per unit commodity.
It is obtained by dividing the total revenue by
total output.
• “The average revenue curve shows that the
price of the firm’s product is the same at each
level of output.” Stonier and Hague
• 3. Marginal Revenue:
• Marginal revenue is the net revenue obtained by
selling an additional unit of the commodity.
“Marginal revenue is the change in total
revenue which results from the sale of one more
or one less unit of output.” Ferguson.
• Thus, marginal revenue is the addition made to
the total revenue by selling one more unit of the
good. In algebraic terms, marginal revenue is
the net addition to the total revenue by selling n
units of a commodity instead of n – 1.
• Therefore,
• Total Revenue, Average Revenue and
Marginal Revenue:
• The relation of total revenue, average revenue
and marginal revenue can be explained with
the help of table and fig.
• Table Representation:
• The relationship between TR, AR and MR can
be expressed with the help of a table-
• The formula to calculate TR, AR and MR is
as under:
• TR = P x q
• Or TR = MR1 + MR2 + MR3 + MR3 +….. MR„
• TR
• AR = TR/q MR = TRn – TRn _ x
 Demand Forecasting
• In the words of Cundiff and Still, “Demand
forecasting is an estimate of sales during a
specified future period which is tied to a
proposed marketing plan and which assumes a
particular set of uncon­trollable and
competitive forces”.
• Therefore, demand forecasting is a projection
of firm’s expected level of sales based on a
chosen marketing plan and environment.
• Demand forecasting is the scientific and
analytical estimation of demand for a product
(service) for a particular period of time.
• It is the process of determining how much of
what products is needed when and where.
• In order to plan the level of production and
make arrangements for the resources to be
consumed, it is important to estimate future
demand.
 Relevance of Demand Forecasting
• i. Fulfilling objectives
• ii. Preparing the budget
• iii. Stabilizing employment and production
• iv. Expanding organizations
• v. Taking Management Decisions
• vi. Evaluating Performance
• vii. Helping Government
Methods of Demand Forecasting
• 1. Opinion Polling Method:
• In this method, the opinion of the buyers, sales force and experts could
be gathered to determine the emerging trend in the market.

• The opinion polling methods of demand forecasting are of three

kinds:

• (a) Consumer’s Survey Method or Survey of Buyer’s Intentions:

• In this method, the consumers are directly approached to disclose their
future purchase plans. This is done by interviewing all consumers or a
selected group of consumers out of the relevant popu­lation. This is the
direct method of estimating demand in the short run. Here the burden
of forecasting is shifted to the buyer. The firm may go in for complete
enumeration or for sample surveys. If the commodity under
consideration is an intermediate product then the industries using it as
an end product are surveyed.
• (i) Complete Enumeration Survey:
• Under the Complete Enumeration Survey, the firm has
to go for a door to door survey for the forecast period
by contacting all the households in the area. This
method has an advantage of first hand, unbiased
information, yet it has its share of disadvantages also.
The major limitation of this method is that it requires
lot of resources, manpower and time.
• In this method, consumers may be reluctant to reveal
their purchase plans due to personal privacy or
commercial secrecy. Moreover, at times the con­sumers
may not express their opinion properly or may
deliberately misguide the investigators.
• (ii) Sample Survey and Test Marketing:
• Under this method some representative households are
selected on random basis as samples and their opinion is
taken as the generalized opinion. This method is based on
the basic assumption that the sample truly represents the
population. If the sample is the true representative, there is
likely to be no significant difference in the results
obtained by the survey. Apart from that, this method is
less tedious and less costly.
• A variant of sample survey technique is test marketing.
Product testing essentially involves placing the product
with a number of users for a set period. Their reactions to
the product are noted after a period of time and an
estimate of likely demand is made from the result.
• (iii) End Use Method or Input-Output Method:
• This method is quite useful for industries which are
mainly producer’s goods. In this method, the sale of
the product under consideration is projected as the
basis of demand survey of the industries using this
product as an intermediate product, that is, the
demand for the final product is the end user demand
of the intermediate product used in the production of
this final product.
• (b) Sales Force Opinion Method:
• This is also known as collective opinion method. In this
method, instead of consumers, the opinion of the salesmen is
sought. It is sometimes referred as the “grass roots approach”
as it is a bottom-up method that requires each sales person in
the company to make an individual forecast for his or her
particular sales territory.
• (c) Experts Opinion Method:
• This method is also known as “Delphi Technique” of
investigation.
• The Delphi method requires a panel of experts, who are
interrogated through a sequence of questionnaires in which
the responses to one questionnaire are used to produce the
next questionnaire.
• Thus any information available to some experts
and not to others is passed on, enabling all the
experts to have access to all the information for
forecasting.
• 2. Statistical Method:
• Statistical methods have proved to be immensely
useful in demand forecasting. In order to main­tain
objectivity, that is, by consideration of all
implications and viewing the problem from an
external point of view, the statistical methods are
used.
• The important statistical methods are:
• (i) Trend Projection Method:
• A firm existing for a long time will have its own data
regarding sales for past years. Such data when
arranged chronologically yield what is referred to as
‘time series’.
• Time series shows the past sales with effective
demand for a particular product under normal
conditions. Such data can be given in a tabular or
graphic form for further analysis.
• This is the most popular method among business
firms, partly because it is simple and inexpensive and
partly because time series data often exhibit a
persistent growth trend.
• (a) Fitting Trend Equation or Least Square Method: The
least square method is a formal technique in which the trend-
line is fitted in the time-series using the statistical data to
determine the trend of demand.
• The most common types of trend equations are:
• Linear Trend: When the time-series data reveals a rising or a
linear trend in sales, the following straight line equation is
fitted:
S = a + bT
Where S = annual sales; T = time (years); a and b are
constants.
• Exponential Trend: The exponential trend is used when the
data reveal that the total sales have increased over the past
years either at an increasing rate or at a constant rate per unit
time.
• (b) Method of Least Squares : If a straight line is
fitted to the data it will serve as a satisfactory trend,
perhaps the most accurate method of fitting is that of
least squares.
• The formula for a straight-line trend can most simply
be expressed as
• Yc = a + bX
where X represents time variable, Yc is the dependent
variable for which trend values are to be calculated
and a and b are the constants of the straight line to be
found by the method of least squares.
• (c) Moving Average and Annual Difference Method-
• A moving average is a technique to get an overall idea
of the trends in a data set; it is an average of any subset
of numbers. The moving average is extremely useful
for forecasting long-term trends.
• An average represents the “middling” value of a set of
numbers. The moving average is exactly the same,
but the average is calculated several times for
several subsets of data. For example, if you want a
two-year moving average for a data set from 2000,
2001, 2002 and 2003 you would find averages for the
subsets 2000/2001, 2001/2002 and 2002/2003. Moving
averages are usually plotted and are best visualized.
• (d) Exponential smoothing is a rule of thumb
technique for smoothing time series data using the
exponential window function. Whereas in the simple
moving average the past observations are weighted
equally, exponential functions are used to assign
exponentially decreasing weights over time. It is an
easily learned and easily applied procedure for
making some determination based on prior
assumptions by the user, such as seasonality.
Exponential smoothing is often used for analysis of
time-series data.
• (ii) Barometric Technique:
• A barometer is an instrument of measuring change.
This method is based on the notion that “the future
can be predicted from certain happenings in the
present.”
• In other words, barometric techniques are based on
the idea that certain events of the present can be used
to predict the directions of change in the future.
• This is accomplished by the use of economic and
statistical indicators which serve as barometers of
economic change.
• (iii) Regression Analysis:
• It attempts to assess the relationship between at least
two variables (one or more independent and one
dependent), the purpose being to predict the value of
the dependent variable from the specific value of the
independent variable.
• The basis of this prediction generally is historical data.
• This method starts from the assumption that a basic
relationship exists between two variables.
• An interactive statistical analysis computer package is
used to formulate the mathematical relationship which
exists.
• (iv) Econometric Models:
• Econometric models are an extension of the regression
technique whereby a system of independ­ent regression
equation is solved. The requirement for satisfactory
use of the econometric model in forecasting is under
three heads: variables, equations and data.
• The appropriate procedure in forecast­ing by
econometric methods is model building.
• Econometrics attempts to express economic theories in
mathematical terms in such a way that they can be
verified by statistical methods and to measure the
impact of one economic variable upon another so as to
be able to predict future events.
 Supply Analysis
• Supply Analysis is a research and analysis
done to understand the supply trends and
responses to changing market and production
variables.
• The analysis helps the manufacturers and
companies to understand the impact of these
variables on supply and eventually demand.
• The goal of demand-supply chain is to make
sure that the supply and demand work
properly. The demand should be met and
supply should not be more than what expected.
There are lot of variables which are considered
in demand analysis and supply analysis.
• Importance of Supply Analysis
• Supply Analysis helps manufacturers to analyse the
impact of production changes, policies on increase or
decrease in supply of finished goods. e.g. newer
upcoming technology can help produce more goods in
same amount of time. The analysis can help determine if
this new technology should be adopted or not. Also if
this technology can help produce more, is the demand
there for more products. What impact will it have on the
current labour and how would be it impact supply in the
market.
• Another example can be impact of increase in
wages in the market on supply. The labour cost
would go up and it will drive the costs of
product along with it. If the supply has to be
kept constant, the costs would go up and if costs
have to be kept constant the supply would go
down hence driving the prices up if the demand
is unchanged. These are some questions which
the supply analysis tries to answer.
• Supply Analysis Parameters
• Some of the key parameter which determine
supply are:
• 1. Product's own price
• 2. Input prices
• 3. Technology
• 4. Expectations of the market
• 5. Number of producers present
 Law of Supply
• The law of supply is the microeconomic law
that states that, all other factors being equal, as
the price of a good or service increases, the
quantity of goods or services that suppliers
offer will increase, and vice versa.
 Supply elasticity
• Key Points
• Elasticity is defined as a proportionate change in one variable
over the proportionate change in another variable:
• Elasticity= % Change in quantity /% Change in price
• The impact that a price change has on the elasticity of supply
also directly impacts the elasticity of demand.
• Inelastic goods are often described as necessities, while
elastic goods are considered luxury items.
• The elasticity of a good will be labelled as perfectly elastic,
relatively elastic, unit elastic, relatively inelastic, or perfectly
inelastic.
• luxury: Something very pleasant but not really
needed in life.
• supply: The amount of some product that
producers are willing and able to sell at a
given price, all other factors being held
constant.
• demand: The desire to purchase goods and
services.
• In economics, elasticity is a summary measure
of how the supply or demand of a particular
good is influenced by changes in price.
Elasticity is defined as a proportionate change
in one variable over the proportionate change
in another variable:
• Elasticity =%Change in quantity /
%Change in price
• The price elasticity of supply (PES) is the measure
of the responsiveness in quantity supplied (QS) to a
change in price for a specific good (% Change QS /
% Change in Price).
• There are numerous factors that directly impact the
elasticity of supply for a good including stock, time
period, availability of substitutes, and spare capacity.
The state of these factors for a particular good will
determine if the price elasticity of supply is elastic
or inelastic in regards to a change in price.
• The price elasticity of supply has a range of values:
• PES > 1: Supply is elastic.
• PES < 1: Supply is inelastic.
• PES = 0: The supply curve is vertical; there is no
response of demand to prices. Supply is “perfectly
inelastic.”
• PES = ∞
• (i.e., infinity): The supply curve is horizontal; there is
extreme change in demand in response to very small
change in prices. Supply is “perfectly elastic.”
• Inelastic goods are often described as
necessities. A shift in price does not drastically
impact consumer demand or the overall supply
of the good because it is not something people
are able or willing to go without. Examples of
inelastic goods would be water, gasoline,
housing, and food.
• Elastic goods are usually viewed as luxury
items. An increase in price for an elastic good
has a noticeable impact on consumption. The
good is viewed as something that individuals
are willing to sacrifice in order to save money.
An example of an elastic good is movie
tickets, which are viewed as entertainment and
not a necessity.
 The price elasticity of supply is determined by:

• Number of producers: ease of entry into the market.

• Spare capacity: it is easy to increase production if there is a shift in demand.
• Ease of switching: if production of goods can be varied, supply is more elastic.
• Ease of storage: when goods can be stored easily, the elastic response increases
demand.
• Length of production period: quick production responds to a price increase
easier.
• Time period of training: when a firm invests in capital the supply is more
elastic in its response to price increases.
• Factor mobility: when moving resources into the industry is easier, the supply
curve in more elastic.
• Reaction of costs: if costs rise slowly it will stimulate an increase in quantity
supplied. If cost rise rapidly the stimulus to production will be choked off
quickly.
• The result of calculating the elasticity of the
supply and demand of a product according to
price changes illustrates consumer preferences
and needs. The elasticity of a good will be
labelled as perfectly elastic, relatively elastic,
unit elastic, relatively inelastic, or perfectly
inelastic.
Price of a Product under demand and supply
forces
• Price is dependent on the interaction between
demand and supply components of a market.
Demand and supply represent the willingness
of consumers and producers to engage in
buying and selling. An exchange of a product
takes place when buyers and sellers can agree
upon a price.
• Equilibrium price
• When a product exchange occurs, the agreed upon
price is called an equilibrium price, or a market
clearing price. Graphically, this price occurs at the
intersection of demand and supply as presented in
Image 1.
• In Image 1, both buyers and sellers are willing to
exchange the quantity Q at the price P. At this point,
supply and demand are in balance. Price
determination depends equally on demand and supply.
Figure 1, Graph showing price equilibrium
curves
• It is truly a balance of the market components. To
understand why the balance must occur, examine what
happens when there is no balance, such as when market
price is below that shown as P in Image 1.
• At any price below P, the quantity demanded is greater than
the quantity supplied. In such a situation, consumers would
clamour for a product that producers would not be willing to
supply; a shortage would exist. In this event, consumers
would choose to pay a higher price in order to get the
product they want, while producers would be encouraged by
a higher price to bring more of the product onto the market.
• The end result is a rise in price, to P, where
supply and demand are in balance. Similarly, if a
price above P were chosen arbitrarily, the market
would be in surplus with too much supply
relative to demand. If that were to happen,
producers would be willing to take a lower price
in order to sell, and consumers would be induced
by lower prices to increase their purchases. Only
when the price falls would balance be restored.
• A market price is not necessarily a fair price, it is merely
an outcome. It does not guarantee total satisfaction on the
part of buyer and seller. Typically, some assumptions
about the behaviour of buyers and sellers are made, which
add a sense of reason to a market price. For example,
buyers are expected to be self-interested and, although
they may not have perfect knowledge, at least they will try
to look out for their own interests. Meanwhile, sellers are
considered to be profit maximizers. This assumption
limits their willingness to sell to within a price range, high
to low, where they can stay in business.