Demand Analysis –Demand Forecasting and Law of Supply for Economics, Management and B Tech Students

1. Demand Analysis –Demand
Forecasting
Dr Naga Sai Kumar Tirthala M.Sc.
MBA PhD ( NIT Warangal)

2. Demand Characteristcs
• Desire to buy (for both use and satisfaction)
• Willingness to pay for the commodity
(Readiness)
• Ability to pay for the commodity ( Buying
capacity)

3. DEMAND FUNCTION
• Dx = f (Px PSC Y, T, AE, W . . . . . . .)
• In the above function
• Dx = Demand for commodity -X (Dependent variable)
• Px = Price of
• Psc = Prices of substitutes and complementary goods to
X
• Y = Income of consumer
• T = Tastes and preferences
• AE = Advertisement expenditures
• W = Weather conditions

4. TYPES OF DEMAND
There are four types of demand. They are:
• Price demand ( Demand based on price)
• Income demand ( Demand based on income)
• Cross demand ( Demand based on substitutes)
• Promotional demand ( Demand based on
promotion)

5. PRICE DEMAND (Law of demand):
• Dx = f ( Px )
• This function tells us that, other things remaining
constant; there exists an inverse relationship
between price of X and the demand for X. As the
price of X falls, the demand for X extends and as
the price of X rises; the demand for X contracts
assuming that there is no change in other
determinants of demand.
• These are called Normal goods.

6. DEMAND SCHEDULE
• The demand schedule is a table showing the
number of units of a commodity that would
be purchased at different prices, at any given
point of time.

7. • Price of X commodity Demand for X
(Rs) (Units)
• 10 100
• 20 90
• 30 80
• 40 70

8. Price
Quantity Demanded

9. Demand curve
• It is a graphic representation of demand
schedule. In the demand curve, we measure
demand for X along horizontal axis and price
on vertical axis
• The main feature of the price demand curve
is, it slopes downward (from left to right).
• The quantity demanded is inversely related to
price.

10. ESTIMATION OF DEMAND
• Price Quantity Purchased
(Rs) (Units)
• 10 10.0
• 11 9.50
• 12 9.00
• 13 8.50
• 14 8.00
• 15 7.50

11. Causes for Negative Slope of the
Demand Curve
• 1. Law of Diminishing Marginal Utility:
As the price of the commodity falls, consumer
purchases more of the commodity, so that
the marginal utility from the commodity also
falls to equal the reduced price and vice-versa

12. 2. Income effect
• As the price of a commodity falls, the real
income of a consumer increases in terms of
the commodity whose price has fallen. As a
result, a part of the increase in real income is
used to buy more of the commodity

13. 3. Substitution effect
• According to ordinal utility approach, the
substitution effect (because of change in price) is
the basic reason for the application of Law of
Demand. When the price of a commodity falls, it
becomes cheaper compared to “other
commodities which the consumer is purchasing”.
• As a result, the consumer would like to
substitute this cheaper commodity ( Tea) for any
other commodity ( Coffee) whose price whose
price remains is relatively higher. ( Tea is
preferred to coffee )

14. 4. New consumers
• When the price of a commodity is reduced,
then a large number of new consumers who
were not consuming the commodity earlier,
now start purchasing it now, because they can
now afford to buy it.

15. 5. Different uses of the commodity
• Commodities have different uses. If their price rises,
they are used only for “important and limited”
purposes. As a result the demand for such
commodities contracts.
• On the other hand, when the price is reduced, the
commodity may be purchased more and used for
satisfying different needs as well.
• Ex: If Tomato price is high, it is purchased for cooking
just curry only. But if the price falls down, then tomato
pickles, tomato sauce, ketchup etc can also be made
along with curries (Unlimited uses).

16. EXCEPTIONS TO THE LAW OF
DEMAND
• The inverse relationship between price and
quantity demand (the law of demand) does not
hold good with respect to all types of
commodities and under all conditions.
• With respect to some commodities, there exists
direct relationship between price and quantity
demanded i.e. as price rises, demand extends
and as price falls, demand contracts.
• Such commodities are to be treated as exceptions
to the law of demand

17. 1. GIFFEN GOODS
• There are certain commodities for survival
sake, which are relatively inferior from the
poor consumers view point.
• Sir Robert Giffen discussed such exceptions.
• Giffen stated that with a fall in price of bread
its quantity demanded was reduced rather
than increased. This is known as Giffen
Paradox.

18. A poor man who has to spend a major portion of his income ( Say,
10 kgs per month , Rs 80 out of his budget Rs 100) on low quality
coarse grain and is therefore, able to spend a very small part of it
(Rs 20) on other goods (say eggs).
If the price of this coarse grain rises ( Now he spends Rs 90 for the
same 10 kgs per month), he will be left with still less money (Rs 10)
to spend on other goods ( eggs).
As a result he may be forced to spend this part of his income ( Rs 10
out of Rs 20)also on the grain whose price has risen
Inference: As price of survival-commodity is rising, even the
demand for the commodity is not falling.
Because hike in price of that commodity reduced the purchase of
other commodity (substitute), it is positive substitution effect wrt
that survival-commodity whose price is increased.

19. • On the other hand, if the price of the grain falls ( Rs 60 for 10 kgs),
the real income of the poor consumer rises ( now he is left with Rs
40 in his pocket) and now, he can go for the consumption of
relatively better quality goods ( He may purchase more number of
eggs or he may meat which is costly).
• Inference :
Extra money saved on reduction in price of the survival-
commodity is not used by the consumer for purchasing more of
that commodity.
• Hence it is NEGATIVE SUBSTITUTION EFFECT which resulted in low
sales for that survival-commodity whose price is dropped but high
sales for the other (relatively costly substitutes) commodities

20. 2. ARTICLES OF DISTINCTION
( Veblen Goods)
• These are prestige goods or status goods or
Veblen goods.
• According to Veblen, the demand for diamonds
and jewellery is more as their price is higher.
• This is because, a rich man’s desire for distinction
(STATUS NEEDS) is satisfied better when the
articles of distinction are highly priced and the
poor people cannot afford to buy.

21. 3. EXPECTATIONS
• These expectations are basically related to rise and fall in
price in future.
• If consumers expect a rise in price of an important
commodity, they rush to purchase more of the commodity
at the current price even though the current price is much
higher than the previous price. (Purchases such as Rice
bags, sweaters just before winter season, umbrellas just
before rainy season are expected to rise in prices later)
• If they expect a fall in price, they purchase less of the
commodity at present in the hope of buying it in future at a
lesser price.( Mangoes in the beginning of summer season
are costlier)

22. Income demand
• Income function as Dx = f (y). Here Dx is the
demand for x commodity and y is the income of
consumer.
• Superior goods: In case of superior goods, there
exist direct relationship between change in
income and demand
• Inferior goods: Demand is inversely related to
change in income with respect to inferior goods.
• Qd = a +by.

23. CROSS DEMAND
• This shows the relationship between changes in demand for one
commodity as a result of change in the price of another commodity,
assuming other things remaining constant.
• These two commodities may be either substitutes or
complementary goods. We can write the cross demand function as
shown below.
• DA = f (PSC)
Where DA = Demand for commodity - A (Dependent
variable)
Psc = Prices of substitutes and complementary goods
to A ( Independent variable)

24. Substitutes
• If two commodities are substitutes, then we can use
A commodity (or B commodity) for the same
purpose.
• Examples of substitutes are Televisions, fans, watches,
AC coolers, bikes, four wheelers from two companies
etc.
• In the case of substitutes, if the price of B rises, the
demand for A increases and if the price of B
falls, the demand for A decreases
• Cross demand curve for substitute goods, slopes
upward from left to right

25. Complementary goods
These goods also known as jointly demanded
products. Examples are petrol and automobiles,
pen and ink, pen and paper etc.
Let us assume that A and B are complementary
goods. Then, if price of B ( Shoes)rises the
demand for A ( Socks) falls and vice versa.
• In case of complementary goods, the cross
demand curve slopes downward from left to
right.

26. PROMOTIONAL DEMAND
• This shows the relationship between changes in demand as
a result of change in advertisement expenditures, assuming
other things remaining constant.
• Companies spend large amounts on promoting the sales of
their products.
• The promotional demand function as shown below.
Dx = f (AE)
• In the above function
Dx = Demand for commodity -X (Dependent variable)
AE = Advertisement expenditures.

27. • In general elasticity means the degree of
responsiveness of the dependent variable to a
given proportionate change in the independent
variable. This we can write as:
• Proportionate change in the dependent variable
• Elasticity of demand = (Proportionate change
in the independent
variable) / (Proportionate
change in the independent
variable)

28. Price Elasticity of demand
(Change in quantity
demanded/Original
quantity)
• Price Elasticity of demand = -------------------
(Change in
price/Original
price)

29. 1.Perfectly elastic demand
• In this case, the value of elasticity will be
equal to infinity and the demand curve will be
parallel to horizontal axis. The price is
constant.

30. 3. Unitary elasticity
• If the proportionate change in quantity
demanded is exactly equal to proportionate
change in price, then it is called as unitary
elastic demand. In this case the value of
elasticity is equal to one(1) and the demand
curve will be like rectangular hyperbola

31. 4. Relatively elastic demand
• If the proportionate change in demand is
more than the proportionate change in price,
it is known as relatively inelastic demand. In
this case the value of elasticity will be less
than one

32. Relatively inelastic demand
If the proportionate change in demand is less
than the proportionate change in price, it is
known as relatively inelastic demand. In this
case the value of elasticity will be less than
one.

33. 2. Perfectly inelastic demand
• The demand curve will be parallel to vertical
axis
• The demand curve will be parallel to vertical
axis

34. Need for demand forecasting
• Sales constitute the primary source of revenue
for the business firm. Thus sales forecasts are
needed for production planning, inventory
planning, profit planning etc

35. Steps in demand forecasting
• 1. Nature of forecast:
• The business firm should be clear about the
use of forecast data. At the same time it has to
state it objective in terms of time period i.e.
short run or long run

36. Nature of product
• It indicates whether the firm is producing final
product like food, or intermediary product like
chemical which is to be used as an input in
final product such as paint

37. 3. Life cycle of the product
• If the product is in the initial years of life cycle,
forecast may show an upward trend, if it is in
the last years, forecast may show downward
trend

38. 4. Identification of determinants
• Business firm has to identify the determinants
such as price, income, promotional
expenditure,etc

39. 5. Analysis of determinants
• Researcher has to analyse all those
determinants as whether they are cyclical,
seasonal or random variables.

40. • 6. Choice of technique:
• To conduct the analysis of demand forecast,
researcher may use different techniques. But
the choice of appropriate technique depends
on the nature of the product. The accuracy
and relevance of forecast data depends on the
choice of technique.

41. 7. Testing of accuracy
• The testing is needed to reduce the margin of
error and there by improve its validity for
practical decision making purpose

42. Techniques of demand forecasting
• Broadly speaking there are two approaches
to demand forecasting.
• They are:
(1) Collect information about the likely
purchase behavior of consumer through
conducting opinion polls or interviews.
(2) Use past experience as a guide through a
set of statistical techniques

43. Survey method
• Consumer survey: Under this method, the
company collects information through personal
interviews on consumers’ preferences regarding
their product, from the respondents (census of
population or from sample population).
• Census method yields reliable results compare to
sample method. But census method needs more
time and money compared to sample method.

44. Experts’ Opinion Method
• It consists of an attempt to arrive at a consensus
in an uncertain area by questioning a group of
experts repeatedly until the response appears to
converge along a single line (or issues causing
disagreement are clearly defined).
• The participants are provided with “responses to
previous questions” from other experts in the
group by a coordinator. This is also known as
Delphi method.

45. Collective Opinion Method
• This method also called sales force polling.
The salesmen estimate future sales in their
respective areas.
• The salesmen being closest to the consumers
know the pulse of consumers and have the
most intimate feel of the market i.e.
customers reaction to the products of the firm
and their sales trends.

46. Time series and trend projection
• A firm which has been in production process,
accumulates data related to price and
corresponding sales. Such data when arranged
in a chronological order yields the time series.
The time series relating to sales represents the
past pattern of demand for a particular
product.

47. Use of economic indicators
(Barometric) method
• This method is useful to forecast cyclical swings in
economic activity or business cycles.
• Under this method we have to identify leading
economic indicators. These are time series that
tend to precede or lead changes in general
economic activity (like changes in the mercury in
a barometer precede weather conditions, hence
it is called barometric method).

48. Steps in Baraometric Method
• Identify if a relationship exists between the
demand (Y) for a product and certain
economic indicators (X)
• Assuming the relationship to be linear, we can
write the equation as Y = a + b X
• Once the regression equation is derived, the
value of Y(dependent variable) can be
estimated for any given values of X.

49. Controlled Experiments
• The researcher varies separately certain
determinants (for example: price, income,
advertisement expenditures etc) of demand
which can be manipulated and conduct
experiments assuming other factors remaining
constant.
• Thus, the effect of demand determinants like
price, advertisement etc can be assessed by
either varying them over different markets

50. Judgmental Approach
Management may have to use its own
judgment when (a) analysis of time series and
trend projection is not feasible. The company
asks the advice from an expert in the industry.

51. Smoothing techniques:
• These techniques predict future values of a time series on
the basis of some average of its past values only. Smoothing
techniques are useful when the time series exhibit little
trend or seasonal variations.
• There are two different smoothing techniques. They are:
(a). Moving Averages: In this method the forecasted value
of a given period is equal to the average value of ( year or
quarter or month) time series in a number of previous
periods.
(b). Exponential smoothing: In exponential smoothing
method, the forecast for period t+1 is a weighted average
of actual and forecasted values of the time series in period
t.

52. Law of Supply
• We can write the simplified supply function as:
• Sn = f ( Pn).
• The function tells us that the supply of ‘n’ units of a
commodity depends on price of ‘n’ commodity.
• There exists direct relationship between price of ‘n’
units and supply of ‘n’ units, other things remaining
constant (Ceteris Paribus).
• That is as price of ‘n’ units of commodity rises the
supply of ‘n’ units goes up and as the price of ‘n’ units
falls; the supply of ‘n’ units goes down.
• This relationship between price and supply is known as
‘Law of Supply’.

53. • The basic feature of supply curve is that it
slopes upward from left to right.
• This reveals the fact that, the quantity
supplied is directly related to price.

54. Elasticity of supply
In general elasticity refers to degree of
responsiveness in dependent variable as a
result of given proportionate change in the
independent variable

55. Degrees of Elasticity of Supply:
• 1. Perfectly Elastic supply
• 2. Perfectly Inelastic Supply
• 3. Unitary Elastic Supply
• 4. Relatively Elastic Supply
• 5. Relatively Inelastic Supply

56. • Measurement of Elasticity of Supply:
• Two methods are generally used to measure supply elasticity. They
• are;
• 1. Mathematical Method
• 2. Graphic Method.
• Mathematical Method:
• By using this method it is possible to find out the exact value
• supply elasticity. We can understand this method with the help
• of following example.
• At price Rs.50, suppliers offered 100 units for sale and at price
• Rs 100 they offered 300 units. Supply elasticity is S = 100 units
• S2 –S1= 300 – 100
• = 200 units
• P2 = Rs 50
• P 2-P1= 100 – 50
• = Rs 50

57. • By substituting the values in the following principle we can get
the value of supply elasticity.
• Elasticity of supply =
[(S2 –S1 ) /S1 ]
___________
[(P2 –P1 )/P1 ]
= 2/1
• Value of elasticity 2/1 means 1% change in price causes 2% change
in supply. This is a case of relatively elastic supply ( elasticity ≥ 1)

58. • Using the linear supply function Qs = a + bPx,
we can find out elasticity of supply at any
given price.
• For example the estimated supply function is
Qs=15 + 1.5 Px.
At price Rs 100, find out supply elasticity
Hint: SLOPE is given which is (S2-S1)/(P2-P1)

59. Determination of equilibrium price:
• Equilibrium price is determined at a point where demand is equal
to supply.
Ex: The given estimated demand function is Qd = 10 - 0.5 Px, Where
as the given supply function is Qs= 5 + 0.5Px.
When Qd = Qs then we can identify the equilibrium price. Now we
shall equate Qd with Qs to identify price.
10- 0.5Px = 5+ 0.5Px
10 – 5 = 0.5Px + 0.5 Px
5 = 1 Px
So the equilibrium price is Rs 5.
• Equilibrium price implies the price that equates demand with
supply. Given the demand and supply functions at price Rs 5, the
demand = 7.5 units and the supply = 7.5 units.

60. • If Qd = 200 - 1.5Px and Qs = 100 + 1.5Px, find
out equilibrium price. Estimate equilibrium
demand and supply