Course code: 23HS02
MANAGERIAL ECONOMICS AND FINANCIAL ANALYSIS
Unit -I
Introduction to Managerial Economics: Economics-Managerial Economics-Nature and Scope.
Demand-Law of demand-Elasticity of demand-Types of Elasticity of demand-Demand Forecasting -Methods.
Unit -II
Theory of Production and Cost analysis: Production Function-Isoquant and Isocost, Least Cost
Combination of inputs. Law of Returns, Internal and External Economies of Scale. Cost Concepts
& Break-even Analysis.
Unit -III
Markets & Pricing Policies
Market structures: Markets-Types of markets - Features and price out determinations under Perfect competition, Monopoly, Monopolistic Competition. Pricing –Pricing polices & its Objectives – Pricing Methods and its applications in business.
Unit -IV
Capital and Capital Budgeting: Nature and its significance-Types of Capital - Sources of raising
capital. Capital budgeting-Significance –Process- Techniques of Capital Budgeting (nondiscounted cash flow techniques and discounted cash flow of techniques).
Unit-V
Financial Accounting and analysis: Accounting –significance – Book keeping-Double entry system –Journal- Ledger- Trial Balance- Final Accounts with simple adjustments. Financial Statement Analysis through ratios.
Textbooks:
1. Varshney & Maheswari: Managerial Economics, Sultan Chand.
2. Aryasri: Business Economics and Financial Analysis, 4/e, MGH.
Reference Books:
1.Ahuja H Managerial economics S Chand.
2.S.A. Siddiqui and A.S. Siddiqui: Managerial Economics and Financial Analysis, New
Age International.
3.Joseph G. Nellis and David Parker: Principles of Business Economics, Pearson, 2/e,
New Delhi.
4.Domnick Salvatore: Managerial Economics in a Global Economy, Cengage.
Online Learning Resources:
https://www.slideshare.net/123ps/managerial-economics-ppt https://www.slideshare.net/rossanz/production-and-cost-45827016 https://www.slideshare.net/darkyla/business-organizations-19917607 https://www.slideshare.net/balarajbl/market-and-classification-of-market
https://www.slideshare.net/ruchi101/capital-budgeting-ppt-59565396
https://www.slideshare.net/ashu1983/financial-accounting
COURSE EDUCATIONAL OBJECTIVES(CEO):
• To inculcate the basic knowledge of microeconomics and financial accounting
• To make the students learn how demand is estimated for different products, input output relationship for optimizing production and cost
• To Know the Various types of market structure and pricing methods and strategy
• To give an overview of investment appraisal methods to promote the students to learn how to plan long-term investment decisions.
• To provide fundamental skills on accounting and to explain the process of preparing financial statements
Course outcomes:
CO1 | Define the concepts related to Managerial Economics, Financial Accounting and Management. (Understand-L2) |
CO2 | Understand the fundament also Economics viz., Demand, Production, cost, revenue and markets. (Understand-L2) |
CO3 | Design algorithms based on techniques like linked list, stack, queue, trees etc. (Apply-L3) |
CO4 | Evaluate the capital budgeting techniques (Analyze-L4) |
CO5 | Develop accounting statements and evaluate the financial performance of business entity. (Analyze-L4) |
Imagine for a while that you have finished your studies and have joined as an engineer in a manufacturing organization. What do you do there? You plan to produce maximum quantity of goods of a given quality at a reasonable cost. On the other hand, if you are a sale manager, you have to sell a maximum amount of goods with minimum advertisement costs. In other words, you want to minimize your costs and maximize your returns and by doing so, you are practicing the principles of managerial economics.
Managers, in their day-to-day activities, are always confronted with several issues such as how much quantity is to be supplied; at what price; should the product be made internally; or whether it should be bought from outside; how much quantity is to be produced to make a given amount of profit and so on. Managerial economics provides us a basic insight into seeking solutions for managerial problems
Introduction to Economics
The word 'economics' comes from two Greek words, 'eco' meaning home and 'nomos' meaning accounts. The subject has developed from being about how to keep the family accounts into the wide-ranging subject of today
In general, economics can be defined as a social science which deals with human behavior, how he uses limited income to satisfy the unlimited wants.
Economics is a study of human activity both at individual and national level. The economists of early age treated economics merely as the science of wealth. The reason for this is clear. Every one of us in involved in efforts aimed at earning money and spending this money to satisfy our wants such as food, Clothing, shelter, and others. Such activities of earning and spending money are called “Economic activities". It was only during the eighteenth century that Adam Smith, the Father of Economics, defined economics as the study of nature and uses of national wealth’.
Definitions Of Economics
The definitions of economics can be broadly classified into three different categories.
1. Economics is Defined as Science of Wealth
Adam smith (the father of economics) defined economics as a science of wealth. According to him “An Inquiry into the Nature and Causes of the Wealth of Nations,"”.
He has given primary importance to wealth and secondary importance to mankind.
2. Economics as Science of Human Welfare
Dr. Alfred Marshall, one of the greatest economists of the nineteenth century, writes “Economics is a study of man’s actions in the ordinary business of life: it enquires how he gets his income and how he uses it”. Thus, it is one side, a study of wealth; and on the other, and more important side; it is the study of man. As Marshall observed, the chief aim of economics is to promote ‘human welfare’, but not wealth.
3. Economics as Science of Scarcity
Here there are two important definitions to be considered.
According to Lionel Robbins, “Economics is a science which studies human behavior as a relationship between unlimited wants, and scarce resources which have alternative uses”. With this, the focus of economics shifted from ‘wealth’ to human behaviour’.
Kinds of Economics
1.Micro Economics
The study of an individual consumer or a firm is called microeconomics (also called the Theory of Firm). Micro means ‘one millionth’. Microeconomics deals with behaviour and problems of single individual and of micro organization. Managerial economics has its roots in microeconomics and it deals with the micro or individual enterprises. It is concerned with the application of the concepts such as price theory, Law of Demand and theories of market structure and so on.
2.Macro Economics
Macro economics is that branch of economics which deals with the aggregate behaviour of the economy, as a whole it makes a study of the economic systems in general. E.g. National income, Total saving, Total Consumption, Unemployment, Economic Growth rate.
Difference between Micro and Macro Economics
Managerial Economics
Introduction
Managerial Economics as a subject gained popularity in USA after the publication of the book “Managerial Economics” by Joel Dean in 1951.
Managerial Economics refers to the firm’s decision making process. It could be also interpreted as “Economics of Management” or “Economics of Management”. Managerial Economics is also called as “Industrial Economics” or “Business Economics”.
As Joel Dean observes managerial economics shows how economic analysis can be used in formulating polices.
Economics is concerned with the problem of allocation of scare resources among competing wants. Those economics principles, concepts methods, tools and techniques that can be applied practically to solve the problems of Business Management is known as managerial economics.
Meaning & Definition:
Definitions:
“Managerial Economics is the economics applied in decision-making”.
Haynes, Mote and Paul
According to Milton H. Spencer, "Managerial Economics is the integration of economic theory with business practice for the purpose of facilitating decision-making and forward planning by management."
This definition emphasizes the practical application of economic principles to solve business problems and guide managerial decisions.
Nature of Managerial Economics:
Close to microeconomics:
Managerial economics is concerned with finding the solutions for different managerial problems of a particular firm. Thus, it is more close to microeconomics
.
Normative Economics:
Managerial Economics is normative as it provides recommendations and solutions for practical business problems. It focuses on what should be done to achieve organizational goals effectively.
Application Oriented:
The subject is highly practical, aiming to apply economic theories to real-world business scenarios for effective decision-making. It bridges the gap between theory and practice.
Macro Economics in Nature:
The macroeconomics conditions of the economy are also seen as limiting factors for the firm to operate. In other words, the managerial economist has to be aware of the limits set by the macroeconomics conditions such as government industrial policy, inflation and so on.
Evaluation of each alternative:
Managerial economics provides an opportunity to evaluate each alternative in terms of its costs and revenue. The managerial economist can decide which is the better alternative to maximize the profits for the firm.
Interdisciplinary:
The contents, tools and techniques of managerial economics are drawn from different subjects such as economics, management, mathematics, statistics, accountancy, psychology, organizational behavior, sociology and etc.
Assumptions:
Managerial Economics is based on certain assumptions and the assumptions are not valid universally. Therefore, if there is a change in assumption, the theory may not hold good.
Scope of Managerial Economics:
The following topics comes under the scope of managerial economics.
Demand Analyses and Forecasting:
A firm can survive only if it is able to the demand for its product at the right time, within the right quantity. Understanding the basic concepts of demand is essential for demand forecasting.
Demand analysis is process of understanding the factors influencing consumer demand for a product or service, including price, income levels, preferences, and external conditions.
Demand forecasting is the process of estimating future consumer demand for a product or service using historical data, market trends, and statistical methods.
Production and cost analysis:
Production analysis examines the relationship between inputs (labor, capital, materials) and output, helping businesses maximize efficiency and achieve optimal production levels.
Cost analysis studies the expenses associated with production and helps businesses determine the cost structures for different levels of output.
In managerial economics, production and cost analysis are crucial for understanding how businesses convert inputs into outputs and manage their expenses. These analyses help in optimizing resource use, reducing costs, and improving profitability.
Pricing Policies:
Pricing is one of the most critical areas in managerial economics because it directly impacts a firm's revenue, profitability, and competitive positioning. The theory of price helps businesses understand how prices are determined in different market structures, whether they are competitive or monopolistic. Effective pricing decisions are essential for maximizing profits, maintaining market share, and ensuring long-term success.
Profit analysis:
Profit analysis is the process of assessing a company’s profitability, which helps managers understand how much money the business is making (or losing) and why. It involves examining various aspects of the company’s revenues and costs to make informed decisions about how to maximize profits and improve business performance.
Investment analyses:
Capital is the foundation of business. Lack of capital may result in small size of operations. Availability of capital from various sources like equity capital, institutional finance etc. may help to undertake large-scale operations. Hence efficient allocation and management of capital is one of the most important tasks of the managers. The major issues related to capital analysis are:
1. The choice of investment project
2. Evaluation of the efficiency of capital
3. Most efficient allocation of capital
Knowledge of capital theory can help very much in taking investment decisions. This involves, capital budgeting, feasibility studies, analysis of cost of capital etc.
DEMAND ANALYSIS
Introduction:
Demand is the basis for the starting of any business, as the product decision and amount of product to be produced would be decided only on the basis of the demand prevailing in the market i.e. depending on the market survey and demand forecast. Demand only decides indirectly the amount of factors of production to be employed in the organization i.e. money, men, material, machinery and management required. Without proper demand analysis, if production activity is undertaken the business firm may suffer huge losses.
Demand: Meaning
Demand for a product refers to
If there is ability and willingness but no desire then it is nor a demand. Similarly, without willingness if there is desire and ability, then also it is not a demand.
Law of demand
According to law of demand there is an inverse relationship or a negative relationship between the price of a product and its demand. The law may be stated as follows “when the price falls, demand extends, price rises demand falls, other things, remaining constant.
Explanation of law of Demand
Demand schedule
Price in Rs. | Quantity Demanded (units) |
5 4 3 2 1 | 1000 2000 3000 4000 5000 |
Demand schedule is the table showing the prices per unit of the commodity and the amount demanded per period of time.
In the above table or schedule when the price of the product is Rs.5, its demand is only 1000 units. But when the price has fallen to Rs.1, demand for the product has gone up to 5000 units. This shows that a fall in the price deals to extension of demand. Similarly when we take Rs. 1 price, the demand for the product is 5000 units, when the price started rising up to Rs.5 the demand for the product has fallen to 1000 units. This shows that a rise in price leads to contraction of demand.
This can be shown with the help of diagram, DD=Demand Curve
On X-axis the quantity of a product demanded is represented. On Y-axis the price of the product is represented. DD represents the demand curve. It slopes downwards from left to right as price increases, demand is decreasing. As price decreases demand curve moves away from the point of origin.
Assumptions of Law of Demand:
The assumptions underlying the Law of Demand are:
No change in Consumer Income
If the income of the consumer increases, inspite of increase in the price of the goods the demand will increase. Similarly if the income decreases, inspite of decrease in the price the demand will decrease.
No change in Consumer Preference
If the consumer have a specific preference of the product or he likes the product or he likes the product very much He purchases the product if it is costlier also.
No change in the Tastes and Fashions
If fashion of the product is outdated, the demand will decrease even if it is offered at a lower price
No change in the Price Related Product
If the price of the related product decreases, demand tends to decrease for the other similar products also.
No change in the population
If the population goes on increasing the demand tends to decrease even though the price increases. On the other hand if the population decreases demand tends to decline even though the price is low
No change in the Govt. Policy
The change in the government policies and political situation will influence the demand for the product.
No change in Weather Conditions
In summer season the demand for fans, air coolers, air-condition is increasing considerably irrespective of changes in the price.
No expectation of future price changes.
No change in the range of foods available to customers.
Hence all these assumptions are kept as constant.
Exceptions Or Limitation To the Law of Demand
Giffen Goods/ Inferior Goods:
Robert Giffen, British economist observed that when the price of the product is decreasing the demand for the product is decreasing. These Products are called as inferior goods or Giffen goods.
Similarly, when the price of the product is increasing the demand is also increasing. Such types of products are called superior goods.
Veblen Goods or Prestige Goods
American economist, Veblen explained that, there are certain goods which are purchased by the consumer not because they really need those goods but they purchase goods because of status symbol i.e., to maintains status in the society. Prestige goods are those which consumers will purchase even though they are costlier.
Consumer Expectations:
Whenever the consumer expects a further fall in the price in future he will not purchase the products or goods immediately, when price decreases, demand tends to decline. Similarly when the consumer expects a further increase in the price for the future he will but the products immediately
Necessaries:
The demand almost remains constant irrespective of the price changes concerned to these goods as people tend to adjust their consumption on other goods as they feel these are most necessary products.
Impulse buying:
In Exhibitions and functions, the social habit, place or situation, force people to purchase goods at higher prices
Demand Function
The demand function for a commodity describes the relationship between quantities of the commodity which consumers demand during a specific period and the factors which influence its demand. Mathematically, demand function can be expressed as follows
FACTORS INFLUENCING THE DEMAND FOR A PRODUCT
Price of the Product:
The most important factor affecting amount demanded is the price of the product. The amount of product demanded at a particular price is called as price demand. Normally a large quantity is demanded at a lower price but not at a higher price. Not only the existing price but also the expected changes in price will affect demand.
2.Income of the Consumer:
When consumer’s income increases the demand will increase significantly. On the other hand if the income decreases the demand will decrease
3. Tastes, Habits and Preferences of the Consumer:
Demand for many goods depends upon the tastes, habits and preference of the consumer.
E.g.: Demand for several goods like ice-cream, chocolates, beverages depends on the taste of the individual
4. Relative Price of Substitute Goods and Complement Goods:
The demand for a product is also affected by the changes in price of the related by the changes in prices of the related goods. Related goods can be of two types
1. Substitutes which can replace each other in use
E.g.: Tea, Coffee and bournvita are substitutes.
2. Complementary goods are those which are jointly demanded
E.g.: Tea, Sugar and milk are complementary goods.
5. Consumer Expectation:
A consumer expectation about the future changes in the price of a given product may also affect its demand. When the consumer expects the prices to fall in the future he tends to but less and vice versa.
6. Population:
Increase in population increases demand for necessaries of life. Decrease in population will also affect the demand for different products.
7. Climate and Weather:
The climates of areas woolen clothes are demanded. On a rainy day, ice-cream is not much demanded.
8. Advertisement Effect:
In modern times the consumer preference can be changed by advertisement and sales propaganda. Demand for may products like toothpaste, soaps, washing powder etc., is partially caused by the advertisement affect.
Types of Demand
Demand for consumer goods and producer goods:
When Goods are demanded by consumer for the direct satisfaction of their wants, they are called demand for consumer goods.
E.g. Food items, Readymade clothes etc.
When goods are demanded by producer for production of other goods including consumer goods, they are called demand for producers’ goods.
E.g. Machines, tools, Equipment etc.
Durable goods and Perishable goods demand
Perishable goods are those which can’t consumed only once, while durable goods are those goods which can be used more than once over a period of time.
Derived Demand and Autonomous Demand
When the demand for a product is tied to the purchase of some parent product. Its demand is
Called derived demand.
E.g. Demand for cement depends upon demand for construction industry.
When goods are demanded independently for the direct satisfaction of the consumer wants, it is called autonomous demand.
E.g. The demand for sugar is loosely tied up with the demand for drinks
Industry Demand and Company Demand :
Industry is a group of firms producing or manufacturing the same or similar product.
Company is an individual business unit or business firm
When goods are demanded which are produced or manufactured by a particular company, that demand is called company’s demand.
E.g. Demand made for Maruti cars produced by Maruti Udyog Ltd.
When goods are demanded which are produced or manufactured by a particular industry that demand is called industry demand.
E.g. Total demand for cars produced by automobile industry.
Short run Demand and Long Run Demand
Short run demand refers to that demand which changes immediately due to reaction in price changes and income fluctuation etc.
Long run demand refers to that demand which does not react immediately due to price change. It will take some time for change in demand
New Demand and Replacement Demand :
New demand refers to the demand for the new products and it is the addition to the existing stock. In replacement demand, the item is purchased to maintain the asset in good condition. The demand for cars is new demand and the demand for spare parts is replacement demand
Total market Demand and Segment Market demand
Take the E.g of the consumption of sugar in a given region. The total demand for sugar in the region is the total market demand. The demand for sugar from the sweet-making industry from this region is the segment market demand.
Concepts Of Elasticity Of Demand
Two Variables are considered while measuring the elasticity of demand :-
Elasticity Of Demand = Percentage change in quantity demanded
Percentage change in determinant of demand
Elasticity of demand explains the relationship between a change in price and consequent change in amount demanded. “Marshall” introduced the concept of elasticity of demand. Elasticity of demand shows the extent of change in quantity demanded to a change in price
In the words of “Marshall”, “The elasticity of demand in a market is great or small according as the amount demanded increases much or little for a given fall in the price and diminishes much or little for a given rise in Price”
Elastic demand: A small change in price may lead to a great change in quantity demanded. In this case, demand is elastic.
In-elastic demand: If a big change in price is followed by a small change in demanded then the demand in “inelastic”.
Types Of Elasticity Of Demand
Demand
Price Elasticity
Cross Price Elasticity
Income Elasticity
Advertisement Elasticity
1. Price elasticity of demand:
Marshall was the first economist to define price elasticity of demand. Price elasticity of demand measures changes in quantity demand to a change in Price. It is the ratio of percentage change in quantity demanded to a percentage change in price.
Proportionate change in the quantity demand of commodity
Price elasticity = ------------------------------------------------------------------
Proportionate change in the price of commodity
There are five cases of price elasticity of demand
or
Types Of Price Elasticity
Price Elasticity
Perfectly Elastic
Perfectly Inelastic
Relatively Elastic
Relatively Inelastic
Unitary Elastic
Perfect Elasticity of Demand (Ep=∞):
When small change in price leads to an infinitely large change is quantity demand, it is called perfectly or infinitely elastic demand. In this case E=∞
The demand curve DD1 is horizontal straight line. It shows the at “OP” price any amount is demand and if price increases, the consumer will not purchase the commodity.
Perfect Inelastic Demand(Ep=0):
In this case, even a large change in price fails to bring about a change in quantity demanded.
When price increases from ‘OP’ to ‘OP’, the quantity demanded remains the same. In other words the response of demand to a change in Price is nil. In this case ‘E’=0.
Relative Elastic Demand(E>1):
Demand changes more than proportionately to a change in price. i.e. a small change in price loads to a very big change in the quantity demanded. In this case
E > 1. This demand curve will be flatter.
When price falls from ‘OP’ to ‘OP1’, amount demanded in crease from “OQ’ to “OQ1’ which is larger than the change in price.
Relatively in-elastic demand.
Quantity demanded changes less than proportional to a change in price. A large change in price leads to small change in amount demanded. Here E < 1. Demanded carve will be steeper.
When price falls from “OP’ to ‘OP1 amount demanded increases from OQ to OQ1, which is smaller than the change in price.
Unit elasticity of demand:
The change in demand is exactly equal to the change in price. When both are equal E=1 and elasticity if said to be unitary.
When price falls from ‘OP’ to ‘OP1’ quantity demanded increases from ‘OQ’ to ‘OQ1’. Thus a change in price has resulted in an equal change in quantity demanded so price elasticity of demand is equal to unity.
2. Income elasticity of demand:
Income elasticity of demand shows the change in quantity demanded as a result of a change in income. Income elasticity of demand may be slated in the form of a formula.
Proportionate change in the quantity demand of commodity
Income Elasticity = ------------------------------------------------------------------
Proportionate change in the income of the people
Income elasticity of demand can be classified in to five types.
Zero income elasticity:
Quantity demanded remains the same, even though money income increases. Symbolically, it can be expressed as Ey=0. It can be depicted in the following way:
As income increases from OY to OY1, quantity demanded never changes.
Negative Income elasticity:
When income increases, quantity demanded falls. In this case, income elasticity of demand is negative. i.e., Ey < 0.
When income increases from OY to OY1, demand falls from OQ to OQ1
Unit income elasticity:
When an increase in income brings about a proportionate increase in quantity demanded, and then income elasticity of demand is equal to one. Ey = 1
When income increases from OY to OY1, Quantity demanded also increases from OQ to OQ1.
Income elasticity greater than unity:
In this case, an increase in come brings about a more than proportionate increase in quantity demanded. Symbolically it can be written as Ey > 1.
It shows high-income elasticity of demand. When income increases from OY to OY1, Quantity demanded increases from OQ to OQ1.
Income elasticity leas than unity:
When income increases quantity demanded also increases but less than proportionately. In this case E < 1.
An increase in income from OY to OY, brings what an increase in quantity demanded from OQ to OQ1, But the increase in quantity demanded is smaller than the increase in income. Hence, income elasticity of demand is less than one.
Cross elasticity of Demand:
A change in the price of one commodity leads to a change in the quantity demanded of another commodity. This is called a cross elasticity of demand. The formula for cross elasticity of demand is:
Proportionate change in the quantity demand of commodity “X”
Cross elasticity = -----------------------------------------------------------------------
Proportionate change in the price of commodity “Y”
In case of substitutes, cross elasticity of demand is positive. Eg: Coffee and Tea
When the price of coffee increases, Quantity demanded of tea increases. Both are substitutes.
Incase of compliments, cross elasticity is negative. If increase in the price of one commodity leads to a decrease in the quantity demanded of another and vice versa.
When price of car goes up from OP to OP!, the quantity demanded of petrol decreases from OQ to OQ!. The cross-demanded curve has negative slope.
In case of unrelated commodities, cross elasticity of demanded is zero. A change in the price of one commodity will not affect the quantity demanded of another.
Quantity demanded of commodity “b” remains unchanged due to a change in the price of ‘A’, as both are unrelated goods.
Factors Influencing Elasticity Of Demand
1.Nature of goods:
Goods may be classified into three groups. They are necessaries, comforts and luxuries. The demand for necessaries like salt, clothes etc is inelastic where as demand for comforts and luxuries like television vehicles etc is elastic
2. Availability of substitutes:
Elasticity of demand depends on availability or non-availability of substitutes. In case of commodities, which have substitutes, demand is elastic, but in case of commodities, which have no substitutes, demand is in elastic.
3. Variety of uses:
If a commodity can be used for several purposes, than it will have elastic demand. i.e. electricity. On the other hand, demanded is inelastic for commodities, which can be put to only one use.
4. Postponement of demand:
If the consumption of a commodity can be postponed, than it will have elastic demand. On the contrary, if the demand for a commodity cannot be postpones, than demand is in elastic. The demand for rice or medicine cannot be postponed, while the demand for Cycle or umbrella can be postponed.
5. Amount of money spent:
Elasticity of demand depends on the amount of money spent on the commodity. If the consumer spends a smaller for example a consumer spends a little amount on salt and matchboxes. Even when price of salt or matchbox goes up, demanded will not fall. Therefore, demand is in case of clothing a consumer spends a large proportion of his income and an increase in price will reduce his demand for clothing. So the demand is elastic.
Time:
Elasticity of demand varies with time. Generally, demand is inelastic during short period and elastic during the long period. Demand is inelastic during short period because the consumers do not have enough time to know about the change is price. Even if they are aware of the price change, they may not immediately switch over to a new commodity, as they are accustomed to the old commodity.
7. Range of Prices:
Range of prices exerts an important influence on elasticity of demand. At a very high price, demand is inelastic because a slight fall in price will not induce the people buy more. Similarly at a low price also demand is inelastic. This is because at a low price all those who want to buy the commodity would have bought it and a further fall in price will not increase the demand. Therefore, elasticity is low at very him and very low prices.
Demand Forecasting
Introduction:
The information about the future is essential for both new firms and those planning to expand the scale of their production. Demand forecasting refers to an estimate of future demand for the product.
It is an ‘objective assessment of the future course of demand”. In recent times, forecasting plays an important role in business decision-making. Demand forecasting has an important influence on production planning. It is essential for a firm to produce the required quantities at the right time.
It is essential to distinguish between forecasts of demand and forecasts of sales. Sales forecast is important for estimating revenue cash requirements and expenses. Demand forecasts relate to production, inventory control, timing, reliability of forecast etc. However, there is not much difference between these two terms.
Types of Demand Forecasting:
Various types of demand forecasting are as follows
1. Passive Forecasting:
Here prediction about future is based on the assumption that the firm does not change the course of its action.
2. Active Forecasting:
Forecasting is done assuming that, it will be changes in the actions by the firm.
3. Micro Forecasting:
When individual business firm forecast the demand for their products, it is known as micro level forecasting.
4. Long term forecasting:
Long term forecasting refers to the forecasts prepared for long period during which the firm’s scale of operations or the production capacity may be expanded or reduced.
5. Short term forecasting:
Short-term forecasting normally related to a period not more than a year. Short term forecasting relate to the day-to-day information. In the short term forecasting a firm is primarily concerned with the optimum utilization of its existing production capacity
Methods of forecasting
Several methods are employed for forecasting demand.
Demand Forecasting Methods
I. Intentions of Customer
1. Survey Method:
Under this method the consumers are contacted personally to disclose their future purchase plans. This can be done by two ways
Census method
Sample Method
a.Census method:
Under this method all consumers are contacted to know their preferences for the products in future. The interviews are conducted either orally or through questionnaire. With the help of census method the probable demand of all consumers is summed up.
b. Sample method:
In this method a sample of consumers is selected for interview. The sample may be random or stratified sampling. This method is easy, less costly and highly useful.
III. Delphi Technique:
Opinions and views are taken from experts coming from different backgrounds. Under this method experts are asked the likely demand for a particular product. The experts may give different opinions on them. This process is repeated again and again unless a common view point is emerged.
IV. Test Market:
This method is used for estimating demand of new products of estimating sales potential of existing products in new geographical areas. In this method a test area is selected which truly represent the market. The product is launched in this area exactly in the manner in which it is intended to be launched in the market. If the product is found successful in the test area then the sales are taken as a basis for estimating sales in the market as a whole.
2. Market Experimentation Method:
This method involves giving a sum of money to each consumer with which he is asked to shop around in a simulated market. Consumer behavior is studied by varying prices, quantity, packing, advertisement, colour etc.
3. Based on Fast Trends:
Fitting a Trend Linear of Trend Forecasting Method:
Under this method actual dales data is drawn on a chart and estimating by observation where the trend line lies. That line can be extended further towards a future period and the corresponding sales graph can be read from the graph.
Least Square Method
This method uses statistical data to find the trend line which best fits the available data. The following regression equation is used
S= a. T+b
Where
S= Sales
a, b = Past Data Calculation
T = The year for which forecast is required
Time Series Analysis:
This method attempts to build seasonal and cyclical variation into the estimating equation
S = a + b + c + d
Where
a= Trend
b= Season
c= Cycle
a, b, c, d= Constant calculated from past data.
Moving Average Method:
This method is based on past sales data and it is used for short term forecasting and it is based on assumption that the future is the average of past performance
4. Economic Barometer:
This method forecasts the future based on the occurrence of present events, first we have to see whether their exists a relationship between the demand for a commodity or product and certain economic indicator. The above relationship can be established through the method of least square. E.g. demand for tractors depends on the farmer’s income or agricultural income.
5. Statistical Method:
Naïve Method:
It is based on the past data of information available for example Historical Observation of sales
Regression Analysis:
This is a statistical technique by which the demand is forecasted with the help of certain independent variables. There are two types of regression analysis
Simple regression analysis is used when the quantity demanded is taken as a function of a single independent variable. Multiple regression analysis is used to estimate demand as a function of two or more independent variables that varies simultaneously.
6. Judgmental Approach:
If the management is unable to use any of the above method they have to make their own judgment in forecasting the demand
These are the demand forecasting techniques .