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29 views32 pagesUnit 2
MEFA UNIT 2 BTECH
Uploaded by
Arnav DadhichCopyright
© © All Rights Reserved
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/ 32
Chapter
018998
Demand & Supply Analysis
Supply and demand is perhaps one of the most fundamental concepts of economics and it is the
backbone of a market economy. Demand refers to how much (quantity) of a product ot service is
desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a
certain price; the relationship between price and quantity demanded is known as the demand
relationship.
Supply represents how much the market can offer. The quantity supplied refers to the amount of
acertain good producers are will=ing to supply when receiving a certain price. The correlation between
price and how much of a good or service is supplied to the market is known as the supply relationship.
Price, therefore, is a reflection of supply and demand.
24 DEMAND
Demand is the desire for a commodity Pack by necessary purchasing power. If a person is
willing to pay for a commodity (desire) but has no ability to pay, there is only desire but no demand.
In economics demand for a commodity implies three things.
(a) Desire to acquire the commodity
(b) Willingness to pay for commodity
(©) Ability to pay for the commodity
Demand analysis is important to decision making in two ways :
> Itprovides the basis for analyzing market influences on the firms products and thus helps in
the adaptation to those influences by incorporating them in PRODUCTION POLICY of the
company
> Itprovides guidelines in the manipulating of demand itself. Some decision requires a passive
adaptation to market forces while other require the active shifting of those forces, this help in
formulating the MARKETING POLICY of the firm. MANAGERIAL,
2a
The dij
yrepne
1
¥
:CONOMICS 6 FINANCIAL ACCOUNTING +-————— |
Types of Demand eRe eae i
ifferent types of Demand are as follow.
Demand for consumer's goods & producer's goods
Demand for perishable and durable goods
Autonomous (direct) and derive (indirect) demand
Aggregate & market demand
Firm and industry demand
- Demand for consumer's goods & producer’s goods : Goods, which directly satisfy
human wants are called consumer goods. For Example: Food, clothing etc. On the other hand things,
which
indirectly satisfy human wants by helping the production of consumer goods, are called producers
goods. For example: tools, machinery etc.
2.
. Demand for perishable and durable goods : Durable goods are those goods which lasts
fora longer period or which are not exhausted in a single use. For example: Television, Refrigerator,
and Car etc. Goods, which wil not last long are called périshable goods. For example: Milk, Vegetables,
Fish a1
3.
ind Flowers etc.
. Autonomous and derive demand : When the demand fora commodity is entirely independent
of demand for any other commodities, it is autonomous demand. When Demand depends on parent
product then it is derive demand, for example Demand for tyres derived from the demand of cars
4,
. Aggregate & market demand : The demand for a good by an individual’s buyer is called
individual demand or aggregate demand while the demand for good by all buyers in a market is called
market demand.
5.
. Firm & Industry demand : The demand for a good by a firm is called firm demand while
the demand for good by an industry buyers in a market is called industry demand.
214.2. Determinants of Demand
Demand drives economic growth. Businesses want to increase demand so they can
improve profits. Governments and central banks (RBI) boost demand to end recessions. They slow
it during the expansion phase of the business cycle to combat inflation.
Ineconomies, there are five determinants of individual demand and a sixth for aggregate demand.
The Fi
The five determinants of demand are:
1.
ae
‘ive Deter: ints of Demand
The price of the good or service.
Prices of related goods or services. These are either complementary, those purchased
along with a particular good or service, or substitutes, those purchased instead of a certain
good or service.
Income of buyers.
t
I
;
f
meme DEMAND & SUPPLY ANALYSIS —_———_@3)
4. Tastes or preferences of consumers.
5. Expectations. These are usually about whether the price will go up.
For aggregate demand, the number of buyers in the market is the sixth determinant.
Demand Equation or Function
This equation expresses the relationship between demand and its five determinants:
QD=f (price, income, prices of related goods, tastes, expectations)
Itsays that the quantity demanded of a product is a function of five factors: price, income of the
buyer, the price of related goods, the tastes of the consumer, and any expectation the consumer has of
future supply, prices, etc.
How Each Determinant Affects Demand
You can understand how each determinant affects demand if you first assume that all the other
determinants don’t change.
Price. The law of demand states that when prices rise, the quantity of demand falls. That also
means that when prices drop, demand will grow. People base their purchasing decisions on price ifall
other things are equal. The exact quantity bought for each price level is described in the demand
schedule. It’s then plotted on a graph to show the demand curve.
If the quantity demanded responds a lot to price, then it’s known as elastic demand. If the
volume doesn’t change much, regardless of price, that’s inelastic demand,
The demand curve only shows the relationship between the price and quantity. If one of the
other determinants changes, the entire demand curve shifts.
Income. When income rises, so will the quantity demanded. When income falls, so will demand.
But if your income doubles, you won’t always buy twice as much of a particular good or service.
There’s only so many pints of ice cream you'd want to eat, no matter how wealthy you are. That’s
where the concept of marginal utility comes into the picture. The first pint of ice cream tastes
delicious. You might have another. But after that, the marginal utility starts to decrease to the point
where you don’t want any more.
Prices of related goods or services. The price of complementary goods or services raises
the cost of using the product you demand, so you'll want less. For example, when petrol prices rose
» the demand for Diesel increased as Diesel is a complementary good to petrol.
The opposite reaction occurs when the price of a substitute rises. When that happens, people
will want more of the good or service and less of its substitute. That’s why Apple continually innovates
With its iPhones and iPods. As soon as a substitute, such as a new Android phone, appears at a lower
rice, Apple comes out with a better product. Then the Android is no longer a substitute.
Tastes, When the public’s desires, emotions, or preferences change in favor of a product, so
does the quantity demanded. Likewise, when tastes go against it, that depresses the amount demanded.
Brand advertising tries to increase the desire for consumer goods. MANAGERIAL ECONOMICS & FINANCIAL ACCOUNTING
Expectations. When people expect that the value of something will rise, they demand more ¢
it, That explains the housing asset bubble of 2005. Housing prices rose, but people bought more
because they expected the price to continue to go up. Prices increased even more until the bubble
burst in 2006-2011. Between 2015 and 2018, housing prices fell 30 percent. But the quantity demanded
didn’t grow. Why? People expected prices to continue falling. Record levels of foreclosures entered
the market due to the subprime mortgage crisis. ee
Demand didn’t increase until people expected future prices would, too.
Number of buyers in the market. The number of consumers affects overall, or “aggregate,”
demand. As more buyers enter the market, demand rises. That’s true even if prices don’t change.
That was another reason for the housing bubble, Low-cost and sub-prime mortgages increased the.
number of people who could afford a house. The total number of buyers in the market expanded. This |
increased demand for housing. ‘
2.4.3 Demand Fun Pee
Variables that affects the product demand quantity are
1 Price of the product 2.Price of other similar product
3.Consumer income 4.Consumer taste
5.Environmental factors.
Demand and price :
Basic economic hypothesis is that lower the price of the product, larger will be demand, ifother
4 variables remain constant. This is because of the reason that with the constant income consumer
will be in position to buy less quantity at comparative higher price.
Demand schedule and demand Curve :
Demand schedule shows quantity demanded and price, It is a tabulation showing quantity
demanded at some selected price. .
io [15 [20 [25 [30 ] -°
0 | 35 | 25 ise aio
Above table shows consumer demand behavior with the change in price, based on these data
we can plot the demand curve-which has quantity on X axis and price on Y axis negative slope of
plotted graph shows that quantity demand increases with fallin price.
25
0 eee eee
25 35 50 70
Demand Curve ———— DEMAND © supply ANALYSIS ———_ GD
Any change that increases the demand ,will shift the demand curve to right.
1.If price of product reduced then demand increases and curve will be shifted to right.
2.[fprice of similar ie. Substitute Product increases then also curve will shift to right.
3. Increase in total income will also increase demand and will also shift curve to the right.
4. hange in favourable taste will also cause similar change as in 4.
5.Change in favourable environment will also cause shifting of curve to right.
Opposite condition to above five will cause decrease in demand ,hence cuve will shift to left.
Individual Demand Function:
Individual demand function refers to the functional relationship between individual demand and
the factors affecting individual demand. It is expressed as:
D.=f@,P. YF)
Where,
D, = Demand for Commodity x
| P, = Price of the given Commodity x
P,= Prices of Related Goods
Y = Income of the Consumer
T = Tastes and Preferences
F = Expectation of Change in Price in future.
Demand function is just a short-hand way of saying that quantity demanded (D,), which is oa the
left-hand side, is assumed to depend on the variables that are listed on the ‘Tight-hand side.
Market Demand Function:
Market demand function refers to the functional relationship between market demand and the
factors affecting market demand. As mentioned before, market demand is affected by all factors
|_ affecting individual demand. In addition, it is also affected by size and composition of population,
season and weather and distribution of income.
So, market demand function can be expressed 2s:
D,=f(P,.P, YT, F, Pp. S,D)
D, = Market demand of commodity x
P. = Price of given commodity x
,= Prices of Related Goods
Y= Income of the consumers;
T= Tastes and Preferences
|
|S) Where, @D ——« MANAG CONOMICS & FINANCIAL ACCOUNTING e———
¥= Expeetation of Change in Pri future;
Po" Size and Composition: of population
S © Season and Weather
D> Distribution of Income
2.2 ELASTICITY OF DEMAND we
In economies, elasticity is the ratio of the
Fespect to an incremental perventage chi
extraondinarily wide range ofapplications i
useful to understand the dynamie
might find that doing so lowers profit if demand is highly elasti as sales would fall sharply. Similarly,
a business considering a price cut ‘might find that it does not increase sales, iftdemand for the product
is price inelastic,
a
incremental percentage change in one variable with
Ke in another variable, The concept of elasticity has
- In particular, an understanding of elasticity is
- For example, a business considering a price increase
‘The demand elasticity refers to how sensitive the demand for a Rood is to changes of other
economic variables. Demand el is important because it helps firms in finding demand due to
changes in affected variables viz change in price of the 00d, the effect of changes in prices of other
goods and many other important market factor sticity greater than one are called “elastic,”
elasticity less than one are “inelastic,” and elasticity ‘equal to one are “unit elastic.”
& measure of how much the quantit
important for setting pi
Demand elas
ty demanded will change if another
's SO as to maximize profit.
. When price elasticity of demand is elastic, the firm should lower price
\ uptick in demand, increasing your total revenue. When price elasticity of demand is inelastic, you
should increase prices be: tse there will be only a small decrease in demand, and again, total revenue
will increase. When price ela city of demand is unit elastic, changing the price will not change total
revenue, since price and quantity will generally change in lock step with each other.
Mathematical definition
s, since it will result in a big
In economics, the definition of elasticity is based on the mathematical notion of point elasticity,
For example it applies o price elasticity of demand and price elasticity of supply in which functions of
the interest are Qd(P) and Qs(P). When working with graphs in economics it is
Quantity on x-axis and Price on y-axis, thus the funetion of the interest is x(y) rather
used in mathematical y(x).In general the “y-clasticity of x” ist
Elasticity =
change
common to put
than commonly
Increamental change in X / Increamental change in Y or in terms of Percentage
Percent Change in x
Ey "Sa nS eW
Y "Percent change in y
atnx|_|ae >|
dy
Ey
diny
The “y-clasticity of x” is also called “the elasticity of x with respect toy” o™
eet DEMAND &@ BUPPLY ANALYSIS: 0—
‘Types of FI
Price Elasticity of Demand : One typical application of the concept of elasticity is to consider
what happens fo consumer demand for a pood when prices increase, As the price of a good rises,
consumers will usually demand a lower quantity of that good, perhaps by consuming, fess substituting
other goods and so on. The greater the extent to which demand falls as price rises, the greater is the
price elasticity of demand. However there may be some goods that consumers cannot consume fess
and cannot find substitutes even if prices rise (for example, certain drugs), For such goods, the price
elasticity of demand might be considered inelastic,
jasticity of Demand
Further elasticity will normally be different In the short term and the long term. For
example supply of many goods can be increased over time by locating alternative sources, investing
inan expansion of production capacity or developing competitive products which can substitute, Ifthe
price of gasoline rises, consumers will find ways to conserver their use by finding a more fuel efficient
care. The price elasticity of demand (PED) is an elasticity that measures the nature and degree of the
relationship between changes in quantity demanded of a good and changes in its price, if in response
toa 10% fall in the price of a good, the quantity demanded increases by 20% the price elasticity of
demand would be 20% / (-10%) = -2
In general a fall in the price of a good is expected to increase the quantity demanded so the price
clasticity of demand is negative as above, note that in economics minus sign is often omitted and the
elasticity is given as an absolute vales, Because both the denominator and numerator of the fraction
are percent changes, price elasticity of demand arc dimensionless numbers.
Mathematical definition : The formula used to calculate the coefficient of price elasticity of
demand is
E,= % change in quantity demanded of product X
fy =
% change in price of product X
= AQ! Oy
AP, 125
Or, using the Differential Calculus +
P00
7
Where
P= Price
Q» Quantity
‘Types of Price Flastlelty +
Price HMasticity of Demand for a good is elastic {Fd} > 1), the percentage change in quantity is
WeMer thon that the price, Hence, when the price is raised the total revenue of producers fills, and
Versa,
dl — te Se
——
MANAGERIAL ECONOMICS € FINANCIAL ACCOUNTING _——-—
a} hice ‘i
‘When the price elasticity of demand for a good is inelastic (Ed! 1) the percentage change i?
sty is smaller than that in pre, Hence, when the price is aised the total revenue of producers
quan
ses and vice Versa. ey ic (!
rises anc mand for a good is unitary elastic ({Ed; = 1) the percentage
ice elasticity of det seas in
pcan deren ‘otha in price. Hence. When the price is ed the total revenue remains
change
unchanged, the demand curve isa rectangular hyperbola.
o %
2 chara Change
oes none in price
in price :
% Change in Quantity % Change in Quantity % Change in Quantity
EDtends to infinite ED= ED tends to Zero
Fig. 2.1 : Price Elasticity
When the price elasticity of demand for a good is perfectly elastic (Ed is undefined), any increase
in the price no matter how small will cause demand for the good to drop to zero. Hence when the
price is raised the total revenue of producers falls to zero, The demand curve is a horizontal straight
line. When the price elasticity of demand for a good is perfectly inelastic (Ed = 0), changes in the
price do not affect the quantity demanded for the good. The demand curve is a vertical straight line;
this violates the law of demand, An example of perfectly inelastic good is a human heart .
Example-calculate the coefficient of price elasticity, using following data
Price in Rs 6 |5 4 3 2
Demand {0 | 10 20 30 40
Casel- When price drop from Rs 5 to Rs 2
Case 2- When price rise from Rs 2 to 5
Soln.-change in quantity corresponding to these prices is 40-10-30
Change in price 5-2=3
As per formula
Casel-
=dQ/Q* P/dP_ = 20/10 x 5/2 a
Case 2- -E=dQ/Q x P/dP = 20/30 x 3/2 = 1
So value of E differ with change of direction
POINT METHOD :
To overcome above, Marshal devis
ised the Poi i i
and deduce tothe formula the for he Point method, this method uses the geometric
of geometry, following expression will clearify it.
E=dQIQ x P/dP = drag x PQ
Principle DEMAND & SUPPLY ANALYsIg
price fall from OA to OC & quantity or demend increases fro1
p&Qare original price and quantity,
gure 2.2 it can be rewritten as
E=BD/AC x PB/OB = QM/PQ x PB/OB = BS/OB S/n
‘ood
ane wig
1m OB to OD
asperi
(because A, PQM &PBS are similar)
So E=PS/PR = Lowe regment/Upper segment
__aspethis method we arrived to the following conclusion
1) Atmid point of the demand curve elasticity is unity,
| 2) Moving up from the mid point of demand curve demand becomes elastic (1)
3)Moving down from the mid point of demand curve demand becomesin lstic (E<1)
s
|
| R
| A P.
| Price | dP
| c u
lia}
oes
| Quantity
Fig. 2.2: Point Method
| Are Elasticity of Demand :
| Arc Elasticity is the elasticity of one variable with respect to another between two given points on
the curve, It is used when there is not a general function for the relationship of two variables. Toavoid
| the discrepancy of above method ,which give different value of E when we are calculating in the
| reverse direction,to avoid ithere E is calculated by taking average of two price and average of 2 quantity
Y
D
P,
price ‘| a |
a D
2
ora Oe _
Fig. 2.3: Arc Method
E=dQ/Q x P/dP
dQ, (RB)
aP * (+02) Gangrene
MANAGERIAL ECONOMICS & FINANCIAL ACCOUNTIN(
Total Expenditure Or Total Outlay Method- tal expenditure,
ot
This method given by Marshall evolved the total out lay or total revenue or tie es and after the
as a measure of elasticity. In it, total expenditure of a purchaser is calculated b
change in price. Total oulay isthe product of price with the corresponding quantity.
[PRICE PER UNIT Quantity” | Total expense=P°q jEtasticity E
710 7 10 Et
9 2 18 Ea
8 3 24 Et
7 4 2 ei
6 5 30) E=1
3 6 30 =f
4 TS 30 =
3 8 24 Ext
2 9 18 E Estimation of quantity & composition of demand
> Estimation of the price
> Sales planning
> Inventory control
2, Determination of the nature of goods under consideration
The goods may be
> Capital Goods
> — Consumer durables
> — Consumer non — durables
3. Selection of a proper method of forecastingdepends on
> — Leadtime available for making decision
> — Level of accuracy desired
> — Quality of data available
4. Interpretation of result
23.4 Purpose of Forecasting es
Demand Forecasting (DF) is a necessary business process which stands between the customer
and the manufacture and supply ofthe item under study. In essence, itis a forecasting technique
Which lines up the factors involved in manufacturing and supply required to meet the Customer's
demand. .
The way to work out what the customer’s re
quirement for next year may be to analyse his
deliveries over a number of years and to make an est
imate based on those numbers (plus an allowance
As er definition, Demand forecasting isthe artand science of forecasting customer demand to
drive holistic execution of such demand by corporate supply chain and business management.
Demand forecasting involves techniques including both informal methods, such as educated
suesses, and quantitative methods, such asthe use of historical sales data and statictical techniques or
current data from test markets, Demand forecasting may be used in production planning, inventory
management, anda! times in assessing future capacity requirements, orin making decisions on whether
to enter a new market.
ov
SseRaBU
bi
fobs ee ee ae
aa ——_———> DEMAND & SUPPLY ANALYSIS ———@3)
Demand forecast will tell production manager that how much inventory he has to ship to the
customer, how much inventory should be stock in the warehouses, how much product needs to be
produced, how much raw material needs to be purchased, how many people need to be employed,
machinery, plant size etc. From a retailer perspective, forecasting demand will inform you about the
amount of products you need to purchase, shelve space management, planning promotional activities
to get rid of some products or to entice the customers to buy more of a product, the shift in customer
buying behavior and so on.
However, above mentioned planning decisions are actually the effects a demand forecast can
have on the supply chain rather than its purpose. The argument is that a forecast is not a decision,
its merely a forecast. A decision incorporates information where might not directly or indirectly
effect sales. Those information should not be considered in a forecast. A forecast should incorporate
all the information that directly affect the sales time series (i.e., promotions, competitors’ actions,
weather and seasonality, advertisement, customer habit change and so on).
Considering this argument, the main purpose for forecasting demand will reveal as to find the
nearest amount of sale for future period. The later considerations, repercussions and consequences
of a forecast are part of a decision making process called supply chain planning. So to forecast
demand one need to forecast it for the sake of foresting. Afterwards, one can consider planning
issues and adjust the forecast based on the need and turn it into a plan.
Economists engaged in Demand forecasting have to consider six factors in the process of demand
forecasting.
1) Period of forecasting
> — Short term (two months to one year)
> Medium terms (one year to three year)
> Long term (five to twenty years)
2) Levels of forecasting
Forecasting is generally done at four levels
> Macro economic forecasting
> Industry demand forecasting
> Firm demand forecasting
> Product line forecasting
3) Nature of the products
> _ Established product
> New product. AGERIAL ECONOMICS © FIN;
NCIAL. ING
PRES
ture of goods
> Consumer durable
> Nondurable
> — Capital goods
5) Risk and uncertainty
6) Coverage of the forecasting
> General
> Specific
In addition to above following are also important determinants of better forecasting =
1. Clearly outline objectives. This is the most important step in the process, as it will form
the framework for your forecasting process. Objectives can include driving growth, reducing
costs. maximizing customer retention, optimizing headcount and others. Company's specific goals
and objectives will help to determine the aspects of forecast that need to focus on the most.
2. Consider the frequency and tire horizon best suited for the organization. The
time horizon is never a one-size-fits-all solution, and it may change as company changes. To
choose the appropriate forecasting cycle and timeframe, you need to con.i4er the availability of
resources as well as the pace and volatility of the business. Fast-growing or dynamic businesses
may require frequent forecasts, maybe monthly, and a shorter time horizon — maybe 1 - 2
quarters out. Businesses that are less volatile may get by with quarterly forecasts and a longer
time horizon ~ maybe 4 quarters out into the future.
3. Ensure the forecast is driver-based. One proven method of ensuring your rolling
forecast is efficient and accurate. With this approach, updates are focused on the key data or
drivers that determine the key financial outcomes of your company, instead of updating each
Jine item in the budget. With a driver-based model, one can account for the most critical variables
that impact finances, allowing to forecast finances strategically and in a way that focuses on
material changes.
4. Focus on the process. One need to consider the strategy and process for implementing
rolling forecasts within an organization, so, can ensure consistency and buy-in across all
departments. The process needs to be efficient, easy to implement, and encourage collaboration
and participation throughout the organization.
5. Encourage participation. Forecasting relies on the input of a wide Variety of
departments and managers. To ensure accuracy, financial team needs to encourage participatio,
from throughout the company. convenient access to reports and planning templates for i
participants in the process. al
6. Align all company goals. Oftentimes, businesses plan their operations and finan,
separate from each other, which can create disparities in resource allocations. For rolling forees®
tobe impactful, one need to integrate operational and financial planning together, 0 the foreqan
sts
are representative of the entire company. _———_————-
DIMAND & SUPPLY ANALYSIS. @ig)
7. Find a system that works, The success of rolling forceasts largely depends on the
system implemented. Mfcompany is relying on Excel and email, one can anticipate forecasting
rocess to be tedions and prone to innceurae
management (EPM) soflware packages offer |
forecasting proce:
“loud-based planning and enterprise performance
ools to Improve data analysis and streamline the
So one can conquer forecasting with greater precision and efficiency.
Determinants- That Impact Foreeast Accurney +
Nearly 85 percent of a company's performance is. dependent upon external factors. Yet with
nillions of data sets available, many companies don't know where to look to determine which external
drivers are affecting business performance,
1, Consumer Sentiment : As the state of economy fluctuates, consumer sentiment indicates
how confident people feel in purchasing houses, cars, electronics, travel and other goods and services,
2, Disposable Income : By tracking the rise and fall of the amount of money consumers have
remaining after paying bills, retailers, manufacturers and service providers are able to determine how
much consumers have to spend. Combined with consumer sentiment, companies can better anticipate
‘whether consumers have money, and whether or not they are willing to spend it.
3. Residential Real Estate Market : Housing starts and sales of existing homes are strong,
indicators of demand for building materials, home goods and even automobiles. Additionally, the health
of the real estate market is a powerful link to the overall health of manufacturing, employment and
consumer spending.
4. Oil / Gas Prices : Changes in oil and gas prices have a heavy impact on industries worldwide,
including tourism and travel, manufacturing and c-commerce. From a consumer's willingness to drive
toa store to the cost to ship goods, oil and gas prices play a role in both hard costs and consumer
behavior.
5. Labor Market and Wages : Changes in the job market and wages affect consumers?
willingness and ability to buy. Combined with the personal savings rate, which shows how much of
their income consumers are stashing away, these metrics are additional indicators of consumers*
buying behaviors.
6. Weather Data : Severe winter weather, harsh droughts, heavy rains and extreme temperatures
all have huge implications for retailers, global manufacturers and construction companies. From
transportation shut downs to construction delays, severe weather can cost companies millions.
7. Raw Material Costs : Fluctuations in raw material costs can reveal more than just a potential
Price change in the product being manufactured. As certain materials become more or less expensive
to make/purchase, demand and even consumer preferences are affected.
8. Industrial Production : Many enterprises are surprised to learn that industrial production of
‘¢y commodities, such as polymers, cardboard, plastics, glass, dairy, coffee, cocoa, wheat and com
are hidden indicators of their future performance.
9. Architecture Billing Index : The billing activity of architectural companies is a 12-month
leading indicator for building materials and supplies. In general, as manufacturers and construction
Companies see architectural billings rise, they can anticipate an increase in demand 12-months late MANAGERIAL ECONOMICS @ FINANCIAL ACCOUNTING _
3.3) Forecasting Methods
se
y speakir pwo methods to demand forccasting- one is to obtain information
panne Ce of the buyer through collecting expert's opinion or by conducting
ere fh eines known as Qualitative method, the other is to use past experi ri .
eugene cor tie dala echekies Ween as auantative method. Both these
Sereda degrees of judgment The ist method is usually found suitable for shor
ao ‘helater for long-term forecasting. There are specific techniques which fall under
erm 2.
each of these broad methods
Qualitative Method:
Qualitative forecasting techniquesare subjective, based on te opinion and judgment of consumers,
experts; appropriate when past data isnot available. Is usually applied to intermediate-long anee
eee eee ota haces needa informed opinion and judgment theD phi
method, market research, nominal group technique, historical life-cycle analogy are some of them
Survey Method :
In this method surveys are conducted about the consumer intention, expert opinion, Market
position ete Date obtained is analyzed & result is calculated. This method is limited to use for short
term, Normally itis conducted in 2 ways : 1. Consumer survey 2, Opinion poll method.
Consumer survey can be conducted by complete enumeration, sample survey or End user method,
whereas Opinion poll method utilizes Expert opinion, Delphi method, and market experiment. Market
experiments can be performed by Test market and Laboratory test.
Delphi Technique :
The RAND Corporation developed the Delphi Technique inthe late 1960s.In light of globalization
itisuseful to Indian companies because it will be difficult in estimating the demand of product mainly
because of mixed reaction of customers. Technological forecasting is another area of application,
‘here no quantities data can be predicted for future technology. In the Delphi Technique, a group of
experts responds to a series of questionnaires... The results of the first Questionnaire are compiled,
and a second questionnaire based on the Tesults of the first is presented to the experts, who are asked
toreevaluate their responses to the first questionnaire, This questioning, compilation and Tequisitioning
Continues until the researchers have a narrow range of opinions
The essential precautions to be followed in
this method are,
a
Panel members must be unknown to each other,
2. The initial questionnaire should be clear in communication, such that all matter should have
detailed explanation, about which opinion has been sought.
3. _Ifvariation among the op
inion is too much, summary of opinion is again circulated.
Nominal Group Technique :
This techni 7
problem so inique was developed by Mr. Andrew Van Devan a Wharton Professor, isa structured
Wing and decision making method The steps involved iv waco folovs * DEMAND & SUPPLY ANALYSIS. «
generation of Hens Group member write
GID
their idea about the question
Cottection Of Date ATL ideas are displayed on Nip chart or black board without any discussion
Dviscneston> ATL the ileas aro discussed in terms of perceive importance, clarity and logic,
Protininary Voting To select the best idea, voting is dono, if there is no consensus regarding
treat idtea, the idlows ate redtiscussedt & clarify
+ Pinal Voting: Rediscussed ideas are
finally voted and most preferred idea/solution/forecast is
selected.
Quantitative Methods :
Quantitative forecasting methods are used to estimate future demands as a function of past
gaia, appropriate when past data are available. The method is usually applied to short-intermediate
range visions, EXamples of quantitative forecasting methods are: last period demand, simple and
weightest moving averages (N-Period), simple exponential smoothing, multiplicative seasonal indexes.
‘These are also known as statistical methods and include time series forecasting or trend projection
method, Barometric method and Econometric method or Regression method.
Time-Series Forecasting or Trend Projection Method :
Time-series forecasting is 8 quantitative forecasting technique. to measures data gathered over
time to identity trends, The data may be taken over any interval: hourly; daily; weekly: monthly;
yearly, or longer. Trend, eyetical, seasonal and irregular components make up the time series. The
trend component refers to the data's gradual shifting over time. Itis often shown as an upward- or
downwant-sloping line to represent inereasing or decreasing trends, respectively, Cyclical components
Iycabove or below the trend line and repeat fora year or longer. In this forecast is done by using any
one of the following method,
|. Simple Moving Average
2. Weighted moving average
3. Exponential Soothing
1, Simple Moving Average :
Itis based on the assumption that past data is a good indicator of actual demand. It is effective
‘When there is little fluctuation in demand & past demand is not seasonal. Simple moving average for
nyear
D\+D2+D3-Dn
N
Example 1: Demand for a product for last 6 yr. is as follow,forecast the demand for yr
on 4 year average basis
SMA=
2012
P2011]
5500
| ae [2006 [2007 | 2008 2009 «#72010
"| 5000 5500 | S000 | 6000 [so
SEM ; wy
MANAGERIAL ECONOMICS & FINANCIAL ACCOUNTING eae
ing 4 yr
Answer : To calculate demand for 2012.0n 4 yr, average basis,sum the data of preceding 4
divide by 4
5000 + 6000 + $000 + 5500/4 =21500/4 = 5375
Forecast for 2012 is 5375.
2, Weighted moving average
Some time the historical data needs some weightage due to some trend or seasonality in demand.
To assign weightage experience expert help is taken. Here each data is weighted by a factor.
Period: Demand (D) Weigtage factor(W) Owes
1 Di Wi Diwi
2 D2 Ww2 D2w2
3 D3 w3 Daw3
4 D4 W4 D4 Ww4
Forecast for 5" period on 3 month weighted average method . wiil be
D2 W2 + D3 W3 + D4 W4
z, W2+W3+ Wa
7 Example : Calculate Forecast for 2012 by WMA & SMA ,using following datas
Year 2009 2010 2011
\ ‘Actual Demand 7000 7100 1200
Y Weightage 1 2 3
(1000 1 +1100 x 2 + 1200 x 3
Answer : (a) WMA ee ees
(1+2+3)
__ 1000 +2200 + 3600
6
6800
== =1133.3
é 3
(oy) siug = 1000+ 1100 + 1200
3300
ee
3 = 1100
It may be noted that when more weight is given to recent value the forecast is near to likely
trend.
A time series may contain all the components of demand—trend, seasonal variations, cyc|i¢
variations, random variations etc. The seasonal variation may be additive or multicapative .In case of
Me DEMAND & SUPPLY ANALYSIS ———_ a)
jons are added where as in case of multicapati
give variations d tulticapative. the trend is multipli
5 mel nee fend is multiplied by seasonal
vsrition
Using following data calculate the expected sales of 4 quarter of next year
te 1: Using fo 1g ted sale
"pe 7 ring d of 4 quarter of r
[ouster Past sale |” Average salelquarter Seasonal factor
; 200 250 08
7 200 250 08
7 300 250 12
7 300 250 12
The seasonal factor = Actual sales/average sale
Answer:
The procedure is
1. Calculate average sales of each qr.
2.Calculate seasonal index.
3, Tabulate the average sales for next year
4.compute new data utilizing new average sale &seasonal index
[Quarter [Seasonal factor!™)| Average sale/Qri) |) Forecast
[4 08 500 400
[2 08 500 400
[aa 12 500 600
4 12 500 600
4 Exponential Soothing-
SMA & WMA are simple & effective method but needs a large amount of historical datas,
“hess Exponential Soothing method utilizes most recent data, which gives better trend for immediate
«cit lresast. There are different models based on periodic trends are First order exponential
°“singand Trend adjusted exponential Soothing ( Double Soothing )
"int order exponential Soothing :
“Sper this method demand forecast for next year
F,=aDy+(1-@ Ft
‘orecast for period t-1
F.= Forecast for period t
D.1=Actual demand for period t-1
= Smoothing constant between 0 & 1
2)
ee
¥ GaD— MANAGERIAL ECONOMICS & FINANCIAL ACCOUNTING
‘on the basis of above formula the demand for last 3 years will be as follow
For aDy+(1-a Fy
Furr aD a+ (1-a hy
Fug taDist(l-a jk;
Replace value of equation 2 in equation 1
Hence Fy aD. + (1-0) dad, + (1a )Fy
Replace value of equation 3 in equation 4
Hence FL = aD 1) + (I-a) @ DL, +(1-a 2 (aD, 3 + (I-@)F3)
So we see that weight assigned to most recent value is of significance and weight assigned to
past values decreases exponentially as we go back in the period.
Example : Actual sales for May 2012 was 2000 units, where as forecast for this period
was 1800,forecast demand for Jun 2012, using smoothing constant 0.2
Fy = 2D ay + (1 ~ OF pay
= 0.2 x 2000+ (I ~ 0.2)1800
= 400 + 1440 = 1840
Ans. : Forecast for June 2012 is 1840
Trend adjusted exponential Soothing ( Double Soothing )
Simple moving average & single exponential smoothing have draw back of lagging behind actual
data, particularly in cases which have a trend of continous increase or decrease. T o adjust this trend
2 smoothing constant cand B are used.In this method both the average & trend are smoothen, then
the final demand is forecast. Following are the equations used for this purpose.
Ay = aD,+ (1-0) (Ay +T)
BAYA) +1 BT
Far = Act Ty
A,= Exponential smoothen average for period t
Per eee
a
T,= Exponential smoothen trend for period t
D,= Demand of period t
A,_, = Average estimate for period t-1
Ty = Trend estimate for period t-1
F,,1 = Forecast for period +1
Value of smoothing constant a and are always between 0 & 1
Example : Last 5 month average sale of an electric bike is 60 units, average increase in
sale per month is 8 units. In the 5" month 62 units were sold fore cast sales for next 2 months,
using double smoothing method. Value of 0. =0.2 and B = 0.15
| — DEMAND & SUPPLY ANALYSIS: «=——___—_——(@a)
Vem Ast Ts
Ap aD Hay (At Ty)
Ag = 0.2% 624(1 ~ 0.2) (604 8)" 12.4 40.8 9 68 = 66.8
Ty = BIA) BT 4
Ts © 0.15 (66.8 ~ 60) + (10.15) #8" 0,15 * 6.84 6.8% 10.24 6.8" 17
Fy = 66.8 +17 = 83,8 Say 84
go forecast for 6" month is 84 units
For 7th month
Fy = Apt T
Ag = 0.2 * 84+ (1 -0.2) (66.8 +17)
6.8-+ 67.4 = 84.2
0.15 (84.2 ~ 66.8) + (1 0.15) 17=0.15 * 17.4 +0.85 * 17
.61 + 13.45 = 16.06.
F, = AgtTg =84.2 +16.06=100.26 Say 101
So forecast for 7!" month is 101 units
1%
Barometric Method
Inthe metrological department metrology uses barometer to forecast weather, similarly in absence
ofclear pattern in time series, an alternative approach is to find a second series of data, correlating
first. This method was first used by Harward Economic Survey in 1920.The barometric technique
identify relevant economic indicator and observe movements of index forecast future trends. It uses
dal
nd
en
mainly 2 techniques
1. Leading Indicator
2. Composite or Diffusion indices. d
Since the method suffer from several weakness, hence not in use.
Regression or Econometric Method
When the demand for a product is dependent on other variable like price, quality, income of the
Customer etc, Ths relationship can be represented by linear regression ( Regression refer to functional
‘elationship between different variables and their influence on each other )
Inlincar regression the relationship between dependent variable & one independent variable is
"eptesented by straight line & algebraic relation for it
Y=atbX
Yis dependent variable, X is independent variable, a & b are constant.
Ifb is + ve trend line increases positively, if-ve trend line decreases negatively —_——_.
@23)— manacerrat ECONOMICS & FINANCIAL ACCOUNTING
Value ofa & b can be found by using following formula
a= EY/n-b*EX/n
Where n is sample size.
: ee
Example 1 : Find the advertising budget for achieving sale of 50 units. Sales & advertsin
b=
EXY-EXEY/n
EX? = (EXP /n
expenses for last 5 years are as detailed below. Use linear regression analysis.
- Sales fH] 20 10 30 40
Advertising =~ 10 5 10 25
Solution :n=4
X (Sales)Units Ty (Advertising)Rs
20 10
10 5
30 10
40 25
Total 100 50
_ EXY-=EXEY/n
IX? -(EX)?/n
Example 2. Using following data calculate the expected quarterly sales of 2012.
_ 1550-100*50/4 _ 300_
~ 3000-100*100/4 500.”
a = EY/n—b*EX/n
= 50/4 -0.6 * 100/4 =12.5 - 15=-2.5
Y=atbXx
=-2.5 + 0.6 *50=-2.5+30=27.5
Ans : For sales of 50 units advertising expenses will be Rs 27.5
Sale
Year Ori er2 EOr see
2009 720 876 Biz
2010 786 930 cn
2011 1010 1236
k
—— _— DHIMAND SUPPLY ANALYSIS: +)
Answer +
We Know Yr atbx
a= YYin-b # 2X/n
EXY ~ EXEV/n
EX? -(EX)"'/n
Formulate the table for computing value of a & byby util izing
Yr. ar, (x) | “Actual domand Ta Ny aoe]
2009 1 720 720 1
os 2 876 1752 4
3 718 2154 9
4 812 3248 16
2010 5 786 3930 25
6 930 5580 36
7 774 5418 49
8 928 7424 64
2011 9 1010 9090 81
10. 1236 12360 100
4 886 9746 121
12. 1080 12960 144
Total 78 10758 74386 650
_ 74386 ~ 78*10758/12
~— 650=78*78/12
74386 - 69927
650-507
= 4459/143=31.18
a = 10758/12—31.18 *78/12
= 896.5 ~202.7 = 693.8
So
Y = 693,8+31.18X
_ Hence forecast for 2012, Ist quarter iedth yr Ist Qr ie. X = 13
Foreeast for 2012, Ist qr, = 693.8 + 31.18*13 = 693.8 + 405.34 = 1099.14 say 1100
Forecast for 2012, 2nd qr. = 693.8 + 31.18*14 = 693.8 + 436.52 = 1130.32 say 1131
Forecast for 2012, 3rd gr, = 693.8 + 31,1815 = 693.8 + 467.7 = 1161.5 say 1162
Forecast for 2012, Ath qr. = 693.8-+ 31.18*16 = 693.8 + 498.88 = 1192.68 say 1193
