MANAGERIAL ECONOMICS

Introduction of
managerial economics
 Managerial Economics deals with that part of the
economics which is useful for managers in decision
making and forward planning

What is means by Economics?

In simple terms:

It study’s the behavior of Individuals, firms,

Government in relating to the money
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Classification of thoughts on economics:

Science of wealth

Science of welfare

Science of choice

Science of growth and development

 Science of wealth

Father of Economics
Economics is
the study of
nature and
uses of
national
wealth.

Adam Smith (1723-1790)

Definition given By Mr. J. B. Say

Science which deals with wealth

 Science of welfare

Economics is a study
of mankind in
ordinary business life

Alfred Marshall
 Science of Choice

Definition of Lionel Robbins (1898-1984)

The Science which studies human behavior as a

relationship between ends and scarce means which have
alternative use.
Scarce resources

Alternative uses

Choosing the best

 Science of growth and development
Definition of Paul A. Samuelson:
Economics is the study of how man and society choose with
without the use of money, to employ scarce productive
resources which could have alternative uses to produce various
commodities over time and distribute them for consumption now
and in the future amongst various people and groups of society

• Scarce resources
• Alternative uses ( Production of various commodities)
• Growth in productivity
• Distributing the product
• Consumption
 Economics
• Micro Economics • Macro Economics

• We study the economic

• Micro economics
behaviors of the large
study’s the economic aggregates such as the
behavior of overall conditions of the
• individuals, firms, economy such as total
production , total
industry in the
consumption, total saving
national economy. and total investment in it.
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What is meant by management?

In simple terms:

Management is getting things done through people

It involves managing scarce resources in an efficient and

effective manner thereby increasing the profit and wealth of
the organization
Management functions:
•Planning (decision making, long-term & short term,
planning the activity, budgeting)

•Organizing (division of work & grouping of common

activities)

•Staffing (recruitment, selection, appointment, training &

appraisal)

•Directing ( guidance, coordinating, motivation)

•Controlling (comparing actual with budgets, remedies to

fill the gap if any
 Nature of Managerial economics

The nature of economic theory considered certain conditions

which are relevant for managerial decision making.

They are:

1.Micro economic conditions (close to micro economics)

2.Micro economics studies about individuals, firm

and industry
3.Managerial economics studies about a firm
2. Marco economic conditions:
Operate against the back drop of macro economics

Firm operates in an economic environment known as

macro economic conditions that includes:

•Nature of economy

•Government policy and government interference

•Technological changes etc.

3.Positive Vs normative approach:

Positive approach is concerned with “what is, was or will”

Normative approach is concern with “what ought to be”

In India
there no
uniform
distribution
of wealth

Positive science- facts

 Wealth
should be
distributed
equally

Normative science – value judgments

4. It is perspective in nature

5. Offers scope to evaluate each alternative

Note: Managerial economics helps in evaluating
alternatives in terms of monetary value but it will
not give the best.

6. Interdisciplinary
 7. Applied in nature

8. Assumptions and limitations

• The major assumptions in economics is “ceteris
paribus”
(Latin phrase) means all other things being same or
equal and
all humans thinks rationally.

• As managerial economics was developed from

economics the same assumptions and limitations
applies to managerial economics i.e., the assumptions

and limitations of managerial economics are

inherited from economics
Oh! Subject
also has the
hereditary
problem
Scope of managerial Economics:
Managerial economics helps in taking th following

decisions of a firm
1. Demand decisions:

The following concepts of demand analysis are useful

for demand decisions.
•Law of demand

•Elasticity of
demand

•Demand
determinants

•Demand
forecasting
2.Cost decisions:

Cost analysis helps in making cost decisions. The

important topics are:

•Cost concepts and classifications

•Cost output relationship

•Economics and diseconomies of scale

•Cost control and cost reduction

3.Production and supply decisions:

Production and supply analysis helps in making

production and supply decisions.

•Supply schedule

•Law of supply

•Elasticity of supply and factors influencing

supply
5.Pricing decisions ,policies and practices:

•Price determination in various market forms

•Pricing methods

•Differential pricing

•Product line pricing

•Price forecasting
6.Profit management:
Ratio analysis
Break even analysis

7.Cost management:

•Cost of capital

•Rate of return

•Selection of project
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Economist
Manager
Interdisciplinary nature of
Managerial economics
 Subject Extensively used concepts of the subject
Economics Demand function, Cost function, revenue function
etc.
Operations research Model Building, Linear programming, queuing,
transportation, Optimization techniques etc
Mathematics Algebra, Calculus, exponential, vectors etc
Statistics Averages, Measures of dispersion, Correlation ,
regression, time series, interpolation, probability
etc.
Accountancy Provides information relating to costs, revenue,
receivables, payables, profits/losses etc.
Psychology To understand the behavior of individuals in
terms of attitudes, perception, behavioral
implications, motivations etc and its helps in study
the behavior of customers, supplier/seller,
investor, worker or an employee
Organizational Behavior Helps in understanding the group behavior in
organization environment.
 Note:

Economics provide to the managerial economist

* An understanding of general economic environment

within
which the firm operates.

•a framework to solve the resource allocation

problems

Purpose of accounting is to record, classify and

interpret the given accounting data.
 Demand Analysis
Demand for a commodity refers to the quantity of the
commodity which an individual consumer or a
household is willing to purchase per unit of time at a
particular price.

Demand for a thing depends on:

i) Desire

ii) means to purchase

iii) Willingness to use those means for that purchase

Determinants of demand:

In general

Price of a commodity
Income of a consumer
Price of related goods

a) Substitute products or competitive products

Ex: Tea vs Coffee
b)Complementary products
Ex: vehicles vs petrol
Taste and preferences of a consumer

Population

• Size of population

• Composition of population

• Distribution of income

Advertising
In specific

Expectations

about price
about income

Credit terms
 Law of demand

Law of demand states that when other things being

equal, if the price of a commodity falls, the quantity
demanded of it will rise and it the price of commodity
rises, its quantity demanded will decline.

Other things which are assumed to be equal or

constant are the prices of related commodities, income
of customers, tastes and preferences of consumers,
and such other factors which influence demand.

There is an inverse relationship between price and

quantity demanded
 Rationale for the law of demand

Income effect:

Price decreases expenses decreases Purchase power

increases (vice versa)

This purchasing power may be used for purchasing extra quantity

Substitution effect:
replaces the
Price decreases cheaper/attractive than substitutes substitutes
(vice versa)
New customers:
Price of commodity falls, more consumers start buying
it because some of those who could not afford to buy it
previously may now afford to buy it.
Law of diminishing marginal utility:
Utility is the want satisfying ability.
Utility:
Utility value is equal to the max.
value that a person ready to pay to have the
commodity rather than not
having it.

Total Utility: It is the sum of the utility

derived from different units of a
Commodity consumed by a consumer
 It is the additional utility
Marginal Utility : derived from additional unit of
a
commodity
This law states that the additional benefit
which a person derives from a given increase
in stock of a thing diminishes with every
increase in the stock that he already has.

Marshall
 Total and Marginal utility schedules
Price per unit Quantity of Total utility Marginal
units consumed Utility

11 1 30 30
10 2 50 20
9 3 65 15
8 4 75 10
7 5 82 7
6 6 88 6
*5 *7 *93 *5
4 8 96 3
3 9 97 1
2 10 96 -1
1 11 93 -3
As long as Marginal utility is positive, Total utility
increases. If marginal utility value is negative total utility
decrease

*At price is equal to marginal utility, the total utility will

be maximum at that point

Customer willing to purchase the product as long as

marginal utility is greater than or equal to price.
Assumptions:

•The different units consumed should be identical in all

respects.

•The habit, taste, treatment and income of the consumer

remains unchanged.

•The different units consumed should consist of

standard units.

•There should be no time gap or interval between the

consumption of one unit and another unit
 According to this law of diminishing marginal utility, the
price paid for a good must be lowered if consumers are
to be induced to take large quantities

Demand Schedule:
A list or tabular statement of the different combinations of
price & quantity demanded of a commodity is known as demand
schedule.
Price per unit Quantity demanded (in
thousands)
15 50
20 40
25 30
30 15
35 10
Demand Curve:

The demand schedule when represented graphically, it is

called demand curve.

It is customary to plot the quantity demanded on the x-axis

and
price on the y-axis.
The demand curve has a negative slope and is convex to
origin.
Extension & Contraction of demand:

An extension is the downward movement along a demand

curve which indicates that a higher quantity is demanded for a
given fall in the price of the good.

A Contraction is the upward movement along a demand

curve which indicates that a lower quantity is demanded for
a given increase in the price of the good.

Shift in demand curve:

The increase or decrease in demand due to change in the factors

other than the price is called change in demand and its lead to shift in
the demand curve.
Increase in demand:

If the consumers are willing and able to buy more quantity at the
same price, because of the factors like increase in income, fall in
price of complementary goods and so on, the result will be an
increase in demand. The demand curve will shift to the right.

Decrease in demand:

A decrease in demand occurs when buyers are ready to

buy less of a product at the same price because of the
factors like fall in income, rise in price of
complementary goods and so on. A decrease in
demand will to curve shift the demand the left.
 Shift in demand curve

Increase in demand curve

Exceptions to the law of demand:

Conspicuous goods:
Some consumers measure the utility of a commodity by
its price. Ex: diamonds
Giffen goods:

Sir Robert Giffen, an economist, was surprised to

find
out as the price of bread increased, the British
workers
purchased more bread and not less of it.

Reason for this is, when the price of bread went up it

caused such a large decline in the purchasing power of
the people that they were forced to cut down the
consumption of meat and other more expensive foods.
Conspicuous necessities:
These goods due to their constant usage, have
become
necessities of life. Ex: TV, Refrigerators, coolers
etc.
Uncertainty of future:
Due to uncertainty of price fluctuations, consumers
are
not willing to purchase more quantity even price
decreases. Ex: Share market (speculative
market) in
recent recession time
Other Reasons:

* Future expectations about prices

* Some times Consumers tend to be irrational and
make impulsive purchases without any cool
calculations about price and usefulness of the
product.
UNIT-II
 Elasticity of demand

Elasticity of demand:

It is the responsiveness of the quantity demanded of a

good to change in one of the variables on which demand
depends upon.

Law of demand : tells us the direction of change

Elasticity of demand: Rate at which the change takes place

Elasticity of demand = % change of quantity demanded

% change of change in variable
Types of Elasticity of demand:

•Price Elasticity of demand

•Income Elasticity of demand
•Cross Elasticity of demand
•Advertisement Elasticity of demand

Price Elasticity of demand:

Price elasticity of demand is the degree of responsiveness of

quantity demanded to a change in price, given the consumer’s
income, his tastes and prices of all other goods etc. (i.e. other
things being the same)
Ep = ((q2-q1)/(p2-p1))*(p1/q1)

Where Ep is price elasticity of demand,

q2 is quantity demand against the new price p2,
q1 is quantity demand against the old price p1,
p2 is new price,
p1 is old price.

Note:
Due to inverse relation between the price and quantity,
the value of price elasticity varies from minus infinity to
zero
However, only Magnitude of the value is considered
for interpretation.

In the case of linear demand curve, the price of elasticity of

demand is equal to
Lower segment/ upper segment
 Point Elasticity:

In point elasticity, we measure elasticity at given

point on a demand curve.

Point elasticity = -(dq/dp)*(p/q)

Where dq/dp is the derivative of quantity with respect to price

p is price at that point,
q is quantity demanded at that point.
Arc Elasticity:

When you are finding the elasticity of demand between two

points, the question arises that which price and quantity take it
as base. The values are varies with the base. To avoid
confusion , we will the average of prices and average of
quantities are taken as base. This is known as Arc Elasticity.

Formula is

Ep(a) = ((q1-q2)/(p1-p2))*((p1+p2)/(q1+q2))

Where p1,q1 are the price and quantity at one point and p2,q2
are price and quantity at second point respectively.
Interpreting the numerical values of demand:

Magnitude of Interpretation Type of Graph

Elasticity of
demand
0 Perfectly inelastic Parallel to y-axis
Infinity Perfectly elastic Parallel to x-axis
1 Unity elasticity Rectangular
hyperbola
<1 Relatively Curve is steep
inelastic
>1 Relatively elastic Curve is flat
Graphs:

Perfectly inelastic Perfectly elastic

Value equal to zero Value equal to infinity
 Unity Elasticity curve Relatively elastic Relatively inelastic
Rectangular Hyperbola (linear curve) (linear curve)
Relatively inelastic curve (steep)
Value is <1
Important points on linear curve:

At the midpoint of the linear demand curve elasticity of

demand equal to one.

The price elasticity of a linear demand curve decreases as

one travels down the curve and vice versa.

The price elasticity of a linear demand curve is zero at the

point where the curve intersect with x-axis and it is infinity at
the point of intersection with y-axis
Important points on nonlinear curve:

The elasticity will be one through out the curve, if it is

rectangular hyperbola. In other cases, it will be never be one
through out in the non-linear curve.

If the tangent of a non-linear demand curve is such that at the

point of the tangency the upper and lower segments are
equal then elasticity of demand equals to one.
Income Elasticity of demand:

Income elasticity of demand is the degree of

responsiveness of quantity demanded of a good to a
small change in the income of consumers.

Ei = % change in quantity demanded

% change in income
= ((q2-q1)/(i2-i1))* (i1/q1)

Goods have –ve income elasticity are known as inferior goods

Ex: Many people considers normal vegetarian food as
inferior good.
If the income elasticity is greater than one, it
shows that the goods bulks larger in
consumer’s expenditure as he becomes richer
such goods are called luxury goods.

Graphs:

If the income elasticity is less than one, it shows

that the goods is relatively less important in
consumer’s eye and therefore it is called
necessary.
Graphs:

Cross Elasticity of Demand:

A change in the demand for one goods in

response to change in the price of another goods
represents cross elasticity of demand of the
former goods for the later goods
Ec = ((q2-q1)/(p2-p1))*(p1/q1)

Where Ec is cross elasticity of demand,

q2 is the quantity of the good demanded in relating to the
price p2 of the other good,
q1 is the quantity of the good demanded in relating to the
price p1 of the other good.
Notes:

• If the two goods are substitutes the cross elasticity is positive

• If the two goods are complementary to each other the cross
elasticity between them is negative.
• However, one need not base the classification of goods on
the above definitions because negative cross elasticity is
also found when the income effect on the price change is
very strong.
• If the goods are unrelated then the cross elasticity between
them is zero.
Factors determining price elasticity of demand:

The elasticity of demand depend on the following factors:

Relating to product

1.Availability or range of substitutes:

Close substitutes then demand is more elastic
Ex: Demand for petrol is inelastic, the demand
for Indian oil is elastic.
2.Nature of the commodity:
Necessary goods demand like demand for food
in general inelastic
Luxury goods demand elastic in nature.
3.Extent of use:
A commodity having a variety of uses has a
comparatively elastic demand.
Ex: Iron, Milk
4.Durability of the product
 5.Purchase frequency of the product
6.Tied demand
The demand for those goods which are tied to
others normally inelastic as against those whose
demand is of autonomous in nature.
7.Degree of postponement
8.Urgency of demand:
Urgency of demand factor depends on
Availability of substitutes
Habit and social custom.

Income related

9.Position of the commodity in a consumer budget.

Greater the proportion of the income spent on a
commodity, the greater will be the generally its elasticity of demand
 10. Income level:
People with high income are less affected by
price changes than people with low incomes.

High income people are inelastic to price

changes

Related to consumer

11.Consumer habits

Related to price

12.Price range
Goods which are in high range or in very low
Range have inelastic demand
Related to time

13. Time period

The longer the time period one has the more
completely adjust to the changes.

14.Time frame

The more the time available for the customer,

the demand for a particular product may be
elastic and vice versa.
Significance of Elasticity of demand:

Price of factors of production:

Production factors are land, labor,

money, technology
and organization. Every factor have a
cost. Each factor’s elasticity
influences the cost factor of production
Ex: if the demand for workers is
inelastic, the efforts of
trade union raise wages.
Level of output and price:
Price fixation:
In monopoly the manufacturer can fix his price
high as
long as it does not attract the attention of the
government. If they are close substitutes,
product
consumption can be postponed etc., then the
price of
the product cannot be fixed very high.
Forecasting the demand:
While price and cross elasticity’s are useful for
pricing
policy. Income elasticity can be used for
forecasting
demand for the product in future in relating to the
income changes that may take place in future.

Government policies:

Taxation policy:
Govt can impose more taxes on those products whose
elasticity of demand is inelastic
Public utilities:
Public utilities are vested with a public interest.
Ex: Electricity, water supply etc.
 Bank interests:
If the govt. wants to procure deposits, they have to raise
the interests of the banks.

Rate of exchange:
For fixing a proper rate for its currency for exchange,
the govt. has to take the nature of elasticity of demand
of the import and export products.
Formulate Govt. policy:
If the demand is inelastic for a product the govt. would
like to exercise close control over the matters related its
supply and demand.
Rate of exchange:
For fixing a proper rate for its currency for exchange,
the govt. has to take the nature of elasticity of
demand
of the import and export products.
Assume that the total exports in toto
elastic/inelastic
Similarly the total imports in toto elastic /inelastic.
 Imports Exports
Elastic Inelastic
Elastic If exports – imports is -ve If exports-imports is –ve
Our currency value may be Our currency value may be
maintained or decrease raised
Inelastic If exports-imports is –ve If exports-imports is –ve .
Our currency value may be Our currency value need not
decreased. changed

India’s Trade balance position:

Major Items of India's balance of Payments (April-March, 2008-09) 

(In $ million)

  April-March (2008-09) (P) April-March (2007-08) (PR)

Exports 175,184 166,163

Imports 294,587 257,789

Trade Balance -119,403 -91,626

 Demand Forecasting

Demand forecasting is an estimate of sales in monetary value or

physical units for a specified future period under a prepared
marketing plan.
American Marketing Association

It is a process of determining how much of which product is needed

when add where.

Demand forecasting involves:

•Estimation of level of demand
•Extent and magnitude of demand
•Responsiveness of demand to a proposed
change in
price, income of consumer, price of other goods
etc.
 Factors effecting demand forecasting:

Factors affecting demand forecasting

Other factors
Levels Nature of the Competition
Micro Period product Orientation Other
Industry Short Durables General demographic
Macro term Long Non durables Specific factors influence
(national term Capital goods demand
level)
 •Levels of forecasting
** micro level i.e. firm level
** Industry level : aggregate demand of all firms
**Macro level: National level forecast is for the
whole economy.

National level forecast related to goods will be done by

National council for applied economic research (NCAER) &
Central statistical organization provides the date relating to
national income and population composition etc.

•Time Period
** Short term forecasting: Max. period 1 year helps in
taking decision regarding production schedule,
inventory, cost of variable factors, sales target,
appropriate pricing
Short run forecast helps to foresee the fluctuations in the demand
based on seasonal and cultural factors such as festivals and so on,
and plan the schedules of production and supply.

** Long term forecasting: from 2 to 20 years helps in taking

decision regarding capacity expansion/reduction, new plant,
wider product range, man power planning, long term capital
requirement, Investment decision

A long run forecast provides information for major strategic

decisions that result in extension or reduction of limiting
resources.

Nature of goods
** Durable consumer goods
** Non-durable consumer goods
** Capital goods
Durable consumer goods:
Durable goods are those goods which have certain life span
and have chance to get repaired of old product instead of
going for new one. Ex: TV, refrigerator, motor bike. Car etc
Each consumer durable has a special market for its product,
which in turn has its peculiarities requires special
techniques to be adapted to forecasting the demand to meet
these peculiarities.
Non-durable consumer goods:
These include those consumer goods which can be used only once.
Ex: Cigarettes, liquor. etc
Capital goods:
Capital goods are defined as those goods which help in
further production. Ex: Machinery, buildings, technology
etc.
 Demand forecasting
Nature of goods

Consumer Non- Capital goods

durables
Consumer Durable
goods Growth possibilities of the industry, extent of
capacity used, existing stock, prices of
related goods

Income levels
Disposable income = income –taxes & deductions.
Discretionary income= disposable income-income of kind-
expenses related to necessities-rent/debt etc.
Price
Demographic factors
Size, population distribution, income levels, edu. Levels etc.

1.Changes is size and characteristic of population.

2.Saturation limit of the product
3.Existing stock of the market
4.New vs replacement demand
Scrap rate for replacement Demand
1.Income levels of consumer
2.Tastes & scales of preference of consumers
3.credit and hire purchase facilities
 •Orientation
** General (Total demand for a commodity)
** Specific (Brand wise demand)

•New product Vs Existing product

•Other factors

For existing product we have past data to use in demand forecasting.

For new products Joel dean suggested some methods. They are

1. Project the demand for the new product as an outgrowth of an

existing old product.

2. Analyze the new product as a substitute for some existing

product or service.
3. Estimate the rate of growth and the ultimate level of demand for the
level the new product on the basis of pattern of growth of established
products.

4. Estimate the demand by making direct enquiries from the ultimate

purchasers either by the use of samples or on a full scale.

5. Offer the new product for sale in a sample market, e.g. by direct mail
or through one multiple shop organization.

6. Survey consumers reactions to a new product indirectly through the

eyes of specialized dealers who are supposed to be informed about
consumers’ need and alternative opportunities.
 Methods of demand forecasting:

Methods of demand forecasting

Survey methods:
Buyers intention:
Census
Sample Survey
Sales force opinion method.

Statistical methods
Trend projection methods
Trend line
Least squares
Time series analysis
Smoothing techniques
Moving average method
Exponential smoothing
Barometric technique
Simultaneous equations method
Correlation and regression method

Other methods
Delphi method
Expert opinion method
Test Marketing method
Controlled experiments
Judgment approach
 Survey methods:

Buyers opinion method:

To anticipate what buyers are likely to be orders at a given

set of circumstances, a most useful source of information
would be the buyer themselves.

We can use two methods for surveying the buyers

1.Census method
2.Sample method.
Census method:

If the company wishes to elicit the opinion of all the

buyers, this is called census method Cost
involved in
this method is high
 This method takes more time.

Certain times consumer are not ready to disclose the

information and also not able access his requirement.

During the time of scarcity, the buyer may tell his

requirement of the quantity more than the actual
requirement.

For industrial goods, this method is the best method to

forecast demand because
Few buyer to contact – time & cost will be less
Readiness of the buyer to disclose the information
More reliable information from the buyers.
Sample Method:

The firm can select a group of buyers who can represent

the whole population. This method is called sample
method.

Time & cost involved is less when compared with census.

Selecting right sample will be the crucial

Sales force opinion method:

Another source of getting more reliable information about

the
possible level of sales or demand for a given product
or
service is the group of people who sell the same
 Other methods:

Expert opinion:

Generally the experts are outside persons an

ot
have any vested interests in the results of the particular
survey.
Experts can be choosed from either network
experienced wholesalers, retailers, experienced marketing
executives.

More reliable
Independent forecasts can be made relatively quickly and
cheaply
Delphi method:

It consists of an attempt to arrive at a consensus in an

uncertain area by questioning a group of experts repeatedly
until the responses appear to converge along a single line or
the
issues causing disagreement are clearly defined

In this method, there is a leader who provides each expert with

the responses of the others including their reasons to previous
questions supplied to them. Each expert is given the
opportunity to react to the information or considerations
advanced by others but interchange is anonymous so as to
avoid or reduce the ego involvements associated with publicly
expressed opinions.

Leader must be very effective.

Reliable information.
Test Marketing method:

In test marketing the entire product and marketing program

is tried out for the first time in a small number of well
chosen and authentic sales environment. The primary
objective here, is to know whether the customer will accept
The acceptability
the product of the
in the present product
form or notcan be judged in a
limited
market.
Before it is too late, the corrections can be made to the
product design, if necessary.
It reveals the quality of the product to the competitors
before
it is launched in the wider market.
It may also be difficult to extrapolate the feed back
received
from such a test market, particularly where the chosen
market
is not fully representative.
Controlled experiments:

Controlled experiments refers to such exercise

where some of the major determinants of demand are
manipulated to suit to the customers with different
tastes and preferences, income groups and such
others. It is further assumed that all other factors
remain the same. In this method, the product is
introduced with different packages, different prices in
different markets or same markets to assess which
combination appeals to the customer most.
 This method is still in the infancy stage
It is costly & time consuming
It involves elaborate process of studying markets &
different
permutations and combinations that can push the
product
aggressively.
If it fails in one market, it may affect other market also.
Judgment approach:

When no method are directly related to the given product or

services, the management has no alternative other than using
its own judgment.
Historical data for significantly long period is
not
available.
Turning points in terms of polices or
procedures or
causal factors cannot be precisely determine
 Statistical methods

Trend projection methods:

These are generally based on analysis of past sales patterns.

These are five main techniques of mechanical extrapolation,
it is assumed that existing trend will maintain all through.

Trend line by observation:

This method of forecasting trend is elementary, easy

and quick as it involves merely the plotting the actual
sales data on a chart and then estimating just by
observation where the trend line lies. This line can be
extended towards a future period and corresponding
sales forecast read from the graph.
Least Squares method:

Certain statistical formulae are used here to find the

trend line which best fits the available data. The trend
line is the basis to extrapolate the line for future
demand for the given product or service on graph.

The estimating linear trend equation of sales is written

As
s =a+b(t)
a & b have been calculated from the past data.
s is sales , t is the year number for which the
forecast is
made.
 To find out the values of a and b, it is need to solve
the
following equations.
∑s =n*a+b∑t
∑s*t = a∑t+b∑t2
n is number of years (observed).

Time Series analysis:

A firm which has been in existence for some time, will have
accumulated considerable data on sales pertaining to different time
periods. Such data when arranged chronologically yield ‘time series’.
The most popular method if analysis of time series is to project the
trend of the time series. A trend line can be fitted through a series
either visually or by means of statistical techniques such as the
method of least squares. The trend line is then projected into the
future by extrapolation
Trend (T): It is also called long term trend, is the result of basic
developments in the population, capital formation
technology. These developments relate to over a period
of lone time say five to ten years not definitely overnight.
The trend is considered statistically significant when it
has reasonable degree of consistency.

Cyclic trend © : It is seen in the wave like moment of sales. The

sales data is quite often affecting the swing in the
level of general economic activity which tend to be
some what periodic.
Ex: Inflation, recession
Seasonal trend (s): It refers to a consistent patter of sales
movement within the year. More goods are
sold during the festival seasons. The
seasonal
component may be related to weather factors,
holidays and so on.
Erratic trend (E): It results from the sporadic occurrence of strikes,
riots & so on. These erratic components can even
damage the impact of more systematic components
and this make the forecasting process much more
complex.

The above four sets of factors which are responsible for the
characterization of time series by fluctuations and turning points in a
time series.
 Moving average method:

This method provides consistent result when the past events are
consistent and unaffected by wide change. As the name itself
suggests, under this method, the average keeps on moving
depending up on the number of years selected. Selection of the
number of years is the decisive factor in this method. Moving
average get updated as new information flows in.

One major advantage with this method is that the old data
can be dispensed with, once the average is computed
Example:

Compute 3-day moving average from the following daily sales:

Date & month Daily sales (lakhs of 3 day moving average

tones)

Jan 1 40

2 44

3 48

4 48 44
5 53 45.7
To calculate 3 day moving average
S4 = (40+44+48)/3 =44
S5 = (44+48+45)/3= 45.7
Exponential smoothing:

This is a more popular technique used for short run

forecasts. This method is an improvement over moving average
method. This method is an improvement over moving average
method. Unlike in moving average method, all time periods here are
given varying weights, that is, the value of the given higher weights &
the value of the given variable in the distant past are given relatively
lower weights for further processing.
The formula used for exponential smoothing is

St+1 = c*St + (1-c) Smt

St+1 is exponentially smoothed average for the new year.
St is actual data in the most recent past
Smt most recent smoothed forecast
C is smoothing constant.

If the smoothing constant ‘c’ is higher, higher weight is given to the

most recent information. The value of ‘c’ varies between 0 &1 inclusive
and the exact value of c is determined by the magnitude of random
variations. If the magnitude of random variations is large, lower value
to c is assigned & vice versa.
It has been found appropriate to have c between 0.1 and 0.2 in many systems.

Time period Actual sales (units in Predicted sales

lakhs)
1 5.0
2 5.6
3 6.7
4 5.8
5 6.9 5.775
6 5.1 5.887
7 8.1 5.808

Let us take four period avg. as the initial forecast year 5 while
smoothing constant of c=0.1
S5 = (S1+S2+S3+S4)/4 =(5.0+5.6+6.7+5.8)/4= (23.1)/4=5.775
Sales for S5 =6.9 S6 is calculated as given

S6= c*S5 + (1-c)* Sm4

= 0.1*6.9 +(1-0.1)*5.773 = 0.69+5.1975
= 5.887

Similarly, predicted sales for year 7 can be worked out

S7 = c*S6 + (1-c)*Sm5
= 0.1*6.9+(1-0.1)*5.775=0.69+5.1975=5.808
 Barometric Technique:

Where forecasting based on times series analysis or extrapolation may

not yield significant results, barometric techniques can made used for
forecasting the demand. In this one set of data is used to predict
another set.

For example

To assess the demand for services in India & abroad, we can

see the population in each occupation, In the US 78% of the labor
force is employed in services and 15% in manufacturing. In India
according to 1991census 21% of the workforce is engaged in services,
13% in manufacturing & 66% in agriculture. The world over, an
increase in prosperity has been accomplished by an increase in
demand for services.
Simultaneous equations method:
Σσσ

Correlation & Regression methods:

If high value of one variable is associated with high value of

another, they are said to be +vely correlated

If high value of one variable is associated with low value of another,

they are said to be –vely correlated.

Karl pearson coefficient of correlation = ∑xy/n σx σy

Where x= X-Arithmetic mean(X)
Where y= Y-Arithmetic mean(Y)
σx is standard deviation of X
σy is standard deviation of Y
In regression analysis an equation is estimated which best fits in the
sets of observations of dependent variable and independent variable.

The dependent variable is unknown and independent is known.

We can find out the value of the dependent variable by using the
regression equations.

The main advantage of this method is that it provides the value

of independent variable from within the model itself.

Regression equation by least square method:

y = a*x + b
Values of a and b can be find out by using the
following
equations.
∑y =n*a+b∑x
∑y*x = a∑x+b∑x2
 By using correlation coefficient
y- Arithmetic mean of y = byx (x-Arithmetic mean
of x)
Where byx = r* σx * σy
r is correlation coefficient
σx is standard deviation of x
σy is standard deviation of y