Unit – II

Demand and Supply Analysis

Demand: Concept of Demand

According to Benham-“The demand for anything, at a given price, is the amount of it, which will be bought per unit of time, at that
price.”

According to Bobber, “By demand we mean the various quantities of a given commodity or service which consumers would buy in
one market in a given period of time at various prices.”

Demand = Desire + Ability to Pay + Willingness to Pay Above conditions must be there to create demand.

Demand in Economics is an economic principle can be defined as the quantity of a product that a consumer desires to purchase goods
and services at a specific price and time.

Factors such as the price of the product, the standard of living of people and change in customers’ preferences influence the demand.
The demand for a product in the market is governed by the Laws of Economics

A market is a place where individuals, households, and businesses are engaged in the buying and selling of products and services
through various modes.

The working of a market is governed by two forces, which are demand and supply. These two forces play a crucial role in determining
the price of a product or service and size of the market.

Demand in economics is a relationship between various possible prices of a product and the quantities purchased by the buyer at each
price. In this relationship, price is an independent variable and the quantity demanded is the dependent variable.

In a market, the behaviour of consumer can be analyzed by using the concept of demand.

In economics by demand, we mean the various quantities of a given good or service which buyer would purchase in one market during
a given period of time, at various prices, or at various incomes, or at various prices of related goods.

We can divide the definitions of demand given by various economists into three Categories:
To consider demand as an effective desire
According to Person – “Demand implies three things
● desire to possess a thing
● means for purchasing it;
● Willingness to use those means for purchasing.”
According to this definition there is no difference between demand and want, demand is considered as a synonym of want.

Determinants of Demand

1 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

1. Price of a product: The price of a product is one of the most important determinants of its demand in the long run and the only
determinant in the short run. The quantity of the product demanded by the consumer inversely depends upon the price of the product.
If the price rises demand falls and vice versa. The relation between price and demand is called Law of demand. It is not only the
existing price but also the expected changes in price which affect demand.

2. Price of related goods: The demand for a commodity is also affected by the changes in the price of its related goods. Related
goods may be substitutes or complementary goods.

(a) Substitutes: Two commodities are substitutes for one another if change in the price of one affects the demand for the other in the
same direction. For example, X and Y are substitutes for one another. If price for X increases, demand for Y increases and vice versa.
Tea and coffee, hamburgers and hot dogs, Coke and Pepsi are some examples of substitutes in the case of consumer goods.

(b) Complements: Complementary goods are those goods which complete the demand for each other, such as car and petrol or pen
and ink. There is an inverse or negative relationship between the demand for first good and price of the second which happens to be
complementary to the first. For example, an increase in the price of petrol causes a decrease in the demand of car and other petrol run
vehicles, other things remaining same

3. Income of the consumer: Income is the basic determinant of quantity of product demanded since it determines the purchasing
power of the consumer. Income as determinant of demand is equally important in both short run and long run. The relationship
between the demand for a commodity say, X and the household income Y, assuming all other factors to remain constant, is expressed
by a demand function such as: Experience shows that numerically there is a positive relationship between income of the consumer and
his demand for a good. In other words, an increase in income would cause an increase in demand and economists therefore call such
goods as normal goods. Normal goods are goods for which an increase in consumer’s income results in an increase in demand. There
are some goods, however which are called inferior goods. Inferior good is a good for which an increase in consumer’s income results
in a decrease in its demand.

4. Consumer taste and preference: The demand for any goods and service depends on individual’s taste and preferences. They
include fashion, habit, custom etc. Tastes and preferences of the consumers are influenced by advertisement, changes in fashion,
climate, and new invention. Other things being equal demand for those goods increases for which consumers develop taste and
preferences. Contrary to it, an unfavorable change in consumer preferences and tastes for a product will cause demand to decrease.

5. Advertisement effect: Advertisement costs are incurred with the objective of promoting sale of the product. Advertisements
help in increasing the demand in the following ways: By informing potential consumers about the product and its availability. By
showing its superiority over rival product by influencing consumer’s choice against the rival products. By setting new fashions and
changing tastes. There are instances when advertisements have changed lifestyle of people. Cadbury India has revolutionized the
market for its leading product Dairy Milk through high profile advertising featuring Amitabh Bachchan with a slogan “Kuch mitha ho
jai”.

6. Consumer’s expectations of future income and price: Consumers do not make purchases only on the basis of current price

2 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

structure. Especially in case of durables, when demand can be postponed, consumers decide their purchase on the basis of future price
and income. If they expect their income to increase or price to fall in future, they will postpone their demand on the other hand if they
expect price to increase in future they will hasten the purchase. For example, purchase of cars and other durables increases before
budget is announced if consumers fear that prices may rise after budget. Or, when people expect pay revisions, they wait for major
purchases till pay is revised.7. Size of population Size of population, age distribution, rural urban distribution and gender distribution
affect aggregate demand. If population of a country is constantly increasing, more food items other goods and services will be needed
to satisfy the needs of the people. Age distribution of the population determines what kind of commodities will be demanded. If
population mostly consists of aged people, there will be demand of more medicines and health care services. On the other hand, if
major section of population is youth, there will be more demand for education, employment opportunities and designer apparels.

7. Credit policy: The credit policy of suppliers or banks also affects the demand for a commodity.

8. Size and composition of the population: An increase in the size of a population increases the demand for commodities as the
number of consumers would increase.

9. Income distribution: Unequal distribution of income results in differences in the income status of different individuals in a
nation.

10. Climatic factors: The demand for commodities depends on the climatic conditions of a region such as cold, hot, humid, and dry.

11. Government policy: Government policies have direct impact on the demand for various commodities.

Law of Demand – Function, Curves and Shifting of curves

What is the Law of Demand?
The law of demand is given as, “If the price of a product falls, its quantity demanded increases and if the price of the commodity
rises, its quantity demanded falls, other things remaining constant.”

Law of Demand Example

Demand Example: Take the example of an individual, who needs to purchase soft drinks. In the market, a pack of three soft drinks is
priced at ₹120 and the individual purchases the pack. In the next week, the price of the pack is reduced to ₹105. This time the
individual purchases two packs of soft drinks. In the third week, the price of the pack has risen to ₹130.

This time the individual does not purchase the pack at all. It is a common observation that consumers purchase a commodity in greater
quantities when its price is low and vice versa.

This inverse relationship between the demand and price of a commodity is called the law of demand.

Law of Demand Definition

The following are some popular definitions of the law of demand given by experts:

Robertson defines law of demand as “Other things being equal, the lower the price at which a thing is offered, the more a man will
be prepared to buy it.”

Marshall defines law of demand as “The greater the amount to be sold, the smaller must be the price at which it is offered in order
that it may find purchasers; or in other words, the amount demanded increases with a fall in price and diminishes with a rise in price.”

Ferguson defines law of demand as “Law of Demand, the quantity demanded varies inversely with price.”

Law of Demand Meaning

The law of demand represents a functional relationship between the price and quantity demanded of a commodity or service.

The law states that the quantities demanded of a commodity increase with a fall in the price of the commodity and vice versa while
other factors like consumers’ preferences, level of income; population size, etc. are constant.

Demand is a dependent variable, while the price is an independent variable.

Therefore, demand is a function of price and can be expressed as follows:

3 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

D= f (P)

Where,
D= Demand
P= Price
f = Functional Relationship

What is Demand Function?

Demand function represents the relationship between the quantity demanded for a commodity (dependent variable) and the price of
the commodity (independent variable).

Demand Function Formula

Let us assume that the quantity demanded of a commodity X is D x, which depends only on its price P x, while other factors are
constant. It can be mathematically represented as:

Dx = f (Px)

However, the quantitative relationship between Dx and Px is expressed as:

Dx = a – bPx
Where a (intercept) and b (relationship between Dx and Px) are constants.

Types of Demand Function

1. Linear demand function
2. Non linear demand function

Linear demand function

In the linear demand function, the slope of the demand curve remains constant throughout its length. A linear demand equation is
mathematically expressed as:

Dx = a – bPx
In this equation, a denotes the total demand at zero price.
b = slope or the relationship between Dx and Px
b can also be denoted by change in Dx for change in Px
If the values of a and b are known, the demand for a commodity at any given price can be computed using the equation given above.

For example, let us assume a = 50, b = 2.5, and Px= 10:

Demand function is:

Dx = 50 – 2.5 (Px)

Therefore, Dx = 50 – 2.5 (10)

or Dx= 25 units

4 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

The demand schedule for the above function is given in Table

Quantity Demanded of Price Levels of

Commodity X Commodity X
5 18
10 16
15 14
20 12

When the demand schedule is plotted on a graph, it produces a linear demand curve, which is shown in Figure below.

Demand Curve in Linear Demand Function

Non-linear demand function

In the non linear or curvilinear demand function, the slope of the demand curve (ΔP/ΔQ) changes along the demand curve. Instead of a
demand line, non-linear demand function yields a demand curve.
A non-linear demand equation is mathematically expressed as:

Dx = a (Px)-b
Or of a rectangular hyperbola of the form

Dx = (a/Px + c) b

Where a, b, c> 0

Exponent –b of price in the non-linear demand function refers to the coefficient of the price elasticity of demand.
Figure, represents a non-linear demand function:

Non-linear Demand Function

5 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

What is Demand Curve?
In economics, Demand curve is a graphical presentation of the demand schedule. It is obtained by plotting a demand schedule.

The demand schedule can be converted into a demand curve by graphically plotting the different combinations of price and quantity
demanded of a product.

Types of Demand Curve

Similar to demand schedule, there are two types of demand curve.

1. Individual demand curve

2. Market demand curve

Individual demand curve

Individual demand curve: It is the curve that shows different quantities of a commodity which an individualis willing to purchase at
all possible prices in a given time period with an assumption that other factors are constant.

Refer to Table 1 below, the individual demand schedules of A and B, when plotted on a graph, will represent the individual demand
curves, which are shown in Figures:

An individual demand curve slopes downwards to the right, indicating an inverse relationship between the price and quantity
demanded of a commodity.

Market demand curve

Market demand curve: This curve is the graphical representation of the market demand schedule. A market demand curve shows
different quantities of a commodity which all consumers in a market are willing to purchase at different price levels at a given time
period, while other factors remaining constant.

A market demand curve can be plotted by consolidating individual demand curves. Therefore, market demand curve is the horizontal
summation of individual demand curves.

Therefore, market demand curve is the horizontal summation of individual demand curves. In the example given in Table 1 below,
plotting the price of eggs (column 1) against the summation of quantities demanded by A and B (column 4) would represent a market
demand curve. This is shown in Figure below:

A market demand curve, just like the individual demand curves, slopes downwards to the right, indicating an inverse relationship
between the price and quantity demanded of a commodity.

The negative slope of a demand curve is a reflection of the law of demand

However, it is important to understand the reasons why the demand curve slopes downward to the right.

6 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 PRICE PER TOTAL MARKET
QUANTITY DEMANDED BY QUANTITY DEMANDED BY
DOZEN DEMAND
A B
(IN ₹ PER (A + B)
(IN DOZENS PER WEEK) (IN DOZENS PER WEEK)
DOZEN) (IN DOZENS PER WEEK)
(1) (2) (3) (4)
80 2 4 2+4=6
70 4 6 4 + 6 = 10
60 6 10 6 + 10 = 16
50 9 15 9 + 15 = 24
40 14 22 14 + 22 = 36

Why the demand curve slopes downward?

Generally, the demand curves slope downwards. It signifies that consumers buy more at lower prices. We shall now try to
understand why the demand curve slopes downward?

Different explanations have been given different economists for the operation of the law of demand. These are explained below:

Factors that cause a demand curve shifts are:

1. Law of diminishing marginal utility
2. Income effect
3. Substitution effect
4. Change in the number of consumers
5. Multiple uses of a commodity

Law of diminishing marginal utility

Consumers purchase commodities to derive utility out of them.

The law of diminishing marginal utility states that as consumption increases, the utility that a consumer derives from the additional
units (marginal utility) of a commodity diminishes constantly.

Therefore, a consumer would purchase a larger amount of a commodity when it is priced low as the marginal utility of the additional
units decreases.

Income effect
A change in the demand arising due to change in the real income of a consumer owing to change in the price of a commodity is called
income effect.

A change in the price of a commodity affects the purchasing power of a consumer.

For example, if an individual buys two dozens of apples at 40 per kg, he/she spends 80. When the price of apples falls to 30 per kg,
he/she spends 60 for purchasing two kg of apples. This results in a saving of 20 for the individual, which implies that the real income
of the individual has increased by 20
The amount saved may be utilised by the individual in purchasing additional units of apples. Thus, the demand for apples increased
due to a change in real income.

Substitution effect
The change in demand due to change in the relative price of a commodity is called the substitution effect.

The relative price of a commodity refers to its price in relation to the prices of other commodities.
Consumers always switch to lower-priced commodities that are substitutes of higher-priced commodities in order to maintain their
standard of living. Therefore, the demand for relatively cheaper commodities increases.

For example, if the price of pizzas comes down, while the price of burgers remains the same, pizzas will become relatively (burgers)
cheaper. The demand for pizzas will increase as compared to burgers.

7 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

Change in the number of consumers
When the price of a commodity decreases, the number of consumers of the commodity increases. This leads to a rise in the demand
for the commodity.

For example, when the price of apples is 120 per kg, only a few people purchase it. However, when the price of apples falls down to
60 per kg, more number of people can afford it.

Multiple uses of a commodity

There are certain commodities that can serve more than one purpose. For example, milk, steel, oil, etc. However, some uses are more
important over others. When the price of such a commodity is high, it will be used to serve important purposes. Thus, the demand will
be low.

On the other hand, when the price of the commodity falls, it will be used for less important purposes as well. Thus, the demand will
increase.

For example, when the price of electricity is high, it is used only for lighting purposes, whereas when the price of electricity goes
down, it is also used for cooking, heating, etc.

Movement and Shift in Demand Curve

1. Movement along Demand Curve
2. Shift In Demand Curve

Movement along Demand Curve

Movement along Demand Curve is when the commodity experience change in both the quantity demanded and price, causing the
curve to move in a specific direction.

Shift In Demand Curve

The shift in demand curve is when, the price of the commodity remains constant, but there is a change in quantity demanded due to
some other factors, causing the curve to shift to a particular side.

Shift and Movement along Demand Curve

In economics, change in quantity demanded and change in demand are two different concepts.
1. Expansion and Contraction of Demand
2. Increase and decrease in demand

8 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

Change in quantity demanded refers to change in the quantity purchased due to rise or fall in product prices while other factors are
constant.

● It can be measured by the movement along the demand curve.

● The terms, change in quantity demanded refers to expansion or contraction of demand.

Change in demand refers to increase or decrease in demand for a product due to various determinants of demand other than price (in
this case, price is constant).
● It is measured by shifts in the demand curve.
● The terms, change in demand means to increase or decrease in demand.

Elasticity of Demand
What is Elasticity of Demand?
Elasticity of demand is a degree of change in the quantity demanded of a product in response to its determinants, such as the price of
the product, price of substitutes, and income of consumers.

In economics, elasticity can be defined as the responsiveness of a variable (demand or supply) with respect to its various determinants.

Elasticity of Demand Definition

The concept of elasticity was first introduced by Dr. Alfred Marshall, who is regarded as the major contributor of the theory of
demand, in his book “Principles of Economics.”

According to him, “The elasticity (or responsiveness) of demand in a market is great or small according as the amount demanded
increases much or little for a given fall in price, and diminishes much or little for a given rise in price.”

Elasticity of demand may be defined as the ratio of percentage change in demand to the percentage change in the price-Lipsey

The elasticity of demand is the proportionate change of amount purchased in response to a small change in price, divided by
the proportionate change in price. -Mrs. Jone Robinson

The elasticity of demand may be defined as the percentage change in the quantity demanded which would result from one
percent change in price.-Prof. Boulding

Types of Elasticity of Demand

Economists have divided the elasticity of demand in three main categories. Three types of elasticity of demand is mentioned below:
1. Price Elasticity of Demand

9 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 2. Income Elasticity of Demand
3. Cross-Elasticity of Demand

Price Elasticity of Demand

Price elasticity of demand is a measure of a change in the quantity demanded of a product due to change in the price of the
product in the market.

Types of Price Elasticity of Demand

● Perfectly Elastic Demand: When a small change (rise or fall) in the price results in a large change (fall or rise) in the
quantity demanded, it is known as perfectly elastic demand.
● Perfectly Inelastic Demand: When a change (rise or fall) in the price of a product does not bring any change (fall or rise) in
the quantity demanded, the demand is called perfectly inelastic demand.
● Relatively Elastic Demand: When a proportionate or percentage change (fall or rise) in price results in greater than the
proportionate or percentage change (rise or fall) in quantity demanded, the demand is said to be relatively elastic demand.
● Relatively Inelastic Demand: When a percentage or proportionate change (fall or rise) in price results in less than the
percentage or proportionate change (rise or fall) in demand, the demand is said to be relatively inelastic demand.
● Unitary Elastic Demand: Unitary elastic demand occurs when a change (rise or fall) in price results in equivalent change
(fall or rise) in demand.

Factors Affecting Price Elasticity of Demand

● Relative Need for the Product: The need of every individual is not the same for the same product. A product that is luxury
for an individual may be a necessity for another person. For example, a laptop may be a luxury product for an ordinary
individual, while a necessity for a computer engineer. Thus, price elasticity differs across people due to their different needs.

● Availability of substitute goods: As discussed in the previous chapters, the availability of substitutes has major impact on
the demand for a product. If substitutes are easily available at relatively low prices, the demand for the product would be
more elastic and vice versa. For example, if the price of tea rises, people may opt for coffee.

● Impact of income: The amount of income that consumers spend on purchasing a particular product also influences the price
elasticity of demand. If consumers spend a large sum on a product, the demand for the product would be elastic. For
example, if the price of salt is raised by 50%, the demand would still be inelastic as consumers would keep on purchasing.
Conversely, if the price of a home theatre system is raised by 25%, the demand for the system would be more elastic.

● Time under consideration: It majorly influences the price elasticity of demand. Demand for a product remains inelastic in
the short run due to failure to postpone demand. For example, if the price of electricity goes up, people may find it difficult
to cut its consumption; thus, the demand would remain less elastic. However, in case of a continuous increase in the price,
people would gradually reduce the consumption of electricity by finding various ways, such as using CFL bulbs. In such a
case, the demand would be more elastic.

● Perishability of the product: If products are perishable in nature, the demand for such products would be inelastic as their
consumption cannot be postponed. For example, if the prices of vegetables that are used regularly are raised, the
consumption would not decrease. Thus, the demand would be inelastic. Similarly, if products such as medicines are to be
used in an emergency, the demand for them would not decrease.

10 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 ● Addiction: Some products, such as cigarettes and other tobacco-based products, have inelastic demand. For instance,
smokers may be willing to pay extra for cigarettes even in case of a price rise. Thus, the demand would remain the same.

Income Elasticity of Demand

In Income elasticity of demand, the responsiveness of demand to change in income.

Types of Income Elasticity of Demand

● Positive income elasticity of demand: When a proportionate change in the income of a consumer increases the demand for a
product and vice versa, income elasticity of demand is said to be positive. In case of normal goods, the income elasticity of
demand is generally found positive.

● Negative income elasticity of demand: When a proportionate change in the income of consumer results in a fall in the
demand for a product and vice versa, the income elasticity of demand is said to be positive. It generally happens in the case
of inferior. For example, consumers may prefer small cars with a limited income. However, with a rise in income, they may
prefer using luxury cars.

● Zero income elasticity of demand: When a proportionate change in the income of a consumer does not bring any change in
the demand for a product, income elasticity of demand is said to be zero. It generally occurs for utility goods such as salt,
kerosene, electricity. Figure 5.15 shows the zero income elasticity of demand:

Factors Affecting Income Elasticity of Demand

● Income of Consumers in a Country: In any country, the income level of consumers is not the same. Therefore, consumers
spend on the basis of not only on their need but also their purchasing capacity. The purchasing capacity of consumers
increases with a rise in their income. For example, a consumer with a low income may prefer using public transport for
commuting. However, with a rise in income, he/she may buy a two-wheeler for the same purpose.

● Nature of Products: The nature of products being consumed by consumers also has an important influence on income
elasticity. For example, basic goods used on a day to day basis, such as salt, sugar, and cooking oil, is elastic. Even with a
rise in the income of a consumer, the demand for such products does not change and remain inelastic.

● Consumption Pattern: With a rise in income, people quickly change their consumption patterns. For example, people may
start buying high priced products with an increase in their income. This leads to an increase in the demand for the products in
the market. However, once the consumption pattern is established, it becomes difficult to lower the demand in case of a
decrease in income. For example, a consumer may buy a two-wheeler that runs on petrol as a result of a rise in his/her
income. However, over a period of time, in case his/her income falls, it will be difficult for him to reduce the consumption of
petrol.

Cross Elasticity of Demand

Cross elasticity of demand can be defined as a measure of a proportionate change in the demand for goods as a result of change in the
price of related goods.

Types of Cross Elasticity of Demand

Positive cross elasticity of demand: When an increase in the price of a related product results in an increase in the demand for the
main product and vice versa, the cross elasticity of demand is said to be positive. Cross-elasticity of demand is positive in the case of
substitute. For example, the quantity demanded tea has increased from 200 units to 300 units with an increase in the price of coffee
from ₹25 to ₹30. Here, the cross elasticity is positive.

Negative cross elasticity of demand: When an increase in the price of a related product results in the decrease of the demand of
the main product and vice versa, the negative elasticity of demand is said to be negative. In complementary goods, cross elasticity of
goods is negative. For example, if the price of butter is increased from 20 to 25, the demand for bread is decreased from 200 units to
125 units. In such a case, cross elasticity will be calculated as: Thus, cross elasticity is negative.

Zero cross elasticity of demand: When a proportionate change in the price of a related product does not bring any change in the
demand for the main product, the negative elasticity of demand is said to be negative. In simple words, cross elasticity is zero in case
of independent goods. In this case, it becomes zero. By studying the concept of cross elasticity of demand, organisations can forecast
the effect of change in the price of a good on the demand for its substitutes and complementary goods. Thus, it helps organisations in

11 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

making pricing decisions by determining the expected change in the demand for its substitutes and complementary goods. Moreover,
it helps an organisation to anticipate the degree of competition in the market.

Supply: Concept of Supply

Demand and Supply are two pillars of business economics. We already know that demand is the quantity of a good or service that
consumers are willing and able to purchase at different prices during a period of time.

Supply is an economic principle can be defined as the quantity of a product that a seller is willing to offer in the market at a particular
price within specific time.

In other words, supply can be defined as the willingness of a seller to sell the specified quantity of a product within a particular price
and time period. Here, it should be noted that demand is the willingness of a buyer, while supply is the willingness of a supplier.

Supply refers to the amount of a good or service that the producers/providers are willing and able to offer to the market at various
prices during a period of time.

Supply may be defined as a schedule which shows the various amounts of a product which a particular seller is willing and able to
produce and make available for sale in the market at each specific price in a set of possible prices during a given period. McConnell

Supply refers to the quantity of a commodity offered for sale at a given price, in a given market, at given time. Anatol Murad

For example, a seller offers a commodity at 100 per piece in the market. In this case, only commodity and price are specified; thus, it
cannot be considered as supply.

However, there is another seller who offers the same commodity at 110 per piece in the market for the next six months from now on.
In this case, commodity, price, and time are specified, thus it is supply.

Determinants of Supply
While the price is an important aspect for determining the willingness and desire to part with goods/services, many other factors
determine the supply of a product or service as discussed below:

● Price of a product
● Cost of production
● Natural conditions
● Transportation conditions
● Taxation policies
● Production techniques
● Factor prices and their availability
● Price of related goods
● Industry structure

12 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 1. Price of a product: The major determinants of the supply of a product are its price. An increase in the price of a product
increases its supply and vice versa while other factors remain the same. The most obvious one of the determinants of supply
is the price of the product/service. With all other parameters being equal, the supply of a product increases if its relative price
is higher. The reason is simple. A firm provides goods or services to earn profits and if the prices rise, the profit rises too.

2. Cost of production: It is the cost incurred on the manufacturing of goods that are to be offered to consumers. Cost of
production and supply are inversely proportional to each other. Production of a good involves many costs. If there is a rise in
the price of a particular factor of production, then the cost of making goods that use a great deal of that factors experiences a
huge increase. The cost of production of goods that use relatively smaller amounts of the said factor increases marginally. For
example, a rise in the cost of land will have a large effect on the cost of producing wheat and a small effect on the cost of
producing automobiles. Therefore, the change in the price of one factor of production causes changes in the relative
profitability of different lines of production. This causes producers to shift from one line to another, leading to a change in
the supply of goods.

3. Natural conditions: The supply of certain products is directly influenced by climatic conditions. For instance, the supply of
agricultural products increases when the monsoon comes well on time.

4. Transportation conditions: Better transport facilities result in an increase in the supply of goods. Transport is always a
constraint to the supply of goods. This is because goods are not available on time due to poor transport facilities.

5. Taxation policies: Government’s tax policies also act as a regulating force in supply. If the rates of taxes levied on goods are
high, the supply will decrease. This is because high tax rates increase overall productions costs, which will make it difficult
for suppliers to offer products in the market. Commodity taxes like excise duty, import duties, GST, etc. have a huge impact
on the cost of production. These taxes can raise overall costs. Hence, the supply of goods that are impacted by these taxes
increases only when the price increases. On the other hand, subsidies reduce the cost of production and usually lead to an
increase in supply.

6. Production techniques: The supply of goods also depends on the type of techniques used for production. Obsolete
techniques result in low production, which further decreases the supply of goods. Technological innovations and inventions
tend to make it possible to produce better quality and/or quantity of goods using the same resources. Therefore, the state of
technology can increase or decrease the supply of certain goods.

7. Factor prices and their availability: The production of goods is dependent on the factors of production, such as raw
material, machines and equipment, and labour.

8. Price of related goods: Let’s say that the price of wheat rises. Hence, it becomes more profitable for firms to supply wheat
as compared to corn or soya bean. Hence, the supply of wheat will rise, whereas the supply of corn and soya bean will
experience a fall. Hence, we can say that if the price of related goods rises, then the firm increases the supply of the goods
having a higher price. This leads to a drop in the supply of the goods having a lower price.

9. Industry structure: The supply of goods is also dependent on the structure of the industry in which a firm is operating. If
there is monopoly in the industry, the manufacturer may restrict the supply of his/her goods with an aim to raise the prices of
goods and increase profits.

Law of Supply – Function, Curves and Shifting of curves;

The law of supply states that the relationship between price and supply of a product.

According to the law of supply, the quantity supplied increases with a rise in the price of a product and vice versa while other factors
are constant. The other factors may include customer preferences, size of the market, size of population, etc.

Law of Supply Example

For example, in the case of rise in a product’s price, sellers would prefer to increase the production of the product to earn high profits,
which would automatically lead to an increase in supply. Similarly, if the price of the product decreases, the supplier would decrease
the supply of the product in the market as he/ she would wait for a rise in the price of the product in the future. Thus, the law of

13 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

supply states a direct relationship between the price of a product and its supply. Therefore, both price and supply moves in the same
direction.

Law of Supply Definition

The law of supply defined as: “Other things remaining unchanged, the supply of a good produced and offered for sale will increase as
the price of the good rises and decrease as the price falls.”

Supply Function
Supply function is the mathematical expression of law of supply. In other words, supply function quantifies the relationship between
quantity supplied and price of a product, while keeping the other factors at constant.

The law of supply expresses the nature of the relationship between quantity supplied and price of a product, while the supply function
measures that relationship.

The supply function can be expressed as: Qs = f (Pa, Pb, Pc, T, Tp)

Where,
Qs =Supply Pa =Price of the good supplied Pb =Price of other goods
Pc =Price of factor input T=Technology Tp = Time Period

According to the supply function, the quantity supplied of a good (Qs) varies with the price of that good (Pa), the price of other goods
(Pb), the price of factor input (Pc), the technology used for production (T), and time period (Tp)

What is Supply Curve?

Supply Curve definition: In economics, supply curve is a graphical representation of supply schedule is called supply curve.
In a graph, the price of a product is represented on Y-axis and quantity supplied is represented on X-axis.

Types of Supply Curve

In, economics, Supply curve can be of two types, individual supply curve and market supply curve. These two types of supply curves
are explained as follows:

Types of Supply Curve is:

1. Individual supply curve
2. Market Supply curve

Individual supply curve

Individual supply curve: It is the graphical representation of individual supply schedule.

The individual supply schedule of commodity A represented in Table when plotted on a graph will provide the individual supply
curve, which is shown in Figure.

14 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 PRICE OF QUANTITY
THE SUPPLIED OF
PRODUCT COMMODITY A
(₹ PER KG) (KG PER WEEK)

5 3,000

10 8,000

15 12,000

20 15,000

The slope moving upwards to the right in individual supply curve shows the direct relationship between supply and price, i.e. increase
in supply along with the rise in prices.

Market Supply curve

Market Supply curve: It is the graphical representation of market supply schedule.
The market supply schedule of commodity A (supplied by Firm X and Firm Y) represented in Table, when plotted on the graph will
provide the market supply curve, which is shown in Figure.
Example

PRICE OF QUANTITY QUANTITY MARKET

PRODUCT SUPPLIED BY FIRM SUPPLIED BY FIRM SUPPLY
A X Y (1000 KG PER
(₹ PER KG) (1000 KG PER WEEK) (1000 KG PER WEEK) WEEK)

5 3 7 10

10 8 12 20

15 12 15 27

20 15 17 32

15 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 Movement and Shift in Supply Curve
1. Movement in Supply Curve
2. Shift in Supply Curve

Movement in Supply Curve

Movement along Supply Curve is when the commodity experience change in both the quantity supply and price, causing the curve
to move in a specific direction.

Shift in Supply Curve

The shift in supply curve is when, the price of the commodity remains constant, but there is a change in quantity supply due to some
other factors, causing the curve to shift to a particular side.

Shifts and Movement along Supply Curve

In economics, like demand, change in quantity supplied and change in supply are two different concepts.
1. Expansion and Contraction of Supply
2. Increase and Decrease In Supply

what causes a shift in the supply curve

16 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

Change in quantity supplied occurs due to rise or fall in product prices while other factors are constant.
● It can be measured by the Movement along Supply Curve.
● The term, Change in quantity supplied refers to expansion or contraction of supply.

Change in supply refers to increase or decrease in the supply of a product due to various determinants of supply other than price (in
this case, price is constant).
● It is measured by shifts in supply curve.
● The terms, while a change in supply means an increase or decrease in supply.

Supply curve shifts

A shift takes place in supply curve due to the increase or decrease in supply, which is shown in Figure.

Increase and Decrease in Supply

In Figure, an increase in supply in indicated by the shift of the supply curve from S1 to S2. Because of an increase in supply, there is
a shift at the given price OP, from A1 on supply curve S1 to A2 on supply curve S2. At this point, large quantities (i.e. Q2 instead of
Q1) are offered at the given price OP.

On the contrary, there is a shift in supply curve from S1 to S3 when there is a decrease in supply. The amount supplied at OP is
decreased from OQ1 to OQ3 due to a shift from A1 on supply curve S1 to A3 on supply curve S3.

However, a decrease in supply also occurs when producers sell the same quantity at a higher price (which is shown in Figure) as OQ1
is supplied at a higher price OP2.

Elasticity of Supply
What is Elasticity of Supply?
Elasticity of supply is a measure of the degree of change in the quantity supplied of a product in response to a change in its price.

As discussed previously, the law of supply states that the quantity supplied of a product increases with a rise in the price of the
product and vice versa, while keeping all other factors constant.

However, an organisation needs to determine the impact of change in the price of a product on its supply in numerical terms. The
concept of elasticity of supply helps organisations to estimate the impact of change in the supply of a product with respect to its price.

Elasticity of Supply Definition

The supply of a commodity is said to be elastic when as a result of a change in price, the supply changes sufficiently as a quick
response. Contrarily, if there is no change or negligible change in supply or supply pays no response, it is elastic.Prof. Thomas

Elasticity of Supply Formula

Mathematically, the elasticity of supply is expressed as:

Percentage change in quantity supplied =

17 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

Percentage change in quantity supplied =

The elasticity of supply can be calculated with the help of the following formula:

Where,
ΔS = S1 – S
ΔP = P1 – P

Elasticity of Supply Example

Let us understand how to calculate the elasticity of supply with the help of an example.

Example: Assume that a business firm supplied 450 units at the price of 4500. The firm has decided to increase the price of the
product to> 5500. Consequently, the supply of the product is increased to 600 units. Calculate the elasticity of supply.

Solution:
Here,
P = 4500 ΔP = 1000 (a fall in price; 5500– 4500 = 1000)
S = 450 units
ΔS = 150 (600 – 450)

By substituting these values in the above formula, we get:

es = 150/1000 x 4500/450 = 1.5

Types of Elasticity of Supply

Similar to elasticity of demand, elasticity of supply also does not remain same. The degree of change in the quantity supplied of a
product with respect to a change in its price varies under different situations.
Based on the rate of change, the types of price elasticity of supply are grouped into five main categories as follows:
1. Perfectly elastic supply
2. Perfectly Inelastic Supply
3. Relatively Elastic Supply
4. Relatively Inelastic Supply
5. Unitary Elastic Supply

Perfectly elastic supply:

When a proportionate change (increase/ decrease) in the price of a product results in an increase/decrease of quantity supplied, it is
called a perfectly elastic supply. In such a case, the numerical value of elasticity of supply would be infinite (es =∞). This situation is
imaginary as there is no such product whose supply is perfectly elastic.

Example: Let us understand the concept of a perfectly elastic supply with the help of an example.
Example: The supply schedule of product X is given as follows:

18 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 PRICE (₹ PER QUANTITY SUPPLIED
KG.) (KGS. IN THOUSANDS)

100 40

100 60

100 80

Draw a supply curve for the supply schedule and find the type of elasticity of supply using the curve.
Solution: The supply curve for product X is shown in Figure.

Perfectly elastic supply curve: Figure shows that the price of product X remains constant at ₹100 per kg. However, the quantity
supplied changes from 40,000 kgs to 80,000 kgs at the same price. Therefore, the supply of product X is perfectly elastic (es =∞).

Perfectly Inelastic Supply:

In this situation, the quantity supplied does not change with respect to a proportionate change in the price of a product. In other words,
the quantity supplied remains constant at the change in price when supply is perfectly inelastic. Thus, the elasticity of supply is equal
to zero ( es =0). However, this situation is imaginary as there can be no product whose supply could be perfectly inelastic.

Example: Let us understand the concept of perfectly inelastic supply with the help of an example.
The quantity supplied and the price of product A is given as follows:

PRICE (₹ QUANTITY SUPPLIED

PER KG.) (KGS. IN THOUSANDS)

45 50

55 50

65 50

Draw a supply curve for the supply schedule and find the type of elasticity of supply using the curve.
Solution: The supply curve for product A is shown in Figure

19 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

Figure, shows that the supply of product A remains constant at 50,000 kgs. However, the price changes from 45 to 65 at the same
supply rate. Therefore, the supply of product X is perfectly inelastic (e = 0).

Relatively Elastic Supply

When a percentage change in the quantity supplied is more than a percentage change in the price of a product, it is called relatively
elastic supply. In this case, the elasticity of supply is less than 1, i.e. es < 1.

Let us understand the concept of relatively elastic supply with the help of an example.
Example: The quantity supplied and the price of product P is given as follows:

PRICE (₹ QUANTITY SUPPLIED

PER KG.) (KGS. IN THOUSANDS)

50 35

53 40

55 45

Draw a supply curve for the supply schedule of product P and find the type of the elasticity of supply using the curve.
Solution: The supply curve for product P is shown in Figure

Relatively Elastic supply curve

In Figure, SS is the supply curve. When the price of product P is 50, the quantity supplied is 35,000 kgs. However, when the price
increases to 53, supply reaches to 40,000 kgs. Similarly, when the price further increases to 55, the supply increases to 45,000 kgs.
This shows that the change in price is only 2 while the change in supply is 5,000 kgs. In other words, the proportionate change in
quantity supplied is more than the proportionate change in the price of product P.
Therefore, the supply of product P is highly elastic (es>1).

Relatively Inelastic Supply

When a percentage change in the quantity supplied is less than the percentage change in the price of a product, it is called relatively
inelastic supply. In this case, the elasticity of supply is greater than 1, i.e. es < 1.
Let us understand the concept of relatively inelastic supply with the help of an example.
Example: The quantity supplied and the price of product B is given as follows:

20 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 PRICE (₹ PER QUANTITY SUPPLIED
KG.) (KGS. IN THOUSANDS)

45 50

55 51

65 52

Draw a supply curve for the supply schedule of product B and find the type of elasticity of supply using the curve.
Solution: The supply curve for product B is given in Figure

Relatively inelastic supply curve

In Figure, when the price of product B is 45, the quantity supplied is 50,000 kgs. When price increases to 55, supply reaches to 51,000
kgs. Similarly, as the price of product B increases to 65, the supply increases to 52,000 kgs, this clearly shows that a change in price is
10 while the change in supply is 1,000 kgs. In other words, the proportionate change in quantity supplied is less than the change in the
price of product B. Thus, the supply of product B is relatively inelastic (es <1).

Unitary Elastic Supply

When the proportionate change in the quantity supplied is equal to the proportionate change in the price of a product, the supply
is unitary elastic. In this case, elastic supply is equal to one (es =1).

Example: Let us understand the concept of relatively elastic supply with the help of an example.
Example: The quantity supplied and the price of product Z is given below:

PRICE (₹ PER QUANTITY SUPPLIED (KGS.

KG.) IN THOUSANDS)

50 30

55 35

65 52

Solution: The supply curve for product Z is shown in Figure

21 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 Unitary elastic supply curve

In Figure, when the price of product Z is 50, the quantity supplied is 30,000 kgs. When price increases to 55, supply reaches to 35,000
kgs. This shows that the proportionate change in quantity supplied is equal to the change in the price of product Y. Therefore, the
supply of product B is unit elastic (es =1).

2.2 Demand Forecasting: Meaning

● It is a process that businesses utilize to understand and predict customer demand over a period. This helps them make
informed decisions about supply chain operations, inventory stocking, capacity planning, cash flow and profit margins.
● Demand forecasting is the prediction of the quantity of goods and services that will be demanded by consumers at a future
point in time.
● It is a technique for estimation of probable demand for a product or services in the future. It is based on the analysis of past
demand for that product or service in the present market condition. Demand forecasting should be done on a scientific basis
and facts and events related to forecasting should be considered.
● Therefore, in simple words, we can say that after gathering information about various aspect of the market and demand based
on the past, an attempt may be made to estimate future demand. This concept is called forecasting of demand.
● For example, suppose we sold 200, 250, 300 units of product X in the month of January, February, and March respectively.
Now we can say that there will be a demand for 250 units approx. of product X in the month of April, if the market condition
remains the same.

Methods of Demand Forecasting

● Trend projection: Trend projection uses historical data to project future sales. It is important to remove outliers, such as
sudden spikes in sales and historical anomalies, before opting for this method. The trend projection method of demand
forecasting is a statistical technique used to forecast sales based on past trends. It assumes that the demand will continue in
the same direction as the past trend, with the same or a similar rate of growth or decline. This involves fitting a trend line to
historical data and extrapolating the line into the future to estimate the trends. Trend projection techniques use different
mathematical models to fit the trend line to the data to minimize the difference between predicted and realized values. The
trend projection method is best suited for forecasting demand in stable, predictable environments where past trends are
expected to continue. However, it is important to consider external factors such as changes in the market, competitors, or
government regulations that may impact demand and adjust the trend projections accordingly.

● Market research: Market research uses data from customer surveys to provide businesses with valuable information. It
helps cluster customers based on their purchasing habits, demographic, geographic and psychographic variables. The Market
Test method of demand forecasting involves conducting a limited-scale launch of a new product or service in a specific
geographic area or customer segment to gather info. The data collected from the market test is then used to forecast regarding
the product or service in a larger-scale launch. This is advantageous when launching a new product or entering a new market.
It provides real-world information on customer demand, which can be difficult to estimate using other forecasting techniques.
However, it can be expensive and time-consuming, and results may not represent trends for other regions. This is often used
with other forecasting methods to increase accuracy.

● Delphi method: It involves sending several questionnaires to an expert panel over several rounds to generate forecasts. The
primary objective of this technique is to arrive at a group consensus which can provide unified expert opinion. The Delphi
method is a group consensus-based approach for demand forecasting. It involves collecting predictions and opinions from a
panel of experts and then using an iterative process to reach a consensus forecast. It involves identifying a panel of experts,

22 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 collecting initial projections from each expert, compiling, and aggregating the initial estimates, providing expert feedback on
the overall results, collecting updated forecasts from the experts, and creating a consensus demand forecast. The Delphi
method is helpful for complex forecasting problems where a single expert's forecast may need to be more reliable. It can help
reduce the influence of personal biases and improve the accuracy of the final predictions.

● Sales force composite: This method uses data from the sales groups to predict future demand for a product or a service. The
sales team provides data such as customer behaviour, product trends, competitors' products and pricing strategies and
customer feedback. The Sales Force Opinion method of demand forecasting involves gathering forecasts from the company's
sales force, such as sales representatives and managers. These individuals are in close contact with customers and have direct
insight into current and future customer demand for a product or service. The sales force's opinions are combined and
analyzed to create a forecast. It can provide valuable information and help to identify regional, customer-specific, and
product-specific trends. However, it may also be subject to biases and personal opinions, so it is often used in conjunction
with other methods to increase accuracy.

● Econometric technique: This technique combines sales data with external economic factors to build a mathematical model
that can accurately predict future customer demand. The external factors can include regulations and policies, technology,
macroeconomic conditions and geopolitical scenarios. The econometric method of demand forecasting is a statistical
approach to predicting future sales for a product or service based on past sales data and relevant economic and market
factors. It uses regression analysis and other statistical tools to establish relationships between demand and independent
variables such as economic indicators, market trends, and other relevant variables. The model is then used to predict future
trends based on expected changes in the independent variables. The econometric method is considered highly reliable and
accurate, especially for products or services with a long sales history. However, it requires a large amount of data and a good
understanding of statistical techniques to implement effectively.

● Statistical Method of Demand Forecasting: Statistical methods are a commonly used approach for demand forecasting as
they can provide accurate predictions based on historical data. Some of them used for predicting include Time series analysis,
Regression analysis, ARIMA (Autoregressive Integrated Moving Average), and Exponential smoothing. The choice of
method depends on the nature of the data and the business problem. A combination of these may also provide a more robust
forecast.

● Survey Method of Demand Forecasting: The survey method of demand forecasting involves gathering data directly from
consumers, customers, or market participants to make predictions about future demand for a product or service. This can be
done through various means, such as telephone, online, focus groups, or in-person interviews. The data collected through
surveys can provide valuable insights into consumers' opinions, attitudes, and buying behavior, which can be used to make
informed predictions about future demand. The forecast's accuracy will depend on the size and representativeness of the
sample, the quality of the survey questions, and the ability to generalize the findings to the larger population.

● Barometric Method of Demand Forecasting: The barometric method of demand forecasting is a technique that predicts the
future trend for a product or service based on an analysis of external factors such as economic indicators, market trends, and
industry-specific variables. It assumes that consumers’ expectation for a product or service is closely related to changes in
these external factors. It involves:
a) Collecting data on relevant indicators.
b) Creating a model to establish the relationship between the indicators and demand.
c) Using the model to forecast future demand.
d) The accuracy of the forecast will depend on the quality of the data and the interdependence between external factors
and demand.
This method is based on the past demands of the product and tries to project the past into the future. The economic indicators
are used to predict the future trends of the business. Based on future trends, the demand for the product is forecasted. An
index of economic indicators is formed. There are three types of economic indicators, viz. leading indicators, lagging
indicators, and coincidental indicators. The leading indicators are those that move up or down ahead of some other series.
The lagging indicators are those that follow a change after some time lag. The coincidental indicators are those that move up
and down simultaneously with the level of economic activities.

● Expert Opinion Method of Demand Forecasting: The expert opinion method of demand forecasting involves gathering
opinions and insights from individuals with expertise in a particular product or market to make predictions about future
demand. It typically relies on experts in a given field's experience, knowledge, and judgment, who can provide insights into
market trends, consumer behavior, and other relevant factors. Expert opinion can be collected through interviews, surveys, or

23 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

 by consulting industry publications and reports. This method can be useful when data is limited or consumer behavior
changes rapidly. Still, it can also be subject to bias and error if the experts consulted do not have a broad or accurate
understanding of the market. The forecast's accuracy will depend on the expertise of the individuals consulted and the
validity of their assumptions.

Types of Demand Forecasting

● Passive demand forecasting: Passive demand forecasting is a simple technique that involves predicting future customer
demand based on historical data. The historical data may include:
a) Identity data: Identity data includes a customer's name, contact information, demographics and links to social media
accounts.
b) Descriptive data: Descriptive data includes additional details, such as a customer's marital status, career details and
educational information.
c) Behavioral data: Behavioral data includes data on past purchases, customer interactions with a business, social
engagement and product usage.
d) Attitudinal data: Attitudinal data is information about customers' thoughts, feelings and opinions about a product,
brand or experience.
This is an ideal strategy for companies that focus on sustainability and priorities stability over growth or expansion.

● Active demand forecasting: This is an ideal strategy for companies that priorities growth and diversification over stability
and sustainability. This technique focuses on various factors besides sales data, such as marketing campaign data,
competitors' activities, external market conditions and trends. Businesses that are looking to change their marketing tactics or
focus on expansion can benefit from employing this method. This type of demand forecasting is a good choice for new start-
ups. This model takes marketing campaigns, market research, and expansion plans into account.

● Macro-level demand forecasting: At a macro-level, demand forecasting examines external factors, including economic
conditions, competition and consumer trends. This helps businesses identify opportunities for product or service expansion,
determine financial risks and procure raw materials in advance. Demand forecasting at the macro level is based on national
income or aggregate expenditures.

● Industry-level demand forecasting: Industry-level demand forecasting measures the overall demand for the products of a
particular industry. This can include industries at the regional or national level. An industry, trade association or a group of
companies may undertake these forecasts.

● Firm-level demand forecasting: This involves predicting the demand for products offered by a particular company.
Companies can develop marketing strategies based on this information. Businesses experiencing rapid growth prefer using
industry-level demand forecasting, whereas those with stable growth benefit from using firm-level demand forecasting.

● Short-term demand forecasting: This type of forecasting predicts customer demand for the period of three months to one
year. The short-term demand forecasting method uses real-time sales data to adjust projections of customer demand. This can
help businesses achieve short-term goals, such as preparing suitable sales policies to improve sales or preparing inventory
based on demand. This forecasting method analyzes for a short-term of 3 to 12 months helps in managing a just-in-time
supply chain and also allows the company to adjust their projections based on real-time sales data.

● Long-term demand forecasting: Businesses use long-term forecasts for periods exceeding one year. It helps them identify
annual patterns, seasonality in sales and production capacity. Using long-term demand forecasting, businesses can devise
long-term strategies to increase their market share, acquire other businesses, grow their customer base and improve
production processes. This forecasting method analyzes for a long-term of one to four years and helps us in focusing and
shaping the growth of business trajectory, planning out the company’s marketing, capital investments, and supply chain
operations. The method is based on sales data and market research.
Short term Demand forecasting:
Short-term demand forecasting, also known as tactical or operational forecasting, typically covers a period of up to one year,
but often less than three months. The main purpose of short-term forecasting is to support operational decisions, such as
scheduling, staffing, replenishment, and allocation. Short-term forecasts are usually more accurate and reliable than long-
term forecasts, as they are based on recent and relevant data, and have less uncertainty and variability. Some common
methods for short-term forecasting are time series analysis, regression analysis, and exponential smoothing. Short-term
forecasting aims to predict events or outcomes in the near future, typically ranging from a few days to a year. This approach

24 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

is most suitable for scenarios where immediate action is required, and the influencing factors are expected to remain stable
over the short period. Some common short-term forecasting methodologies include:

● Time Series Analysis: Time series analysis is a widely used method for short-term forecasting, especially when
dealing with data points collected over regular intervals. This approach relies on historical data patterns to identify
trends, seasonal variations, and cyclical fluctuations. Techniques like moving averages and exponential smoothing
are often employed to make short-term predictions based on past performance.
● Market Research and Surveys: For businesses, short-term forecasts can heavily rely on market research and
customer surveys. Collecting data on consumer behavior, preferences, and purchasing patterns can help anticipate
demand fluctuations in the immediate future.
● Leading Indicators: Short-term forecasts can also be derived from leading indicators, which are economic variables
that tend to change before the overall economy does. Examples include stock market indices, consumer sentiment
indexes, and building permits, which can provide insights into economic conditions for the next few months.
● Artificial Intelligence and Machine Learning: With the advent of advanced technologies like AI and machine
learning, short-term forecasting has benefited from more sophisticated prediction models. These technologies can
analyze large datasets, identify patterns, and adjust forecasts in real-time, making them particularly valuable in fast-
paced industries.

Pros and Cons of Short-Term Forecasting

Short-term forecasting has several advantages, including its ability to provide real-time insights and facilitate quick decision-
making. It is well-suited for tactical planning, inventory management, and responding to immediate changes in the market.
However, short-term forecasts are susceptible to fluctuations caused by sudden external events, and they may lack accuracy
when trying to predict long-term trends. Short-term forecasting typically focuses on predicting demand over a relatively brief
period, ranging from a few days to a few months. The objective is to manage day-to-day or week-to-week operations,
ensuring the business can meet demand without over-committing resources or running out of stock.

Key Characteristics:
● Time Horizon: Days to months (usually up to 3-6 months).
● Focus: Day-to-day operations, inventory levels, production planning, and workforce scheduling.
● Granularity: Often detailed and based on specific product lines or customer segments.
● Purpose: Optimize inventory, reduce stock outs, and manage supply chain fluctuations in the short run.

Methods for Short-Term Forecasting:

● Moving Average: A simple method where past demand data is averaged over a set period (e.g., the last 7 days, 30
days). It helps smooth out random fluctuations. Example: A 7-day moving average to predict next week’s demand.
● Exponential Smoothing: A weighted average method that gives more weight to recent data, allowing the forecast to
adapt more quickly to trends. Example: Simple Exponential Smoothing (SES) or more advanced forms like Holt-
Winters for seasonality.
● Time Series Analysis: Analyzes historical data over time to identify trends, cycles, and seasonality. Techniques like
ARIMA (Auto Regressive Integrated Moving Average) are often used.
● Regression Analysis: Forecasts demand based on relationships between demand and other influencing variables (like
marketing spend, economic indicators, etc.).

Applications in Short-Term Forecasting:

● Retail: Predicting weekly sales and adjusting inventory levels.
● Manufacturing: Scheduling production runs and ensuring the right amount of materials are available.
● Airlines: Forecasting seat bookings and adjusting ticket prices or capacity.

Long term Demand Forecasting:

Long-term demand forecasting, also known as strategic or planning forecasting, usually covers a period of more than one
year, and sometimes up to several decades. The main purpose of long-term forecasting is to support strategic decisions, such
as capacity planning, market entry, product development, and investment. Long-term forecasts are usually less accurate and
reliable than short-term forecasts, as they are based on historical and projected data, and have more uncertainty and
variability. Some common methods for long-term forecasting are trend analysis, scenario analysis, and simulation. Long-term
forecasting, as the name suggests, involves predicting events, trends, or outcomes over an extended period, typically

25 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)

spanning multiple years or even decades. This approach is instrumental in strategic planning, infrastructure development, and
policy-making. Some common long-term forecasting methodologies include:

● Trend Extrapolation: Trend extrapolation is a fundamental long-term forecasting technique that extends historical
data trends into the future. It assumes that past patterns and relationships will continue to hold true over the forecast
period.
● Scenario Analysis: Scenario analysis involves constructing multiple plausible future scenarios based on different
assumptions and uncertainties. Decision-makers can then assess the implications of each scenario and develop
strategies to address potential challenges and opportunities.
● Delphi Method: The Delphi method is a structured approach to long-term forecasting that involves collecting
opinions from a panel of experts. These experts provide forecasts anonymously, and the process continues iteratively
until a consensus is reached.
● System Dynamics Modeling: System dynamics modeling is a simulation-based approach that considers feedback
loops and complex relationships within a system. It is particularly valuable for understanding dynamic systems and
their behavior over extended periods.

Pros and Cons of Long-Term Forecasting

Long-term forecasting provides a broader perspective, enabling organizations to set long-range goals and allocate resources
accordingly. It helps identify potential challenges and opportunities well in advance, allowing for proactive planning.
However, long-term forecasts are subject to more uncertainties, and errors made in the early stages of the forecast can
amplify over time. Additionally, long-term forecasts may lack the agility needed to adapt to rapidly changing circumstances.
Long-term forecasting looks further into the future, typically beyond one year, and is used for strategic planning and capital
investment decisions. It helps businesses make decisions about large-scale production capacity, product development, and
market expansion.

Key Characteristics:
● Time Horizon: One year or more, often 3-5 years or even longer.
● Focus: Strategic decisions like facility planning, large investments, product life cycle management, and market
entry/exit strategies.
● Granularity: Broader trends and macroeconomic factors; less detailed than short-term forecasts.
● Purpose: Inform decisions on long-term capacity, new product development, market strategies, and investment.

Methods for Long-Term Forecasting:

● Trend Analysis: Identifying and extrapolating long-term trends in demand, often using historical data to predict
future changes. Example: Projecting future demand based on the historical growth rate of a product or market.
● Causal Models: Using statistical techniques to forecast demand based on factors that influence demand, such as
economic indicators, population growth, or industry trends. Example: Using GDP growth and consumer confidence
indices to predict demand in the consumer goods market.
● Delphi Method: A qualitative forecasting technique where a panel of experts provides opinions on future demand,
and those opinions are refined through iterative rounds of feedback. Example: Used in industries like technology
where expert knowledge about future developments is crucial.
● Scenario Planning: This method involves creating different “scenarios” or “what-if” models based on assumptions
about the future (e.g., changes in regulations, technology, or consumer behavior).
● Market Research: Collecting data from surveys, focus groups, and consumer panels to gauge demand over the long
term.

Applications in Long-Term Forecasting:

● Automotive Industry: Planning for new car models, future production volumes, and R&D investments.
● Energy Sector: Predicting long-term demand for electricity or oil and planning for infrastructure development.
● Technology Firms: Planning for the demand of new software/hardware products over the next several years.

26 Prof. Digambar B. Sonawane (KCES’s COEM-Jalgaon)