UNIT – II

Demand and Supply Analysis

Elasticity of Demand: Elasticity, Types of Elasticity, Law of Demand, Measurement and

Significance of Elasticity of Demand, Factors affecting Elasticity of Demand, Elasticity of
Demand in decision-making, Demand Forecasting: Characteristics of Good Demand
Forecasting, Steps in Demand Forecasting, Methods of Demand Forecasting.
Supply Analysis: Determinants of Supply, Supply Function and Law of Supply.
************************************************************************************************
DEMAND ANALYSIS
DEMAND:
In common parlance, Demand means the desire for an object. However, in economics demand is something
more than this. According to Stonier and Hague, ―Demand in economics means demand backed up by
enough money to pay for the goods demanded. This means that the demand becomes effective only it if is
backed by the purchasing power. In addition to this, there must be willingness to buy a commodity.
Thus, Demand in economics refers to the quantity of a commodity, which an individual consumer or a
household is willing to purchase per unit of Time for a particular Price.
Demand for a commodity implies:
1. Desire of the consumer / household to buy the commodity
2. His/Her/Its willingness to buy the commodity, and
3. Sufficient purchasing power in his/her/its possession to buy the commodity.

Individual Demand: When an individual demands a product / service, it is called as Individual Demand.
Household Demand: When a household demands a product/service, it is called as Household Demand.
Market Demand: When all the individuals/households, in the market, together demand a product/service, it
is called as Market Demand or Aggregate Demand.
DEMAND FUNCTION
Demand function is a function, which describes a relationship between one variable and its determinants. The
demand function for a good relates the quantity of good that consumers demand during a given period to the
factors that influence the demand. Quantity demanded is dependent variable and all the factors are
independent variables. The factors can be built up into a demand function. The demand function can be
mathematically expressed as follows:
Q = Quantity demanded
Q = f (P, I, T, P1..Pn, EP, EI, A, O)
f = Function of
P = Price of goods itself
I = Income of consumers
T = Taster and preferences
P1..Pn = Price of related goods
EP = Expectation about future price
EI = Expectation about future income
A = Advertisement
O = other factors
 LAW OF DEMAND:
Law of demand shows the relationship between price and quantity demanded of a commodity in the market.
In the words of Marshall, ―the amount demand increases with a fall in price and diminishes with arise in price.
The law of demand states that “other things remaining constant, the higher the price of the commodity,
the lower is the demand and lower the price, higher is the demand”. It is called as ceteris paribus (Latin
phrase meaning other things constant.)
The law of demand may be explained with the help of the following demand schedule.
Demand Schedule: Demand Curve:

Price of Apple Quantity

(In. Rs.) Demanded
2 6
3 4
4 3
5 2
6 1

When the price falls from Rs. 6 to 5, quantity demand increases from 1 to 2. In the same way as price falls,
quantity demanded increases. On the basis of the demand schedule, we can draw the demand curve. The
above demand curve shows the inverse relationship between price and quantity demanded of apple. It is
downward sloping.
Assumptions:
Law of demand is based on certain assumptions:
 There is no change in consumers taste and preferences.
 Income should remain constant.
 Prices of other goods should not change.
 There should be no substitute for the commodity
 The commodity should not confer at any distinction
 The demand for the commodity should be continuous
 People should not expect any change in the price of the commodity

EXCEPTIONS TO LAW OF DEMAND

According to law of demand, other things being constant, as the price increases, the demand for the
commodity decreases and vice-versa. However, this is not true all the time. In some cases, as the price
increases, the demand for the commodity will also increase and the demand decreases when the price
decreases. All these cases are considered as exceptions to the law of demand. The following are the exceptions
to the law of demand.
1. Giffen goods or Giffen paradox: The Giffen good or inferior good or cheap good is an exception to the
law of demand. The demand for these goods varies directly with the variations in prices i.e., there exists direct
relation between the quantity demanded and the price of the commodity. Giffen goods may or may not exist
in the real world.
2. Goods of status (Velben’s Goods): In some situations, certain commodities are demanded just because
they are expensive or prestige goods and are usually used as status symbols to display one‘s wealth in the
society. Examples of such commodities are diamonds, air conditioned car, duplex houses etc. as the price of
these commodities increase, they are more considered as status symbols and hence their demand gets
raised. This goes against the law of demand. Such goods were called as Velben’s Goods.
3. Ignorance: Sometimes, the quality of the commodity is Judged by its price. Consumers think that the
product is superior if the price is high. As such they buy more at a higher price.
4. Consumer expectations of future prices: If the price of the commodity is increasing, the consumers will
buy more of it because of the fear that it increase still further. Similarly, if the consumer expects the future
prices to decrease, he may not purchase the commodity thinking that the good may be of bad quality. This
violates the law of demand.
5. Fear of shortage: During the times of emergency of war, People may expect shortage of a commodity. At
that time, they may buy more at a higher price to keep stocks for the future.
6. Necessaries: In the case of necessaries like rice, vegetables etc. people buy more even at a higher price.
DETERMINANTS OF DEMAND
Several factors or determinants affect the individual demand and market demand for a product. These factors
are economic, social as well as political factors. The effect of all the factors on the amount demanded for the
commodity is called Demand Function. These factors are as follows:
1. Price of the Commodity: The most important factor-affecting amount demanded is the price of the
commodity. The amount of a commodity demanded at a particular price is more properly called price
demand. The relation between price and demand is called the Law of Demand. The demand for a commodity
varies inversely with its price. A decrease in price increases the purchasing power of consumers and an
increase in the price decreases the purchasing power of the consumers.

2. Income of the Consumer: The second most important factor influencing demand is consumer income.
Individual consumer‘s income determines his purchasing ability. When other things remaining constant, if
income increases, demand increases and vice-versa. An increase in income makes an individual to buy many
commodities. The effect of income on demand can be analysed for normal goods, perishable goods and
inferior goods.
Income Demand
1000 1
2000 2

3. Normal goods: Usually, the demand for a normal good goes in the same direction with consumer‘s income
i.e., demand for normal goods is directly related to consumer‘s income.
Perishable goods: For perishable goods like foods, fruits, meat, vegetables, milk etc., whose life is very short,
the quantity demanded raises with an increase in income, but after a certain level it remains constant even
though the income raises.

Demand for milk

Income
1000 1 Lt.
2000 2 Lts.
3000 3 Lts.
4000 4 Lts
5000 4 Lts.
4. Inferior goods: The goods for which the demand decreases even though the income level increases are inferior goods
or cheap good or ordinary goods.
Demand for
Income (Rs.)
ordinary ice-cream
100 1
200 2
300 3
400 1

5. Prices of related goods: In a given market, if the price of one good influences the quantity demanded of
another good, these two goods are said to be related goods. Two commodities in a given market are related to
each other either as Substitutes or Complementary goods.
a) Substitutes: When a want can be satisfied by alternative similar goods,
they are said to be substitutes to each other. Ex: Tea and Coffee, Santoor soap
and Lux soap etc. The below graph indicates that as the price of coffee
increases, the demand for tea increases.

Price of Coffee (Rs.) Demand for Tea

5 50
6 80

There is direct relation between price of coffee and demand for Tea.

b) Complementary goods: When a want can be satisfied by two or more goods in a combination. These
goods are termed as complementary goods. In other words, if the price of one good increases, the demand for
another good will decrease. Ex: Bread and Butter, Pen and Ink, Car and Petrol, Sugar and Tea and Shoe and
Socks etc. The below table and graph indicate the indirect relationship between price of one good and
demand for one good.
Price of Sugar (Rs.) Demand for Tea
30 50
50 20

6. Tastes and habits of the Consumers: Irrespective of price of good and income levels of consumers,
demand for many goods depends on consumers’ tastes and habits. For example, the demand for ice-creams,
chocolates, tea, etc. depend on individual tastes and habits.
7. Population: Increase in population increases demand for necessaries of life. The composition of
population also affects demand. Composition of population means the proportion of young and old and
children as well as the ratio of men to women. A change in composition of population has an effect on the
nature of demand for different commodities.
8. Government Policy: Government policy affects the demands for commodities through taxation. Taxing a
commodity increases its price and the demand goes down. Similarly, financial help from the government
increases the demand for a commodity while lowering its price.
9. Expectations regarding the future prices and incomes: If consumers expect changes in price of
commodity in future, they will change the demand at present even when the present price remains the same.
Similarly, if consumers expect their incomes to rise in the near future they may increase the demand for a
commodity just now.
ELASTICITY OF DEMAND
Elasticity of demand explains the relationship between a change in price and consequent change in
amount demanded. ―Marshall introduced the concept of elasticity of demand. Elasticity of demand shows the
extent of change in quantity demanded to a change in price.
Definition of Elasticity of Demand:
Elasticity of Demand (Ed) is defined as the percentage (%) change in the quantity demanded caused by 1% change
in the demand determinant under consideration, while other determinants remain constant.
Ed = % change in Demand / % change in the Determinant
Elasticity of Demand is a tool that helps an Economist to measure the effect of changes in any one of the
determinants of the Demand Function.
Elastic demand: A small change in price may lead to a great change in quantity demanded. In this case,
demand is elastic.
In-elastic demand: If a big change in price is followed by a small change in demanded then the demand in
―inelastic.
TYPES OF ELASTICITY OF DEMAND:

There are four types of elasticity of demand:

1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
4. Advertisement elasticity of demand
Price elasticity of demand: Marshall was the first economist to define price elasticity of demand. Price
elasticity of demand measures changes in quantity demand to a change in Price. It is the ratio of percentage
change in quantitydemanded to a percentage change in price. There are five cases of price elasticity of
demand
a) Perfectly elastic demand: When small change in price leads to an infinitely large change is quantity
demand, it is called perfectly orinfinitely elastic demand. In this case E=∞. Sometimes, even there is no
change in the price, the demand changes in huge quantity. In case of perfect elastic demand, the demand for a
commodity changes even though there is no change in price.
b) Perfectly Inelastic Demand: A commodity is said to have perfectly inelastic demand, when even a large
change in price of the commodity causes no change in the quantity demanded. The elasticity coefficient of
perfectly in elastic demand is Ep = 0.
c) Relatively elastic demand: Demand changes more than proportionately to a change in price. i.e. a small
change in price leads to a very big change in the quantity demanded. In this case E > 1.
d) Relatively in-elastic demand: Quantity demanded changes less than proportional to a change in price. A
large change in price leads to small change in quantity demanded. Here E < 1
e) Unitary elasticity of demand: The change in demand is exactly equal to the change in price. When both
are equal, E=1 and elasticity is said to be unitary.

Income elasticity of demand:

Income elasticity of demand shows the change in quantity demanded as a result of a change in income.
Income elasticity of demand may be slated in the form of a formula.
Proportionate change in the quantity demand of commodity
EI = Income Elasticity = --------------------------------------------------------------------------
Proportionate change in the income of the people
Income elasticity of demand can be classified in to five types.
High-income elasticity of demand: In this case, an increase in come brings about a more than proportionate
increase in quantity demanded. Symbolically it can be written as EI > 1. This elasticity can be observed in the
case of non-necessarygoods such as TV, AC etc.
Income Demand
1000 1
2000 3

It shows high-income elasticity of demand. When income increases from Rs.1000 to Rs.2000, Quantity
demanded increases from 1 unit to 3 units.
Low-income elasticity of demand: When income increases quantity demanded also increases but less than
proportionately. In this case E < 1
The necessary goods such as rice, vegetables etc, have this type of elasticity.

Income Demand
1000 1
3000 2
An increase in income from Rs.1000 to Rs.3000, brings an increase in quantity demanded from 1 unit to 2
units, But the increase in quantity demanded is smaller than the increase in income. Hence, income elasticity
of demand is less than one.
Unitary income elasticity of demand: A commodity is said to possess unitary income elasticity of demand,
when the percentage change in the quantity demanded of a commodity and the percentage change in the
consumer‘s income are equal. The elasticity coefficient is equal to one. . EI = 1 and its demand curve is at an
angle of 450 as shown below.

Income Demand
1000 1
2000 2

When income increases from Rs. 1000 to Rs.2000, Quantity demanded also increases from 1 unit to 2 units.
Zero income elasticity of demand: Quantity demanded remains the same, even though money income
increases. Symbolically, it can be expressed as EI=0. Suppose, even our income increases, we don‘t purchase
medicines in larger quantity. It can be depicted in the following way:

Income Demand
1000 1
2000 1

As income increases from OY to OY1, quantity demanded never changes.

Negative Income elasticity of demand: When an increase in consumer‘s income causes a decrease in the
quantity demanded of a commodity and vice-versa, then the commodity is said to have negative income
elasticity of demand. Ex: Inferior goods or low quality goods have negative income elasticity because the
want to buy high quality goods as income increases. In this case, income elasticity of demand is negative. i.e.,
EI < 0.

Income Demand
1000 2
2000 1
When income increases from Rs. 1000 to Rs.2000, demand falls from 2 units to 1 unit.

Cross elasticity of Demand: A change in the price of one commodity leads to a change in
the quantity demanded of anothercommodity. This is called a cross elasticity of demand.
In case of substitutes, cross elasticity of demand is positive. Eg: Coffee a and Tea
When the price of coffee increases, Quantity demanded of tea increases. Both are substitutes.
In case of compliments, cross elasticity is negative. If an increase in the price of one
commodity leads to a decrease in the quantity demanded of anotherand vice versa. When
price of car goes up, the quantity demanded of petrol decreases. The cross- demanded curve
has negative slope.

Advertisement elasticity of demand: It refers to increase in the sakes revenue

because of change in the advertising expenditure. In other words, there is a direct relationship
between the amount of money spent on advertising and its impact on sales. Advertising
elasticity is always positive.
Proportionate change in the quantity demand of commodity
EA = Advertisement elasticity =
Proportionate change in advertisement costs

MEASUREMENT OF ELASTICITY OF DEMAND

Point Elasticity of Demand:

Point elasticity is the price elasticity of demand at a specific point on the demand curve
instead of over a range of it. A demand curve does not have the same elasticity throughout its
entire length. In general, elasticity differs at different points on a given demand curve. Point
elasticity does not hold good in the case of perfectly elastic and perfectly inelastic. In these
cases, the demand curves possess a single elasticity throughout its entire length.

The following graph simplifies the concept of point elasticity. To calculate point elasticity at
any point on the demand curve, the below equation is used. We take mid - point of the
demand curve as point C where elasticity is one. When we move to the right direction from
point C, elasticity of demand decreases i.e., E <1 and elasticity of demand increases i.e., E>1,
when we move to the left direction from the point C.

The elasticity at point C can be calculated as:

Ed = CE/CA = 40/40 = 1
Elasticity at point D can be calculated as under:
Ed = DE/DA = 20/60 = 0.33 ( E<1)
Elasticity at point B can be calculated as under:
Ed = BE/BA = 60/20 = 3 (E>1)
Elasticity at point A can be calculated as under:
Ed = AE/A = 80/0 = ∞
Elasticity at point E can be calculated as under:
Ed = E/EA = 0/80 = 0

Arc Elasticity or Mid–Point Method:

Arc elasticity of demand is the average elasticity over a segment of the demand curve. In
point elasticity, we find elasticity on straight line demand curve. We cannot always find a
demand curve in the form of straight line. A demand curve is not linear. So, how do we find
elasticity on such a curve?. What we do is that we have to identify two points, say point A
and point B and then draw a chord (a straight line joining two points on a curve) between
these two points. Join these two points with a straight line. What happens is we get a straight
line with arc (a part of a curve). Now, how do we find elasticity between these two points?.
We have a formula for that: The following graph presents the clear meaning of the arc
elasticity.

Price Demand
150 6
100 15

FACTORS AFFECTING ELASTICITY OF DEMAND

Elasticity of demand depends on many factors.

1. Nature of commodity: Elasticity or in-elasticity of demand depends on the nature of the
commodity i.e. whether a commodity is a necessity, comfort or luxury, normally; the demand
for Necessaries like salt, rice etc is inelastic. On the other band, the demand for comforts and
luxuries is elastic.
2. Availability of substitutes: Elasticity of demand depends on availability or non-
availability of substitutes. In case of commodities, which have substitutes, demand is elastic,
but in case of commodities, which have no substitutes, demand is in elastic.
3. Variety of uses: If a commodity can be used for several purposes, than it will have elastic
demand. i.e. electricity. On the other hand, demanded is inelastic for commodities, which can
be put to only one use.
4. Postponement of demand: If the consumption of a commodity can be postponed, than it
will have elastic demand. On the contrary, if the demand for a commodity cannot be
postpones, than demand is in elastic. The demand for rice or medicine cannot be postponed,
while the demand for Cycle or umbrella can be postponed.
5. Amount of money spent: Elasticity of demand depends on the amount of money spent on
the commodity. If the consumer spends a smaller amount on salt and matchboxes. Even when
price of salt or matchbox goes up, demanded will not fall. Therefore, demand is in case of
clothing a consumer spends a large proportion of his income and an increase in price will
reduce his demand for clothing. So the demand is elastic.
6. Time: Elasticity of demand varies with time. Generally, demand is inelastic during short
period and elastic during the long period. Demand is inelastic during short period because the
consumers do not have enough time to know about the change is price. Even if they are aware
of the price change, they may not immediately switch over to a new commodity, as they are
accustomed to the old commodity.
7. Range of Prices: Range of prices exerts an important influence on elasticity of demand. At
a very high price, demand is inelastic because a slight fall in price will not induce the people
buy more. Similarly at a low price also demand is inelastic. This is because at a low price all
those who want to buy the commodity would have bought it and a further fall in price will not
increase the demand. Therefore, elasticity is low at very him and very low prices.
SIGNIFICANCE/IMPORTANCE OF ELASTICITY OF DEMAND
The concept of elasticity is very useful to the producers and policy makers alike. It is very
valuable tool to decide the extent of increase or decrease in price for a desired change in the
quantity demanded for the products and services in the firm or the economy. The practical
importance of this concept will be clear from the following application.
1. Price fixation: A knowledge of elasticity of demand may help the businessman to make a
decision whether to cut or increase, the price of his product or to shift the burden of any
additional cost of production on to the consumers by charging high price. Each seller under
monopoly and imperfect competition has to take into account elasticity of demand while
fixing the price for his product. If the demand for the product is inelastic, he can fix a higher
price.
2. Production: The elasticity of demand helps the businessman to decide about production.
A businessman choose the optimum product mix on the basis of elasticity of demand for
various products. The products having more elastic demand are preferred by the
businessman. The sale of such products can be increased with a little reduction in their prices.
Hence, elasticity of demand helps the producers to take correct decision regarding the level
of output to be produced.
3. Prices of factors of production: A factor with an inelastic demand can always command a
higher price as compared to a factor relatively elastic demand. This helps the trade unions in
knowing that where they can easily get the wage rate increased. Bargaining capacity of trade
unions depend upon elasticity of demand for workers services. Elasticity of demand also
helps in the determination of rewards for factors of production. For example, if the demand
for labour is inelastic, trade unions will be successful in raising wages. It is applicable to
other factors of production.
4. International Trade: Elasticity of demand helps in finding out the terms of trade
between two countries. Terms of trade refers to the rate at which domestic commodity is
exchanged for foreign commodities. Terms of trade depends upon the elasticity of demand of
the two countries for each other goods. A country will benefit from international trade when
it fixes lower price for exports items whose demand is price elastic and high price for those
exports whose demand is inelastic. The demand for imports should be elastic for a fall in
price and inelastic for raise in price. The terms of trade between the two countries also
depends upon the elasticity of demand of exports and imports. If the demand is inelastic, the
terms of trade will be in favourof the seller country. If the demand is elastic, the terms of
trade will be in favour of the buyer country.
5. Tax policies: The government can impose higher taxes and collect more revenue if the
demand for the commodity on which a tax is to be levied is inelastic. On the other hand, in
case of a commodity with elastic demandhigh tax rates may fail to bring in the required
revenue for the government. Elasticity of demand helps the government in formulating tax
policies. For example, for imposing tax on a commodity, the Finance Minister has to take into
account the elasticity of demand.
6. Nationalization of public utilities: The nationalization of public utility services can also
be justified with the help of elasticity of demand. Demand for public utilities such as
electricity, water supply, post and telegraph, public transportation etc., is generally inelastic in
nature. If the operation of such utilities is left in the hands of private individuals, they may
exploit the consumers by charging high prices. Therefore, in the interest of general public, the
government owns and runs such services.
DEMAND FORECASTING

Forecasting is predicting or expecting the needs of the consumers in future. Forecasting the
demand for its products is the essential function for an organization irrespective of its nature.
Forecasting customer demand for products and services is a proactive process of determining
what products are needed, where, when and in what quantities. So, demand forecasting is a
customer focused activity. It supports other planning activities such as capacity planning,
inventory planning and even overall business planning. Many organizations follow it as a
custom to completely and accurately forecast the demand of its products regularly. Demand
forecasting is not helpful at the firm level but also at national level. The need for demand
forecasting arises due to the following purposes.
It serves as a road map for production plans.
It plays a significant role in situations of uncertain production or demand.
It facilitates the managers to line up their business activities.
It is a basis for export and import policy and fiscal policy.
It can help businessman to take decisions regarding inputs of production process such as
labor, capital etc.

CHARACTERISTICS OF GOOD DEMAND FORECASTING

1. It is in terms of specific quantities

2. It is undertaken in an uncertain atmosphere.
3. A forecast is made for a specific period of time which would be sufficient to take a
decision and put it into action.
4. It is based on historical information and the past data.
5. It tells us only the approximate demand for a product in the future.
6. It is based on certain assumptions.
7. It cannot be 100% precise as it deals with future expected demand
Demand forecasting is the activity of estimating the quantity of a product or service that
consumers will purchase. Demand forecasting involves techniques including both informal
methods, such as educated guesses, and quantitative methods, such as the use of historical
sales data or current data from test markets. Demand forecasting may be used in making
pricing decisions, in assessing future capacity requirements, or in making decisions on
whether to enter a new market.
STEPS IN DEMAND FORECASTING

1. Determining the objectives: The first step in this regard is to consider the objectives of
sales forecasting carefully.
2. Period of forecasting: Before taking up forecasting, the company has to decide the period
of forecasting — whether it is a short-term forecast or long-term research.
3. Scope of forecast: The next step is to decide the scope of forecasting— Whether it is for
the products, or for a particular area or total industry or at the national/international level.
4. Sub-dividing the task: Sub-dividing the task into homogeneous groups, according to
product, area, activities or consumers. The figure of sales forecasting shall be the sum total of
the sales forecasts of all the groups.
5. Identify the variables: The different variables or factors affecting the sales should be
identified so that due weight age may be given to those different factors.
6. Selecting the method: The Company, after taking into account all the relevant
information, purpose of forecasting and the degree of accuracy required, will select the
appropriate method of Sales Forecasting.
7. Collection and analysis of data: Necessary data for the forecast are collected, tabulated,
analyzed and crosschecked. The data are interpreted by applying the statistical or graphical
techniques, and then to draw necessary deductions there from.
 METHODS OF FORECASTING:

Several methods are employed for forecasting demand. All these methods can be grouped
under survey method, statistical method and other methods. Survey methods and statistical
methods are further subdivided in to different categories.
1. Survey Method:
a) Survey of buyers intention: To anticipate what buyers are likely to do under a given set
of circumstances, a most useful source of information would be the buyers themselves. It is
better to draw a list of potential buyers. Approach each buyer to ask how much does he plans
to buy of the given product at a given point of time under particular conditions.
b) Census method: If the company wishes to elicit the opinion of all the buyers, this method
is called census method. This method is not only time-consuming but also costly. Suppose
there are 10,000 buyers for a particular product. if the company gets the opinion of all these
ten thousand customers, this method is known as census method.
c) Sample method: If the company selects a group of buyers, who can represent the whole
population, this method is called the sample method. A survey of buyers based on sample
basis can be completed faster with relatively lower cost. Normally a questionnaire is
designed to elicit the information. There are specialized organizations to collect the
information from the potential buyers, ex: ORG-Marg. Etc.
d) Sales force opinions: The sales people are those who are in constant touch with the main
and large buyers of a particular market, and hence they constitute anther valid source of
information about the likely sales of a product. the sales force is capable of assessing the
likely reactions of the customers of their territories quickly, given the company‘s strategy. It
is less costly as the survey can be conducted instantaneously through telephone, fax or video-
conference, and so on. The data thus collected, forms another valid source of reliable
information.
II. Statistical Methods: Statistical methods are used for long run forecasting. Different
statistical and mathematical techniques are used to forecast demand. The following are the
different Statistical Methods:
Trend Projection Methods
1. Trend line by observation: This method of forecasting trend is elementary, easy and
quick as it involves merely the plotting theactual sales data on a chart and then estimating
just by observation where the trend line lies. The line can be extended towards a future period
and corresponding sales forecast read from the graph.
2. Least squares method: Here, certain statistical formulae are used to find the trend line
which best fits the available data. It is assumed that there is a proportional change in sales
over period of time. In such a case, the trend line equation is in linear form.
The estimating linear trend equation of sales is written as: S = x + y(T), where x and y have
been calculated form past data, S is sales and T is the year number for which the forecast is
made. To find the values of x and y, the following equations have to be used.
ΣS = Nx + yΣT
ΣST = xΣT + yΣT2

Where S is the sales; T is the year number, N= number of years.

3. Times series analysis: Time series forecasting is the use of a model to predict future
values based on previously observed values. The first step in making estimates for the future
consists of gathering information from the past. In this connection one usually deals with
statistical data which are collected, observed or recorded at successive intervals of time. Such
data are generally referred to as time series. Thus when we observe numerical data at different
points of time the set of observations is known as time series. It may be noted that any or all
of the components may be present in any particular series. The components are Secular
trend(Long term trend), Seasonal trend , Cyclical trend (periods in the business cycle such as
prosperity, decline, depression, improvement), Irregular trend(also called as erratic or
accidental or random variations in business). From the following equation future sales can be
measured. The constants T,S,C,I. are calculated from past data.
Y=T+S+ C+ I

4. Moving average method: This method considers that the average of past events determine
the future events. As the name itself suggests, under this method, the average keeps on
moving depending up on the number of years selected. This method is easy to compute.
5. Exponential Smoothing: It is the most popular technique used for short-run forecasts.
Unlike in moving average method, in this method, all time periods are given varying weights.
Recent values are given higher weights and distance past values are given lower values. The
reason is that the recent past reflects more in nearest future.
6. Barometric techniques: Under the barometric technique, one set of data is used to predict
another set. In other words, to forecast demand for a particular product or service, use some
other relevant indicator (which is known as barometer) of future demand. Ex: The demand for
cable TV may be linked to the number of new houses occupied in a given area or demand for
new houses in a particular area.
7. Regression method: In regression method, the demand function for a product is estimated
where demand is dependent variable and other variables that determine the demand are
independent variables. If only one variable (say, price) affects the demand, then it is called
single variable demand function. Thus, simple regression techniques are used. Simple
regression refers to studying the relationship between two variables where one is independent
and the other is dependent variable. If demand is affected by many variables, then multi-
regression techniques are used.
Other Methods
1. Experts Opinion: Well-informed persons are called experts. Experts constitute yet another
source of information. These persons are generally the outside experts and they do not have
any vested interests in the results of a particular survey.
2. Test Marketing: It is likely that opinions given by buyers, salesmen or other experts may
be, at times, misleading. This is the reason why most of the manufacturers favour to test their
product or service in a limited market as test-run before they launch their products
nationwide. Based on the results of test marketing, valuable lessons can be learnt on how
consumers react to the given product and necessary changes can beintroduced to gain
wider acceptability. To forecast the sales of a new product or the likely sales of an established
product in a new channel of distribution or territory, it is customary to find test marketing in
practice.
3. Controlled experiments: Controlled experiments refer to such exercises 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.
4. Judgment approach: When none of the above methods is directly related to the given
products or services, the management has no alternative other than using its own judgment.
SUPPLY

In economics, we have two forces: the producer, who makes things, and the consumer,
who buys them. Supply is the producer's willingness and ability to supply a given good at
various price points, holding all else constant. An increase in price will increase producers'
revenues, so they'll be willing to supply more; a decrease in price will reduce revenues, and
so producers will supply less.
Supply refers to the amount of commodity, which an individual producer is willing to sell at a
given price in a given period.
 LAW OF SUPPLY
Definition: Law of supply states that other factors remaining constant, price and quantity
supplied of a good are directly related to each other. In other words, when the price paid by
buyers for a good rises, then suppliers increase the supply of that good in the market.
In the Words of Dooley, ―The law of supply states that other things remaining the same,
higher the prices the greater the quantity supplied and lower the prices the smaller the
quantity supplied‖.
Assumption of the Law:
1. It is assumed that incomes of buyers and sellers remain constant.
2. It is assumed that the tastes and preferences of buyers and sellers remain constant.
3. Cost of all the factors of production is also assumed to be constant.
4. It is also assumed that the level of technology remains constant.
5. It is also assumed that the commodity is divisible.
6. Law of supply states only a static situation.

Description: Law of supply depicts the producer behavior at the time of changes in the prices
of goods and services. When the price of a good rises, the supplier increases the supply in
order to earn a profit because of higher prices.

Price (Rs) Quantity Supplied

2 0
4 3
6 6
8 9

The above diagram shows the supply curve that is upward sloping (positive relation between
the price and the quantity supplied). When the price of the good was at P4, suppliers were
supplying Q3 quantity. As the price starts rising, the quantity supplied also starts rising.

SUPPLY FUNCTION
The supply function is the mathematical expression of the relationship between supply
and those factors that affect the willingness and ability of a supplier to offer goods for

sale.

SX = Supply of goods X PX = Price of goods X

PF = Factor input employed (used) for production.

  Raw material
 Human resources
 Machinery
O = Factors outside economic sphere. T = Technology t = Taxes. S = Subsidies
There is a functional (direct) relationship between price and supply.

DETERMINANTS OF SUPPLY

1. Number of Sellers: Greater the number of sellers, greater will be the quantity of a product
or service supplied in a market and vice versa. Thus increase in number of sellers will
increase supply and shift the supply curve rightwards whereas decrease in number of sellers
will decrease the supply and shift the supply curve leftwards. For example, when more firms
enter an industry, the number of sellers increases thus increasing the supply.
2. Prices of Resources: Increase in resource prices increases the production costs thus
shrinking profits and vice versa. Sinceprofit is a major incentive for producers to supply
goods and services, increase in profits increases the supply and decrease in profits reduces the
supply. In other words supply is indirectly proportional to resource prices. Increase in
resource prices reduces the supply and the supply curve is shifted leftwards whereas decrease
in resource prices increases the supply and the supply curve is shifted rightwards.
3. Taxes and Subsidies: Taxes reduces profits, therefore increase in taxes reduce supply
whereas decrease in taxes increase supply. Subsidies reduce the burden of production costs
on suppliers, thus increasing the profits. Therefore increase in subsidies increase supply and
decrease in subsidies decrease supply.
4. Technology: Improvement in technology enables more efficient production of goods and
services. Thus reducing the production costs and increasing the profits. As a result supply is
increased and supply curve is shifted rightwards. Since technology in general rarely
deteriorates, therefore it is needless to say that deterioration of technology reduces supply.
5. Suppliers' Expectations: Change in expectations of suppliers about future price of a
product or service may affect their current supply. However, unlike other determinants of
supply, the effect of suppliers' expectations on supply is difficult to generalize. For example
when farmers suspect the future price of a crop to increase, they will withhold their
agricultural produce to benefit from higher price thus reducing the supply. In case of
manufacturers, when they expect the future price to increase, they will employ more
resources to increase their output and this may increase current supply as well.
6. Prices of Related Products: Firms which are able to manufacture related products (such
as air conditioners and refrigerators) will the shift their production to a product the price of
which increases substantially related to other related product(s) thus causing a reduction of
supply of the products which were produced before. For example, a firm which produces
cricket bats is usually able to manufacture hockey sticks as well. When the price of hockey
sticks increases, the firm will produce more hockey sticks and less cricket bats. As a result,
the supply of cricket bats will be reduced.
7. Prices of Joint Products: When two or more goods are produced in a joint process and the
price of any of the product increases, the supply of all the joint products will be increased and
vice versa. For example, increase in price of meat will increase the supply of leather.

Important Questions:
Essay / Long Answer Questions:

1 Explain the types of elasticity of demand.

2 Explain the demand-forecasting methods.
3 Explain significance of elasticity of demand.
4 Explain the factors affecting elasticity of demand.
5 What is law of demand? Explain the exceptions to law of demand.

Short Answer Questions:

1 Demand Function, Individual Demand, Household Demand.
2 Law of demand and exceptions
3 Elasticity of Demand
4 Giffen goods, Velben Goods
5 Determinants of Demand
6 Define demand forecasting.