UNIT – II

DEMAND FORECASTING
Demand theory:

Demand in common parlance means the desire for an object. But 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 means
the desire backed by the willingness to buy a commodity and the purchasing power to
pay.

Law of Demand:
Law of demand shows the relation 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 a rise in price”. A rise in the price of a commodity is followed by a
reduction in demand and a fall in price is followed by an increase in demand, if a condition
of demand remains constant.

The law of demand may be explained with the help of the following demand schedule.

Demand Schedule.

Price of Appel (In. Rs.) Quantity Demanded

10 1
8 2
6 3
4 4
2 5

When the price falls from Rs. 10 to 8 quantity demand increases from 1 to 2. In the same
way as price falls, quantity demand increases on the basis of the demand schedule we
can draw the demand curve.

1
 Price

The demand curve DD shows the inverse relation between price and quantity demand of
apple. It is downward sloping.

Assumptions:
Law is of demand is based on certain assumptions:

1. This is no change in consumers taste and preferences.

2. Income should remain constant.
3. Prices of other goods should not change.
4. There should be no substitute for the commodity
5. The commodity should not confer at any distinction
6. The demand for the commodity should be continuous
7. People should not expect any change in the price of the commodity

Exceptional demand curve:

Sometimes the demand curve slopes upwards from left to right. In this case the demand
curve has a positive slope.

2
 Price

When price increases from OP to Op1 quantity demanded also increases from to OQ1 and
vice versa. The reasons for exceptional demand curve are as follows.

1. Giffen paradox:

The Giffen good or inferior good is an exception to the law of demand. When the price of
an inferior good falls, the poor will buy less and vice versa. For example, when the price
of maize falls, the poor are willing to spend more on superior goods than on maize if the
price of maize increases, he has to increase the quantity of money spent on it. Otherwise
he will have to face starvation. Thus a fall in price is followed by reduction in quantity
demanded and vice versa. “Giffen” first explained this and therefore it is called as Giffen’s
paradox.

2. Veblen or Demonstration effect:

Veblen has explained the exceptional demand curve through his doctrine of conspicuous
consumption. Rich people buy certain good because it gives social distinction or prestige
for example diamonds are bought by the richer class for the prestige it possess. It the
price of diamonds falls poor also will buy is hence they will not give prestige. Therefore,
rich people may stop buying this commodity.

3. Ignorance:

Sometimes, the quality of the commodity is Judge by its price. Consumers think that the
product is superior if the price is high. As such they buy more at a higher price.

3
4. Speculative effect:

If the price of the commodity is increasing the consumers will buy more of it because of
the fear that it increase still further, Thus, an increase in price may not be accomplished
by a decrease in 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.

Demand forecasting:

The information about the future is essential for both new firms and those planning to
expand the scale of their production. Demand forecasting refers to an estimate of future
demand for the product. It is an ‘objective assessment of the future course of demand”.
In recent times, forecasting plays an important role in business decision-making. Demand
forecasting has an important influence on production planning. It is essential for a firm
to produce the required quantities at the right time.
It is essential to distinguish between forecasts of demand and forecasts of sales. Sales
forecast is important for estimating revenue cash requirements and expenses. Demand
forecasts relate to production, inventory control, timing, reliability of forecast etc.
However, there is not much difference between these two terms.

Types of demand forecasting:

Based on the time span and planning requirements of business firms, demand
forecasting can be classified in to 1. Short-term demand forecasting and 2. Long – term
demand forecasting.
1. Short-term demand forecasting:

Short-term demand forecasting is limited to short periods, usually for one year. It relates
to policies regarding sales, purchase, price and finances. It refers to existing production
capacity of the firm. Short-term forecasting is essential for formulating is essential for
formulating a suitable price policy. If the business people expect of rise in the prices of

4
raw materials of shortages, they may buy early. This price forecasting helps in sale policy
formulation. Production may be undertaken based on expected sales and not on actual
sales. Further, demand forecasting assists in financial forecasting also. Prior information
about production and sales is essential to provide additional funds on reasonable terms.

2. Long – term forecasting:

In long-term forecasting, the businessmen should now about the long-term demand for
the product. Planning of a new plant or expansion of an existing unit depends on long-
term demand. Similarly a multi-product firm must take into account the demand for
different items. When forecast are mode covering long periods, the probability of error is
high. It is very difficult to forecast the production, the trend of prices and the nature of
competition. Hence quality and competent forecasts are essential.

Prof. C. I. Savage and T.R. Small classify demand forecasting into time types. They are
1. Economic forecasting, 2. Industry forecasting, 3. Firm level forecasting. Economics
forecasting is concerned with the economics, while industrial level forecasting is used for
inter-industry comparisons and is being supplied by trade association or chamber of
commerce. Firm level forecasting relates to individual firm.

Objectives of demand forecasting:

a. objectives of short-term forecasting :

1) Appropriate product scheduling

2) Reducing costs of purchasing raw materials
3) Determining appropriate price policy
4) Setting sales targets and establishing controls and incentives
5) Evolving a suitable advertising and promotion programme
6) Forecasting short-term financial requirements

b. Objectives of long-term forecasting :

1) Planning of a new unit or expansion of an existing unit
2) Planning long –term financial requirements
3) Planning man power requirements

5
 Methods of forecasting:

Several methods are employed for forecasting demand. All these methods can be
grouped under survey methods and statistical method. Survey methods and statistical
methods are further subdivided in to different categories.

1. Survey Method or Polling method:

Under this method, information about the desires of the consumer and opinion of exports
are collected by interviewing them. Survey method can be divided into four type’s viz.,
Option survey method; expert opinion; Delphi method and consumers interview methods.
A. survey of buyer intentions method:
Under this method we elicit or collect information from buyers about a particular product
by asking questions about buyer experience regarding the products. Here we try to find
the positive and negative factors which influence buyer behaviour and his satisfaction
levels.
B. sales force opinion method
This method is also known as sales-force composite method (or) collective opinion
method. Under this method, the company asks its salesman to submit estimate of future
sales in their respective territories. Since the forecasts of the salesmen are biased due to
their optimistic or pessimistic attitude ignorance about economic developments etc. these
estimates are consolidated, reviewed and adjusted by the top executives. In case of wide
differences, an average is struck to make the forecasts realistic.

This method is more useful and appropriate because the salesmen are more knowledge.
They can be important source of information. They are cooperative. The implementation
within unbiased or their basic can be corrected.

C. Expert opinion method:

Apart from salesmen and consumers, distributors or outside experts may also e used for
forecasting. In the United States of America, the automobile companies get sales
estimates directly from their dealers. Firms in advanced countries make use of outside
experts for estimating future demand. Various public and private agencies all periodic
forecasts of short or long term business conditions.

D. Delphi Method:
A variant of the survey method is Delphi method. It is a sophisticated method to arrive
at a consensus. Under this method, a panel is selected to give suggestions to solve the
problems in hand. Both internal and external experts can be the members of the panel.
Panel members one kept apart from each other and express their views in an anonymous
manner. There is also a coordinator who acts as an intermediary among the panelists.

6
He prepares the questionnaire and sends it to the panelist. At the end of each round, he
prepares a summary report. On the basis of the summary report the panel members have
to give suggestions. This method has been used in the area of technological forecasting.
It has proved more popular in forecasting. It has provided more popular in forecasting
non-economic rather than economic variables.

E. Consumers interview method:

In this method the consumers are contacted personally to know about their plans and
preference regarding the consumption of the product. A list of all potential buyers would
be drawn and each buyer will be approached and asked how much he plans to buy the
listed product in future. He would be asked the proportion in which he intends to buy.
This method seems to be the most ideal method for forecasting demand.

2. Statistical Methods:
Statistical method is used for long run forecasting. In this method, statistical and
mathematical techniques are used to forecast demand. This method relies on post data.

a. Time series analysis or trend projection methods:

A well-established firm would have accumulated data. These data are analyzed to
determine the nature of existing trend. Then, this trend is projected in to the future and
the results are used as the basis for forecast. This is called as time series analysis. This
data can be presented either in a tabular form or a graph. In the time series post data of
sales are used to forecast future.

b. Barometric Technique:

Simple trend projections are not capable of forecasting turning paints. Under Barometric
method, present events are used to predict the directions of change in future. This is
done with the help of economics and statistical indicators. Those are (1) Construction
Contracts awarded for building materials (2) Personal income (3) Agricultural Income.
(4) Employment (5) Gross national income (6) Industrial Production (7) Bank Deposits
etc.

c. Regression and correlation method:

Regression and correlation are used for forecasting demand. Based on post data the
future data trend is forecasted. If the functional relationship is analyzed with the
independent variable it is simple correction. When there are several independent
variables it is multiple correlation. In correlation we analyze the nature of relation
between the variables while in regression; the extent of relation between the variables is

7
analyzed. The results are expressed in mathematical form. Therefore, it is called as
econometric model building. The main advantage of this method is that it provides the
values of the independent variables from within the model itself.

Criteria for good forecasting method:

1. Accuracy
2. Simplicity and ease of comprehension
3. Economy
4. Availability
5. Maintenance of timeliness

Forecasting demand for existing products

a) Identify and state the objectives of forecasting clearly

b) Select appropriate method of forecasting in the light of (a)
c) Identify the variables affecting the demand for the given product or service
d) Express these variables in appropriate forms
e) Collect the relevant data to represent the variables
f) Determine the most probable relationship between the dependent variable and
independent variable using the appropriate statistical techniques
g) Make appropriate assumptions to forecast and interpret results
h) Let there be alternative forecasts to make the forecasting exercise more
meaningful.

Forecasting demand for new Products:

Joel dean has suggested a number of possible approaches to the problems of forecasting
demand for new products.
1) Project the demand for the new product as on outgrowth of an existing old product.
2) Analyze the new product as substitute for some existing product or service
3) Estimate the rate of growth and the ultimate level of demand for the new product
on the basis of the pattern of growth of established products.
4) Estimate the demand by making direct enquiries from the ultimate purchasers
either by use of the samples or on a full scale
5) offer the new product for in in a sample market
6) Survey consumers’ reactions to new product in directly through the eyes of
specialized dealers.