UNIT – I

Syllabus:
Unit 1: Introduction to Managerial Economics
Definition, Nature and Scope of Managerial Economics– Relation of Managerial Economics
with other disciplines.
Demand Analysis: Demand Determinants, Law of Demand and its exceptions, Significance &
Types of Elasticity of Demand. Factors governing demand forecasting- Methods of Demand
forecasting.
Objective:
 To access the demand for a particular product.
 To make optimal business decisions by integrating the concepts of economics,
mathematics and statistics.
 To understand the economic goals of the firms and optimal decision making.
Learning Outcomes:
 Know the various factors that influence demand of particular product
 Forecast the future demand using various tools & Techniques
 Take the Further Decisions based on demand
Learning Material
Introduction
Managerial Economics as a subject gained popularity in USA after the publication of the book
“Managerial Economics” by Joel Dean in 1951.
Managerial Economics refers to the firm’s decision making process. It could be also interpreted
as “Economics of Management”. Managerial Economics is also called as “Industrial Economics”
or “Business Economics”.
Meaning & Definition:
In the words of E. F. Brigham and J. L. Pappas Managerial Economics is “the applications of
economics theory and methodology to business administration practice”.
Managerial Economics bridges the gap between traditional economics theory and real business
practices in two ways. First it provides a number of tools and techniques to enable the manager
to become more competent to take decisions in real and practical situations. Secondly it serves as
an integrating course to show the interaction between various areas in which the firm operates.
M. H. Spencer and Louis Siegelman explain the “Managerial Economics is the integration of
economic theory with business practice for the purpose of facilitating decision making and
forward planning by management”.
Nature of Managerial Economics
Managerial economics is, perhaps, the youngest of all the social sciences. Since it originates
from Economics, it has the basis features of economics, such as assuming that other things
remaining the same. This assumption is made to simplify the complexity of the managerial
phenomenon under study in a dynamic business environment so many things are changing
simultaneously. This set a limitation that we cannot really hold other things remaining the same.
In such a case, the observations made out of such a study will have a limited purpose or value.
Managerial economics also has inherited this problem from economics.
The other features of managerial economics are explained as below:
(a) Close to microeconomics: Managerial economics is concerned with finding the solutions
for different managerial problems of a particular firm. Thus, it is more close to
microeconomics.
(b) Operates against the backdrop of macroeconomics: The macroeconomics conditions of
the economy are also seen as limiting factors for the firm to operate. In other words, the
managerial economist has to be aware of the limits set by the macroeconomics conditions
such as government industrial policy, inflation and so on.
(c) Normative statements: A normative statement usually includes or implies the words
‘ought’ or ‘should’. They reflect people’s moral attitudes and are expressions of what a team
of people ought to do. For instance, it deals with statements such as ‘Government of India
should open up the economy. Such statement are based on value judgments and express
views of what is ‘good’ or ‘bad’, ‘right’ or ‘ wrong’.
(d) Prescriptive actions: Prescriptive action is goal oriented. Given a problem and the
objectives of the firm, it suggests the course of action from the available alternatives for
optimal solution. If does not merely mention the concept, it also explains whether the
concept can be applied in a given context on not.
(e) Applied in nature: ‘Models’ are built to reflect the real life complex business situations and
these models are of immense help to managers for decision-making. The different areas
where models are extensively used include inventory control, optimization, project
management etc. In managerial economics, we also employ case study methods to
conceptualize the problem, identify that alternative and determine the best course of action.
(f) Offers scope to evaluate each alternative: Managerial economics provides an opportunity
to evaluate each alternative in terms of its costs and revenue. The managerial economist can
decide which is the better alternative to maximize the profits for the firm.
(g) Interdisciplinary: The contents, tools and techniques of managerial economics are drawn
from different subjects such as economics, management, mathematics, statistics,
accountancy, psychology, organizational behavior, sociology and etc.
(h) Assumptions and limitations: Every concept and theory of managerial economics is based
on certain assumption and as such their validity is not universal. Where there is change in
assumptions, the theory may not hold good at all.
Scope of Managerial Economics:

THE MAIN AREAS OF MANAGERIAL ECONOMICS:

1. Demand decisions.
The analysis and forecasting of demand for a give product and service is the first task
of the managerial economist. The behavioural implications such as needs of the
customer’s responses to a given chance in the price or supply are analysed in a
scientific manner. The impact of changes in prices, income levels and prices of
alternative products/services are assessed and accordingly the decisions are taken to
maximize the profits. Demand at different price levels at different points of time is
forecast to plan the supply accordingly and initiate changes in price, if necessary to
enlarge the customer’s base and gain more profits.
2. Input-output decision
The costs of inputs in relation to output are studied to optimise the profits. Production
function and cost function are estimated given certain parameters. The behaviour of
cost at different levels of production is assessed here. Some costs are fixed, some are
semi variable. The quantity of production increases remains constant or decreases with
additional increase in the inputs. The decision deals with changes in the production
following changes in inputs which could be substitutes or complementary. The entire
focus of this decision is to optimise (maximise) the output at minimum cost.
3. Price-output decision
The production is ready and the task is to determine price these in different market
situations such as perfect market and imperfect markets ranging from monopoly,
monopolistic competition, duopoly and oligopoly.
The features of these markets and how price is determined in each of the
competitive situation is studied here. The pricing policies, methods, strategies and
practices constitute crucial part of the study of managerial economics.
4. Profit-related decision
We employ the techniques such as break even analysis, cost reduction and cost control
and ratio analysis to ascertain the level of profits. In break even analysis, we are
concerned with profit planning and control. We determine breakeven point beyond
which the firm starts getting profits. In other words, if the firm produces less than
breakeven point, it loses. We can also plan the production needed to attain a given level
of profits in the short-run. Cost reduction and cost control deal with the strategies to
reduce the wastage and thereby reduce the costs. These indirectly enhance the level of
profits.
5. Investment decision
Investment decisions are also called capital budgeting decisions. These involve
commitment of large funds, which determine the fate of the firm. These decisions are
irreversible. Hence the manager needs to be more attentive while committing his scarce
funds. Which have alternative uses. The allocation and utilisation of the investments is
paramount importance. Capital has a cost. It is expensive. Hence, it is to be utilised in
such a way as to maximise the return on the capital invested. It is necessary to study the
cost of capital, choice of capital structure and investment projects before the funds are
committed.
 6. Economic forecasting and forward planning.
Economic forecasting leads to forward planning. The firm operates in an environment
which is dominated by the external and internal factors. The external factors include
major forces such as government policy, competition, employment, labour, price and
income levels and so on. These influence its decisions relating to production, human
resources, finance and marketing. The internal factors include it policies and
procedures relating to finance, people, market and products. It is necessary to forecast
the trends in the economy to plan for the future in terms of investments, profits,
products and markets. This will minimise the risk and uncertainty about the future.
Managerial economics relationship with other disciplines:
Managerial Economies is closely linked with many other disciplines such as economics,
accountancy, mathematics, statistics, operations research, paychology and organisational
behaviour. let us see the linkages in detail
Economics: Managerial economics is the offshoot of economics and hence the concepts of
managerial economics are basically economic concepts. if economics deals with theoretical
concepts, managerial economics is the application of these in the real life. In the process of
addressing various managing problems, several empirically estimated functions such as demand
function, cost function, revenue function and so on are extensively used economics and
managerial economics, both are concerned with the problems of scarcity and resource allocation.
if the economist is concerned with study of markets, the managerial economist is interested in
studying the impact of such markets on the performance of a gives firm economics provides to
the managerial economist
 an understanding of general economic environment within which the firm operates
 a framework to solve the resource allocation problems
Operations Research: Decision making is the main focus in operations research and managerial
economics. If managerial economics focuses on "problems of decision making", operations
research focuses on solving the managerial problems. In other words, operations research is the
tool for finding the solutions for many a managerial problem. Model building is one area of
common exercise. It is used a establish economic and logical relationships among the given
variables. The operations research model such as linear programming, queuing, transportation,
optimization techniques and so on, are extensively used in solving the managerial problems.
Optimization is an interesting word. It refers to be minimization of costs and maximization of
revenues.
Mathematics: Managerial economist is concerned with estimating and predicting the relevant
economic factors for decision making and forward planning in this process, He extensively
makes use of the tools and techniques of mathematics such as algebra, calculus, exponentials,
vectors, input-out tables and such other. Mathematics facilitates derivation and exposition of
economic analysis.
Statistics: Statistics deals with different techniques useful to analyse the cause and effect
relationship in a given variable or phenomenon. It also empowers the manager to deal with the
situations of risk an uncertainty through its techniques such as probability. The business
environment for the managerial economist is full of risk and uncertainty and he extensively
makes use of the statistical techniques such a averages, measures of dispersion, correlation,
regression, time series, interpolation, probability, and s on. these techniques, enhance the
relevance of the conceptual base in managerial economics.
Accountancy: The accountant provides accounting information relating to costs, revenues,
receivables, payables, profits losses etc. and this forms the basis for the managerial economist to
act upon. This forms authentic source of data about the performance of the firm. The main
objective of accounting function is to record, classify and interpret the given accounting data.
The managerial economist pro-fusely depends upon accounting data for decision making and
forward planning.
Psychology: consumer psychology is the basis on which managerial economist acts upon. How
the customer reacts to a given change in price or supply and its consequential effect on demand
profits the main focus of study in managerial economics. We assume that the behaviour of the
consumer always rational, which in reality is not so. Psychology contributes towards
understanding the behavioural implications, attitudes and motivations of each of the
microeconomic variables such as consumer, supplier/seller, investor, worker or an employee.
Organisational Behavior: Organisational behaviour enables the managerial economist to study
and develop behavioural models of the firm integrating the manager's behaviour with that of the
owner. This further analyses the economic rationality of the firm in a focused way.
DEMAND ANALYSIS
Introduction & Meaning:
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.
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 Apple (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.
The demand curve DD shows the inverse relation between price and quantity demand of apple. It
is downward sloping.

Assumptions:
Law is 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.

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.
There are certain exceptions to this law. In other words, the law does not hold good in the
following cases:
1. Where there is a shortage of necessities feared: If the customers fear that there could be
shortage of necessities, then this law does not hold good. They may tend to buy more than what
they require imme diately, even if the price of the product increases.
2. Where the product is such that it confers distinction(Veblen goods):Products such as
jewels, diamonds and so on, confer distinction on the part of the user. In such a case, the
consumers tends to buy (to maintain their prestige) even though there is increase in its price.
Such products are called "veblen' goods
3. Giffens' paradox: People whose incomes are low purchase more of a commodity such as
broken rice, bread etc (which is their staple food) when its price rises. Conversely when its price
falls, instead of buying more, they buy less of this commodity and use the savings for the
purchase of better goods such as meat. This phenomenon is called Giffens' paradox and such
goods are called inferior or giffen goods.
4. In case of ignorance of price changes: At times, the customer may not keep track of changes
in price. In such a case, he tends to buy even if there is increase in price.
Factors Affecting Demand:
There are factors on which the demand for a commodity depends. 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.
The demand for a commodity or service depends upon a number of factors. These include
(a) Price of the commodity: The price of a given commodity is an important factor in
influencing its demand if the price is very high, only few persons can afford to buy it Hence, the
quantity of the commodity bought at this high price will be low is the commodity will have a
lower demand. On other hand, if the price is low, it will be within the reach of a large number of
people. Consequently, a greater amount of the commodity will be bought and the demand will be
high. Thus, the price for a commodity or service is an important determinant of the level of its
demand.
(b) Income of the consumer: Besides the price level, income of the consumer greatly
determines the demand for a commodity. If there is a change in the income of the consumer, then
it will reflect on the demand of the commodity he purchases A rise in his income will lead to
purchase more units of the commodity and vise versa Thus, the demand for the commodity goes
up or comes down with the increase or decrease in income of the consumer.
(c) Size and composition of the population: If there is a change in the population of a given
market, there will be a change in demand. Rise in the population will result in increase in
demand and fall will lead to decrease. The change in the composition of the population will also
effect the demand. Teenagers, middle-age, older, male-female ratio, play a vital role in deciding
demand of a product.
(d) Price of substitutes: In case of substitutes of a product, the change in the price of substitute
will affect the demand for the other product. For example, the rise in the price of tea will result in
increase of demand for coffee, and vice versa.
(e) Price of complementary goods: The changes in the price of a complementary good will
affect the demand for primary good. For example, the price of car will affect the demand for
petrol. The decrease in the price of car will result in increase in demand for petrol.
(f) Tastes and fashions: Changes in tastes and fashions of the society will affect the demand for
a product. If a product goes out off fashion, then its demand will come down.
(g) Advertisement and sales promotion: In today's world, advertisement has a major role in
demand creation for a product. Advertisement creates the awareness about product, so the
consumer will be influenced and the demand for the product goes up.
(h) Quality of the product: Any product with proven high quality will have a greater demand.
(i) Season and weather: Certain goods are seasonal in nature. They will be demanded only in a
particular season. Weather condition also creates demand for some products. For example
umbrellas in rainy season, cotton clothes in summer, cool drinks in hot days, etc. have seasonal
demand. Thus, season and weather also play a very important role in demand.
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.
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 three types of elasticity of demand:
1. Price elasticity of demand
2. Income elasticity of demand
3. Cross elasticity of demand
4. Advertising elasticity of demand
1. 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
quantity demanded to a percentage change in price.
Proportionate change in the quantity demand of commodity
Price elasticity = ------------------------------------------------------------------
Proportionate change in the price of commodity

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 or infinitely elastic demand. In this case E=∞

The demand curve DD1 is horizontal straight

line. It shows the at “OP” price any amount is
demand and if price increases, the consumer
will not purchase the commodity.

B. Perfectly Inelastic Demand

In this case, even a large change in price fails to
bring about a change in quantity demanded.
C. Relatively elastic demand:
Demand changes more than proportionately to a change
in price. i.e. a small change in price loads to a very big
change in the quantity demanded. In this case
E > 1. This demand curve will be flatter.

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 amount demanded. Here E < 1.
Demanded carve will be steeper.
E. Unit elasticity of demand:
The change in demand is exactly equal to the change in price. When both are equal E=1 and
elasticity if said to be unitary.
When price falls from ‘OP’ to ‘OP1’ quantity demanded
increases from ‘OP’ to ‘OP1’, quantity demanded increases
from ‘OQ’ to ‘OQ1’. Thus a change in price has resulted in
an equal change in quantity demanded so price elasticity of
demand is equal to unity.

2. 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
Income Elasticity = ------------------------------------------------------------------
Proportionate change in the income of the people

Income elasticity of demand can be classified in to five types.

A. Zero income elasticity:
Quantity demanded remains the same, even though money income increases. Symbolically, it
can be expressed as Ey=0. It can be depicted in the following way:

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

B. Negative Income elasticity:
When income increases, quantity demanded falls. In this case,
income elasticity of demand is negative. i.e., Ey < 0.
When income increases from OY to OY1, demand falls from
OQ to OQ1.
c. Unit income elasticity:
When an increase in income brings about a proportionate increase in quantity demanded, and
then income elasticity of demand is equal to one. Ey = 1

When income increases from OY to OY1, Quantity demanded also increases from OQ to OQ1.
d. Income elasticity greater than unity:
In this case, an increase in come brings about a more than proportionate increase in quantity
demanded. Symbolically it can be written as Ey > 1.

E. Income elasticity leas than unity: When income increases quantity demanded also increases
but less than proportionately. In this case E < 1.

3. Cross elasticity of Demand:

A change in the price of one commodity leads to a change in the quantity demanded of another
commodity. This is called a cross elasticity of demand. The formula for cross elasticity of
demand is:
Proportionate change in the quantity demand of commodity “X”
Cross elasticity = -----------------------------------------------------------------------
Proportionate change in the price of commodity “Y”

a. In case of substitutes, cross elasticity of demand is positive. Eg: Coffee and Tea
When the price of coffee increases, Quantity demanded of tea increases. Both are substitutes.
b. In case of compliments, cross elasticity is negative. If increase in the price of one commodity
leads to a decrease in the quantity demanded of another and vice versa.

c.

In case of unrelated commodities, cross elasticity of demanded is zero. A change in the price of
one commodity will not affect the quantity demanded of another.

4. Advertising Elasticity of demand:

The advertisement elasticity of demand is a degree of responsiveness of a change in the sales of a
product with respect to a proportionate change in advertisement expenditure.
Percentage Change in quantity demanded
EDA = —————————————————————–
Percentage Change in advertisement cost
EDA = (∆Q /∆A) X (Q/A)
Where,
∆Q=Q1 –Q
∆A = A1 – A
Q is the original quantity demanded
Q1 is the new quantity demanded
A is the original advertisement cost
A1 is the new advertisement cost
Factors influencing the elasticity of demand
Elasticity is governed by a number of factors. Change in any one of these factors is likely to
affect the elasticity of demand. The factors are
(a) Nature of product Based on their nature: The products and services are classified into
necessities comforts and luxuries. Necessaries imply the absolute or basic necessities such as
food, clothing, housing Comforts refer to TV refrigerator and so on. By luxuries, mean sofa sets,
marble flooring in house and such others. These necessaries, luxuries and comforts are changing
from person to person, time to time and place to place.
For example, a scooter may be a comfort or luxury for a student but when he does a part-time
job, it may be a necessity for him.
The name of product has a significant impact on the elasticity of demand. For instance, if there is
a increase in the price of rice, we still buy it because it is a necessity for us. This means that the
demands inelastic to price. Though there is an increase in price, we tend to buy the necessaries
such as petrol, diesel and so on. In other words, the demand does not fall because of increase in
price. From this, we can that the necessaries have inelastic demand. For comforts and luxuries,
the demand is relatively elastic means that any increase in the price of comforts or luxuries will
lead to moderate to significant fall in the demand.
(b) Time frame: The more the time suitable for this customer, the demand for a particular
product may be elastic and vice versa. Take the case of vegetables. When you do not have time,
you go to a nearby shop and buy whatever you want at the given price. Had you had little free
time, you would have preferred get the same from a vegetable market a lesser price.
(c) Degree of postponement: Where the product consumption can be postponed, the product is
said to have elastic demand and where it cannot be postponed, it is said to have inelastic demand.
The consumption of necessaries cannot be postponed and hence they have inelastic demand.
(d) Number of alternative uses: the numbers of alternative uses are more, the demand is said to
be highly inelastic and vice versa. Take the case of power or electricity. It is used for a number
of alternative uses such as running of machines in industries, offices, households, trains, and so
on.
(e) Tastes and preferences of the consumer: Where the customer is particular about his taste
and preferences, the product is said to be inelastic. For the customers who are particular or loyal
to certain brands such as Colgate, Tata Tea, Annapurna Atta, and so on, price increases do not
matter. They tend to buy that brand inspite of the price changes. I
(f) Availability of close substitutes: Where there are a good number of close substitutes, the
demand is said to be elastic and vice versa. For gold, there is no close and literal substitute and
hence the demand for gold is inelastic. If coffee and tea are equally good for me, if there is an
increase in price of coffee, I may tend to switch over to tea. But this may not hold good when I
am particular about coffee only. I may be prepared to pay higher price for coffee.
(g) In case of complementaries or joint goods: In case of complementaries or goods having
joint demand, the elasticity is comparatively low.
(h) Level of prices: If the price is very expensive (such as diamonds) or very cheap (such as
salt), then the product is likely to have an inelastic demand. If the price is too high, a fall in it
will not increase the demand much. Similarly, if the price is too low, a further fall in its price is
not likely to result in more demand. The demand of the relatively poor people is more sensitive
to price changes. In order to derive maximum satisfaction from their limited income, they try to
plan their purchases in response to changes in prices. The rich may not bother about price
changes.
(i) Availability of subsidies: Subsidy refers to money paid by a government or other public
authority in order to help a company financially or to make something cheaper for the public.
There is need for subsidies in case of goods with inelastic demand such as LPG, sugar, wheat
and so on.
(j) Expectation of prices: Where people expect a fall in the price the demand for the product is
likely to be inelastic.
(k) Durability of the product: Where the product is durable in case of consumer durables such
as TV, the demand is elastic. In the case of perishable goods such as milk, the demand is
inelastic.
(l) Government policy: Where the government policy is liberal, the product is likely to have
elastic demand and vice versa. Government, in the interest of the lower income group
consumers, closely monitors the prices of certain products (such as, ration goods as sold in fair
price shops are likely to have inelastic demand). Also, another example could be taxes.
Government can raise tax collections with a little reduction in the tax rates.
DEMAND FORECASTING
Demand forecasting is a technique that is used for the estimation of what can be the demand for
the upcoming product or services in the future.
METHODS OF DEMAND FORECASTING:
I. Survey method.
1) Survey of buyer’s intention.
A] Census method
B] Sample method.
2) Sales force opinion method.
II. Statistical methods
1) Trend projection method.
A] Trend line observation.
B] Least square method.
C] Time series analysis.
D] Moving average method.
E] Exponential smoothing.
2) Barometric techniques.
3) Simultaneous equations method.
4) Correlation & regression method.
III. Other methods
1) Expert opinion method
2) Test marketing.
3) Controlled experiments.
4) Judgmental approach.
I. Survey methods:-
1) Survey of buyer’s 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 all
potential buyers, approach each buyer to ask how much does her plans to buy of the given
product at a given point of time under particular conditions.
 This is the most effective method because the buyer is the ultimate decision maker and
we are collecting the information directly from him.
The survey of the buyers can be conducted either by covering the whole population or by
selecting a sample group of buyers.
Advantages of the survey methods:-
1. Where the product is new in the market for which no data exists previously.
2. When the buyers are few and they are accessible.
3. When the cost of reaching them is not significant.
4. When consumers stick to their intentions.
5. When they are willing to disclose what they are willing to do.
Disadvantages:-
1. Survey may be expensive.
2. Sample size and timing of survey.
3. Methods of sampling.
4. In consisted buying behavior.
2) Sales Force Opinions:-
Another source of getting reliable information about possible level of sales or demand for a
given product or services is the group of people who sell the same. Thus we can control the
limitation of cost and delays in contacting the costumers. The sales people are those who are in
constant touch with the main and large buyers of particular market. The sales force is capable of
assessing the likely reaction of the costumers in their territories quickly; giving the company’s
marketing strategy. It is less costly and can be conducted through telephones, fax, video
conferences and many more.
Here also there is a danger that salesmen may sometimes become biased with their views.
 The sales people are paid based on their results.
 Targets are set for the salesmen.
 The salary of the salesmen depends upon the targets.
 Incentives are paid to the salesmen who achieved the targets.
 Salespersons having more knowledge about the information of sources.
 Salesmen are cooperative.
 II. Statistical Methods:-
For forecasting the demand for goods and services in the long-run, statistical and mathematical
methods are used considering the past data.
(a)Trend projection methods:-
This is based on past sales patterns. The necessary information is already available in company
files with different time periods.
There are five main techniques:
1. Trend line by observation.
2. Least square method.
3. Time series analysis.
4. Moving average method.
5. Exponential smoothing.
(1)Trend line by observation:-
It is easy and quick as it involves plotting the actual sales data on a chart and then
estimating just by observation when the trend line lies.
(2) Least square method:-
In this statistical method is used. The trend line is the basis to extrapolate the line for
future demand for the given product or service on graph. Here it is assumed that there is a
proportional exchange in sales over a period of time. In such a case the trend line equation is in
linear form.
The estimated linear trend equation of sales is written as:
S = x + y (T)
x & y have been calculated from past data.
S = sales;
T = year no. for which the forecast is made.
To find x & y values,
Σ S = N x + yΣ T
Σ ST = x Σ T + yΣ (T * T)
S = sales;
T = year number
N = no. of years.
Example 1:

Year 1996 1998 2000 2002 2004

Sales (lakhs) 75 84 92 98 88

Estimate the sales for the years 2006 & 2008.

Sol:
Σ S = N x + yΣ T
Σ ST = x Σ T + yΣ (T * T )

Year Year no. (T) Sales (s) ST T*T

1996 1 75 75 1

1998 3 84 252 9

2000 5 92 460 25

2002 7 98 686 49

2004 9 88 792 81

ΣT = 25 ΣS=437 ΣST=2265 Σ(t*t)=165

Substituting the values in the formula,

437 = 5x + 25 y
2265 = 25x + 165 y
By solving these equations
x=77.4 & y=2;
Years 2006 & 2008 take on the year numbers 11 and 13 respectively.
By substituting the values in the trend equations x + y (T)
S 2002 = 77.4 + 2 (11)= 99.4 lakh units
S 20o4 = 77.4 + 2 (13)= 103.4 lakh units.
Thus the forecast sales for year 2004 & 2006 are 99.4 and 103.4 lakh units.
3) Time Series Analysis:-
Where the surveys or market tests are costly and time consuming, statistical and
mathematical analysis of past sales data offers another method to prepare the forecasts that is
time series analysis.
The product should have actively been traded in the market for quite sometime in the
past.
Considerable data on the performance of the product or service over significantly large
period should be available for better results under this method.
Time series emerge from a data when arranged chronologically, given significantly large
data.
The following 4 major components analyzed from time series while forecasting the demand.
a) Trend (T):
It also called as long term trend, is the result f basic developments in the population,
capital formation & technology. These developments relate to over a period of long time say 5 t0
10 years, not definitely over night. The trend is considered statistically significant when it has
reasonable degree of consistency. A significant trend is central and decisive factor considered
while preparing a long range forecast.
b) Cycle Trend (C):
It is wave like movement of sales inflation, during the period of inflation prices go up and
down.
c) Seasonal Trend (S):
More goods are sold in festivals seasons, weather factors, holidays.
d) Eratic Trend (E):
Results from the sporadic occurrence of strikes, riots etc.
4) MOVING AVERAGE METHOD:
This method considers that the average of past events determine the future events.
This method provides consistent results when the past events are consistent and
unaffected by wide changes.
The average keeps on moving depending upon the no. of years selected. Selection of no.
of years is the decisive factor in this method. Moving averages get updated as new information
flow in.
 This method is easy to compute. One major advantage with this method is that the old
data can be dispensed with once the averages are calculated. These averages, not original data,
are further used as the forecast for next period. It gives equal weightage to data both in the recent
past and the earlier one.
Example: - Compute 3-day moving average from the following daily sales data.

Date and month Daily sales (lakhs) 3-day moving average

Jan 1 40
Jan 2 44
Jan 3 48 44
Jan 4 45 45.7
Jan 5 53

Sol:-
To calculate 3-days moving avg…
S4 = (40 + 44 + 48)/ 3 == 44
S5 = (44 + 48 + 45)/3 == 45.7
5) EXPONENTIAL SMOOTHING:
This is a more popular technique used for short-run forecasts. This method is an
improvement over moving averages method.
All time periods ( ranging from the immediate part to distant part ) here are given varying
weights , that is the value of the given variable in the recent times are given higher weights and
the values of the given variable in the distant past are given relatively lower weights for further
processing.
The formula used for exponential smoothing,
S t + 1 == c S T + (1 -- C) S MT
S t + 1 == exponentially smoothed average for New Year.
S t == actual data in the most recent part.
S Mt == most recent smoothed forecast.
C = smoothing constant.
If the smoothing constant ` c ` is higher, higher weight is given to the most recent
information. The value of `c` varies between `0` and inclusive and the exact values of `c` is
determined by the magnitude of random variation. If the magnitude of random variations is large,
lower values of c are assigned and vice versa. However, it is considered that a value between 0.1
& 0.2 is more appropriate in most of cases.
6) BAROMETRIC TECHNIQUES:
Where forecasting based on time series analyses or extrapolation may not yield
significant results, barometric techniques can be made use of. Under the barometric technique,
one set of data is use to predict another set.
To forecast demand for a particular product or service, use some other relevant indicator which is
known as a barometer of future demand.
To assess the demand for services in India and abroad. We can see the percentage of
population in each occupation. In the US 78%of the labour force is employed in services 15% of
them in manufacturing. In India, according to 1991 census, 21%of work force is engaged in
services, 13%in manufacturing, and 67% in agriculture. The world over, an increase in
prosperity has been accomplished by an increase in demand for services.
7) SIMULTANEOUS EQUATION METHOD
In this method al variables are simultaneously considered, with the conviction that every
variable influences the other variable in an economic environment. Hence the set of eqns equal
the no. of dependent variable which is also called endogenous variables.
This method is more practical in the sense that it requires to estimate the future values of
only predetermined variables. it is difficult to compute where the no. of eqns is larger.
8) CORRELATION AND REGRESSION METHODS:
Correlation and regression methods are statistical techniques. Correlation describes the
degree of association between 2 variables such as sales and advertisement expenditure, when the
2 variables tend to change together then they are said to be correlated. The extent to which they
are correlated can be measured by correlation coefficient.
In regression analysis an equation is estimated which best fits in the sets of observations
of dependent variables and independent variables. The main advantage of this method is that it
provides the values of independent variables from within the model itself. Thus it frees the
forecaster from the difficulty of estimating them exogenously.
III. OTHER METHODS
1) EXPERT OPINION:
Well informed persons are called experts. Experts constitute yet another source of
information. These persons are generally the generally the outside experts and they do not have
any vested interests in the results of a particular survey.
Main advantages are:
1. Results of this method would be more reliable as the expert is unbiased, has no direct
commercial involvement in its primary activities.
2. Independent demand forecast can be made relatively quick and cheap.
3. This method constitutes a valid strategy particularly in the case of new products.
The main disadvantage is that an expert can’t be held accountable if his estimates are found
incorrect.
2) TEST MARKETING:
It is likely that opinions give in by buyers, sales man 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 matter as test-run before they launch their products nationwide.
Advantages:
1. Acceptability of the product can be judged in a limited market.
2. Before its too late, the corrections can be made to product design if necessary, thus
major catestrophy, in terms of failure, can be avoided.
3. The customer psychology is more focused in this method and the product and services
are aligned or redesigned accordingly to gain more customer acceptance.
Disadvantages:
1. It reveals the quality of product to the competitors before it is launched in his wider
market. The competitors may bring about a similar product or often misuse the results
of the test marketing against the given company.
2. It is not always easy to select a representative audience or market.
3. It may also be difficult to extrapolate the feedback received from such a test market,
particularly where the chosen market is not fully representative.
 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. This method cannot provide better results, unless these markets are
homogenous in terms of, tastes and preferences of customers, their income and soon.
This method is in infancy state and not much tried because of following reasons:
It is costly and time consuming. It involves elaborate process of studying different
markets and different permutations and combinations that push the product aggressively. If it
fails in one market, it may affect other markets also.
4) JUDGEMENT APPROACH:
When none of the above methods are directly related to the given product or service, the
management has no other alternative than using its own judgment. Even when the above
methods are used, the forecasting process is supplemented with the factor of judgment for the
following reasons:
1. Historical data for significantly long period is not available.
2. Turning points in terms of policies or procedures or casual factors cannot be precisely
demanded.
3. Sales fluctuations are wide and significant.