BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

Unit I
Introduction - Meaning, nature and scope of Business Economics, Significance in decision making, Fundamental principles
Demand Analysis- Meaning of demand. Determinants of Demand, Law of demand, Types of demand- individual and market
demand curves & schedule, Elasticity of Demand - Meaning, types, measurement and significance, Demand forecasting meaning,
significance and methods.

ECONOMICS: INTRODUCTION
The word Economics is derived from the Greek words OKIOS NEMEIN meaning household management .Father of Economics
Adam Smith in his book Wealth of Nations 1776 defined economics is the study of wealth (Wealth Definition). Alfred Marshall
in his book Principles of Economic Science-1890 defined Economics is the study of mankind in the ordinary business of life
(Welfare Definition). Lionel Robbins gave us the most accepted scarcity-oriented definition of Economics. He says Economics is a
social science which studies human behavior as a relationship between unlimited wants and scarce means which have alternative
uses (Scarcity Definition). Economics Noble prize winner (1970) Paul Samuelson proposes a dynamic definition in his book
Economics (1948). Economics is the study of how people and society end up choosing with or without money to employ scarce
productive resources that could have alternative uses to produce various commodities and distribute them for consumption, now
or in the future among various persons and groups in society. Economic analysis is the cost and benefits of improving patterns of
resources use (Growth Definition).
MICRO- MACRO ECONOMICS:
Economic theory can be broadly divided into micro economics and macroeconomics. Economics noble prize winner (1969), Ragner
Frisch was the first to use the terms micro and macro in economics in 1933.
The terms micro and macro derived from Greek. Mikros means small and makros means large. In terms of economic study Micro
means individualistic and macro aggregative.
Micro Economics
Micro economics is the study of particular firms, households, individual prices and particular commodity. Micro economics is based
on the assumption of full employment and ceteris paribus (other things remain constant).
Macro economics
Macro economics is the study of economic system as a whole. Macro economics studies aggregates values like National Income,
National output, general price level, total consumption, saving and investment of a country.
An Example of a microeconomic issue could be the effects of raising wages within a business. If a large business raises its
wages by 10 percent across the board, what is the effect of this policy on the pricing of its products going to be?
Since the cost of producing products has increased, the price of these products for consumers is likely to follow suit. Likewise,
what will happen if a company raises wages for its most productive employees but fires its least productive workers? Likewise,
what will happen if a company raises wages for its most productive employees but fires its least productive workers?
An Example of Macroeconomic issue would be to observe the effects that low interest rates have on the national housing
market or the unemployment rate. Another common focus of macroeconomics is the way taxes affect the economics of a
nation. A macroeconomist would look at the effects of a decrease in income taxes using measures like GDP and national
income, rather than individual factors.

DEFINITION OF MANAGERIAL ECONOMICS

FEW DEFINITONS
Prof. Evan J Douglas - Managerial economics
is concerned with the application of economic
principles and methodologies to the decisionmaking process within the firm or
organization.

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Spencer and Siegleman defined managerial

Economics as the integration of economic
theory with business practice for the purpose
of facilitating decision making and forward
planning of management.
Pappas & Hirschey - Managerial economics
applies economic theory and methods to
business and administrative decision-making.
From the above definitions Nature of
Managerial economics can be traced easily.

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

NATURE OF BUSINESS/MANAGERIAL ECONOMICS

1. Managerial Economics is application oriented and uses the body of economic concepts and principles. Thus, we can say
managerial economics is Pragmatic (i.e. practical) in approach.
2. Managerial Economics is mainly used for managerial decision making and forward planning.
3. Managerial economics is deep rooted with micro-economics but it also uses macroeconomics concept also as both are equally
important for decision making and business analysis. Further, Managerial economics heavily depends on mathematical and
optimization techniques. Thus, we can say managerial economics is Eclectic (i.e. diverse).
4. Managerial Economics is more Normative (i.e. focuses on prescriptive statement and help establishing rule aimed at attaining
the specified goal of business) than Positive (i.e. describing the phenomenon). It is positive when it is confined to statements
about causes and effects and to functional relationships of economic variables. It is normative when it involves norms and
standards, mixing them with cause and effect analysis.
5. Managerial Economics is a Management Oriented Tool.

SCOPE OF BUSINESS/MANAGERIAL ECONOMICS

All the economic theories, tools, and concepts are covered under the scope of managerial economics to analyze the business
environment. Scope of managerial economics is widening day by day with its continuous development.
Demand analysis and forecasting, Production, Supply and Cost Analysis, Pricing policy, Profit Policy, and Capital Management
is the major areas considered under the scope of managerial economics.
Demand Analysis and Forecasting: A business firm is an economic organisation which transforms productive resources into goods
to be sold in the market. A major part of business decision making depends on accurate estimates of demand. Demand analysis
and forecasting provided the essential basis for business planning and occupies a strategic place in managerial economic. The
Demand Analysis and Forecasting mainly covers: Demand Determinants, Demand Distinctions and Demand Forecast.
Cost and Production Analysis: A study of economic costs, combined with the data drawn from the firms accounting records, can
yield significant cost estimates which are useful for management decisions. Production analysis frequently proceeds in physical
terms while cost analysis proceeds in monetary terms. The Cost and Production Analysis mainly covers : Cost concepts and
classification, Cost-output Relationships, Economics and Dis-economics of scale, Production function and Cost control.
Pricing Decisions, Policies and Practices: The success of a firm largely depends on how correctly the pricing decisions are taken.
The important aspects dealt with under pricing includes: Price Determination in Various Market Forms, Pricing Method,
Differential Pricing, Product-line Pricing and Price Forecasting.
Profit Management: In a world of uncertainty, expectations are not always realized so the profit planning and measurement
constitute a difficult area of managerial economic. The important aspects covered under this area are: Nature and Measurement
of profit, Profit policies and Technique of Profit Planning like Break-Even Analysis.

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Capital Management: Among the various types business problems, the most complex and troublesome for the business manager
are those relating to a firms capital investments. Capital management implies planning and control of capital expenditure. The
important aspects covered under this area are: Cost of capital Rate of Return and Selection of Projects.

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

MICRO, MACRO, AND MANAGERIAL ECONOMICS RELATIONSHIP

Microeconomics studies the actions of individual consumers and firms; managerial economics is an applied specialty of this
branch. Macroeconomics deals with the performance, structure, and behavior of an economy as a whole.
Managerial economics applies microeconomic theories and techniques to management decisions. It is more limited in scope as
compared to microeconomics.
Macroeconomists study aggregate indicators such as GDP, unemployment rates to understand the functions of the whole
economy. Macroeconomics models and their estimates are used by the government to assist in the development of economic
policy.
Microeconomics and managerial economics both encourage the use of quantitative methods to analyze economic data.
Managerial economic principles can aid management decisions in allocating these resources efficiently.
MACROECONOMICS
MANAGERIAL ECONOMICS
It is the study of economy as a whole and It is the study of application of economic
its aggregates.
theory for business decision making in
individual economic units of an economy
2. It deals with individual income,
It deals with aggregates like national
It deals with individual income, individual
individual prices and individual output, income, general price level and national prices and individual output, etc. wrt a
etc.
output, etc.
business firm
3. Its Central problem is price
Its central problem is determination of Its Central problem is optimum allocation
determination and allocation of resources.
level of income and employment.
of resources and decision making
4. Its main tools are demand and supply of Its main tools are aggregate demand and Its main tools are demand and supply as
a particular commodity/factor.
aggregate supply of economy as a whole.
well as production economies of a
particular commodity/factor.
5. It helps to solve the central problem of It helps to solve the central problem of full . It helps to solve the central problem of
what, how and for whom to produce in employment of resources in the economy. what, how, for whom and how much to
the economy
produce in the economy
6. It discusses how equilibrium of a
It is concerned with the determination of
It discusses how equilibrium of a
consumer, a producer or an industry is
equilibrium level of income and
consumer, a producer or an industry is
attained.
employment of the economy.
attained with holding firms objective.
7. Price is the main determinant of
Income is the major determinant of
Firms objective as well as prices is the
microeconomic problems.
macroeconomic problems.
main determinant of microeconomic
problems.
8. Examples are: individual income,
Examples are: National income, national Examples are: Pricing Decision, Make are
individual savings, price determination of savings, general price level, aggregate
Buy Decision, Decision on Production
a commodity, individual firm's output,
demand, aggregate supply, poverty,
Technique, Decision on Inventory Policies,
consumer's equilibrium.
unemployment etc.
Employment & Training Decision, Project
Selection Decision

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MICROECONOMICS
1. It is the study of individual economic
units of an economy

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

MANAGERIAL ECONOMICS & DECISION MAKING

Decision making is an integral part of modern management. Decision making is the process of selecting one action from two or
more alternative course of actions. Resources such as land, labour and capital are limited and can be employed in alternative uses,
so the question of choice arises. Managers of business organizations are constantly faced with wide variety of decisions in the
areas of pricing, product selection, cost control, asset management and plant expansion. Manager has to choose best among the
alternatives by which available resources are most efficiently used for achieving the desired aims.

The steps for decision making like problem description, objective determination, discovering alternatives, forecasting
consequences are described below:
Define the Problem
What is the problem and how does it influence managerial objectives are the main questions. Decisions are usually made in the
firms planning process. Managerial decisions are at times not very well defined and thus are sometimes source of a problem.
Determine the Objective
The goal of an organization or decision maker is very important. In practice, there may be many problems while setting the
objectives of a firm related to profit maximization and benefit cost analysis. Are the future benefits worth the present capital?
Should a firm make an investment for higher profits for over 8 to 10 years? These are the questions asked before determining the
objectives of a firm.
Discover the Alternatives
For a sound decision framework, there are many questions which are needed to be answered such as: What are the alternatives?
What factors are under the decision makers control? What variables constrain the choice of options? The manager needs to
carefully formulate all such questions in order to weigh the attractive alternatives.
Forecast the Consequences
Forecasting or predicting the consequences of each alternative should be considered. Conditions could change by applying each
alternative action so it is crucial to decide which alternative action to use when outcomes are uncertain.
Make a Choice
Once all the analysis and scrutinizing is completed, the preferred course of action is selected. This step of the process is said to
occupy the lions share in analysis. In this step, the objectives and outcomes are directly quantifiable. It all depends on how the
decision maker puts the problem, how he formalizes the objectives, considers the appropriate alternatives, and finds out the most
preferable course of action.

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Following are the important areas of decision making;

Selection of product.
Selection of suitable product mix.
Selection of method of production.
Product line decision.
Determination of price and quantity.
Decision on promotional strategy.
Optimum input combination.
Allocation of resources.
Replacement decision.
Make or buy decision.
Shut down decision.
Decision on export and import.
Location decision.
Capital budgeting.

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

FUNDAMENTAL CONCEPTS: SOME DEFINITIONS

POSITIVE & NORMATIVE APPROACH:
Positive Science is a systematic knowledge of a particular subject wherein we study the cause and effect of an event. In other
words, it explains the phenomenon as: What is, what was and what will be. Under the study of positive science, principles are
formulated and they are tested on the yardstick of truth. Forecasts are made on the basis of them.
From this point of view, managerial economics owns Positive Approach, as it has its own principles/theories/laws by which cause
and effect analysis of business events/activities is done, forecasts are made and their validities are also examined.
Normative Science studies things as they ought to be. Ethics, for example, is a normative science. The focus of study is What
should be. In other words, it involves value judgment or good and bad aspects of an event. Therefore, normative science is
perspective rather than descriptive.
On the basis of the above arguments and facts, it can be said that managerial economics is a blending of positive approach with
normative approach. It is positive when it is confined to statements about causes and effects and to functional relationships of
economic variables. It is normative when it involves norms and standards, mixing them with cause and effect analysis. Managerial
economics is not only a tool making, but also a tool using science. It not only studies facts of an economic problem, but also
suggests its optimum solution.
OPTIMIZATIONS:
Optimization is the process of finding an alternative with the most cost effective or highest achievable performance under the
given constraints, by maximizing desired factors and minimizing undesired ones. Optimization is very crucial activity in managerial
decision making process. According to the objective of the firm, the manager tries to make the most effective decision out of all
the alternatives available.

MARGINAL AND INCREMENTAL PRINCIPLE

Marginal analysis helps to assess the impact of a unit change in one variable on the other variable. The word marginal is used
for small changes say a unit change. According to marginal analysis, as long as marginal benefit of an activity is greater than its
marginal cost, it pays for an organization to continue increase the activity.
In contrast; incremental concept applies to changes in revenue and cost due to a policy change.
The incremental principle states that a decision is profitable when:
it increases revenue more than costs;
it decreases some costs to a greater extent than it increases others;
it increases some revenues more than it decreases others; and
it reduces costs more than revenues.
Suppose a firm gets an order that brings additional revenue of Rs 3,000. The cost of production from this order is:
Rs
Labour
800
Materials
1,300
Overheads
1,000
Selling and administration expenses
700
Full cost
3,800
At a glance, the order appears to be unprofitable.
But suppose the firm has some idle capacity that can be utilized to produce output for new order.
Then the incremental cost to accept the order will be:
Rs
Labour
600
Materials
1,000
Overheads
800
Total Incremental cost
2,400
Incremental reasoning shows that the firm would earn a net profit of Rs 600 (Rs 3,000 2,400), though initially it appeared to
result in a loss of Rs 800. The order should be accepted.
OPPORTUNITY COST PRINCIPAL
Opportunity Cost is the cost of a decision in terms of the next best alternative not chosen i.e. Opportunity cost refers to the value
forgone in order to make one particular investment instead of another. Opportunity cost comes into play in any decision that
involves a tradeoff between two or more options. This cost arises because most economic resources have more than one use.
For instance, Let's say you have $15,000 and your choice is to either buy shares of Company XYZ or leave the money in a FD that
earns 8% per year. If the Company XYZ stock returns 10%, you've benefited from your decision because the alternative would have
been less profitable. However, if Company XYZ returns 2% when you could have had % from the FD, then your opportunity cost is
(8% - 2% = 6%).

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The first step in optimization is to examine the methods to express economic relationship. Expression may be in the form of Table,
Graph, or by some Algebraic Expression. This Expression (Model) is then analyzed for optimization. We usually depend upon
mathematical concepts and operation research for optimization. In computer simulation (modeling) of business problems,
optimization is achieved usually by using linear programming techniques of operations research.

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

DEMAND: MEANING AND TYPES OF DEMAND

DEMAND: The demand for a commodity is the quantity of the good that is purchased over a specific of period of time at a certain
price.
The following five elements are inclusive in it:
1. Desire to acquire a commodity -willingness to have it,
2. Ability to pay for it-purchasing power to buy it,
3. Willingness to spend on it,
4. Given/particular price, and
5. Given/particular time period.
In demand first three elements i.e. desire to acquire the product, willingness to pay for it along with the ability to pay creates the
demand and last two elements i.e. price and time period decides the quantity of demand.
Types of Demand:
Individuals Demand and Market Demand
Firm and Industry Demand
Demand by Market Segments and by Total Market
Autonomous and Derived Demand
Domestic and industrial demand:
New and replacement demand
INDIVIDUALS DEMAND AND MARKET DEMAND:
Individual demand refers to demand of a commodity by an individual buyer.: Market demand is the summation of demand for a
good by all individual buyers in the market. For example, if the market of good x has, say only three buyers then individual and
market demand (monthly) could be:

A firm would be interested in the market demand for its products while each consumer would be concerned basically with only
his own individual demand.
FIRM AND INDUSTRY DEMAND:
Goods are produced by more than one firm and so there is a difference between the demand facing an individual firm and that
facing an industry. For example, demand for Fiat car alone is a firms demand and demand for all kinds of cars is industrys demand.
DEMAND BY MARKET SEGMENTS AND BY TOTAL MARKET:
Different market segment may have different price, profit margins, competition, seasonal patterns or cyclical sensitivity, then it
may be worthwhile to distinguish the market by specific segments for a meaningful analysis. In that case, the total demand would
mean the total demand for the product from all market segments while a particular market segment demand would refer to
demand for the product in that specific market segment.

DOMESTIC AND INDUSTRIAL DEMAND:

The distinction between domestic and industrial demand is very important from the pricing and distribution point of view of a
product. For instance, the price of water, electricity, coal etc. is deliberately kept low for domestic use as compared to their price
for industrial use.
NEW AND REPLACEMENT DEMAND:
New demand is meant for an addition to stock, while replacement demand is meant for maintaining the old stock of capital/asset
intact. The demand for spare parts of a machine is a good example of replacement demand, but the demand for new models of a
particular item [say computer or machine] is a fine example of new demand. Generally, new demand is of an autonomous type,
while the replacement demand is induced one-induced by the quantity and quality of existing stock. However, such distinction is
more of a degree than of kind.

By Pashupati Nath Verma

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AUTONOMOUS AND DERIVED DEMAND:

The goods whose demand is not tied with the demand for some other goods are said to have autonomous demand, while the rest
have derived demand. Thus, the demand for all producer goods is derived demands as they are needed to obtain consumer goods
or producer goods. Though, there is hardly anything whose demand is totally independent of any other demand. But the degree
of this dependence varies widely from product to product.

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

DETERMINANTS OF DEMAND
The demand for a good in a market depends on many factors. Some of the important factors are
1. Price of the good under consideration
2. Prices of Substitutes
3. Prices of Complements
4. Consumer Income level
5. Price Expectation
6. Consumer tastes and preferences
7. Advertising & Promotion
8. Socio economic and
9. Demographic factors
10. Climate
11. Government Policies
The impact of these determinants on Demand is:
1. Price effect on demand: Demand for a normal good x is inversely related to its own price (negative effect).
2. Substitution effect on demand: If y is a substitute of x, then as price of y increases, demand for x also increases (positive
effect).
3. Complementarity effect on demand: If z is a complementary of x, then as price of z increases, demand for x also decreases
(negative effect).
4. Income effect on demand: As income rises, consumers buy more of normal goods (positive effect) and less of inferior
goods (negative effect).
5. Price expectation effect on demand: Here the relation may not be definite as the psychology of the consumer comes into
play.
6. Consumer tastes and preferences effect: Taste, preference and habits of consumers may also have decisive influence on
the pattern of demand. Social customs, traditions and conventions are Socio psychological determinants of demand
these are non-economic and non-market factors.
7. Advertising & Promotional effect on demand: Advertisement has great influence on demand. It is in observed fact that
sales turnover of firms increases up to a point due to advertisement.
8. Socio-economic Factor effect: e.g accumulated wealth, band wagon effect also influence the demand.
9. Demographic Factors effect: Population composition also influences the demand.
10. Climate also influences the demand for different goods. For instance, the demand for coolers and A.C. Increases in
summers, while their demand declines in winters.
11. Government policy on taxes and subsidies also influences the demand of different goods differently. For instance, increase
in tax rates / imposition of new taxes reduces the demand, while increase in subsidies increases the demand.

DEMAND SCHEDULE AND DEMAND CURVE

DEMAND SCHEDULE: Demand schedule is a tabular statement showing how much of a commodity is demanded at different
prices, other factors remaining the same. In Demand Schedule prices placed in descending (or ascending) order and the
corresponding quantities which, consumers would like to buy per unit of time.

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DEMAND CURVE: A demand curve is a locus of points showing various alternative price quantity combinations. The demand
schedule can be converted into a demand curve by plotting curve between Price & Demand in which prices are kept on vertical
axis and quantity on horizontal axis. Demand curve slopes downwards (negatively).

WHY DOES THE DEMAND CURVE SLOPE DOWNWARDS (NEGATIVELY)

The demand curve slopes downwards mainly due to the law of diminishing marginal utility. The law of diminishing marginal utility,
states that an additional unit of a commodity gives a lesser satisfaction. Whenever price change, consumer starts to compare
utility of the commodity with money paid for it. Thus whenever price increases, commodity's utility goes down in comparison to
money paid for it, consumer starts buying less. Therefore, the consumer buys less at higher price and more at lower price.

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

CHANGES IN QUANTITY DEMANDED VERSUS CHANGES IN DEMAND

The changes in quantity demanded relates to the law of demand and referred as extension (Demand increase due to fall in price)
or contraction (Demand decrease due to rising price) of demand due to change in price of the commodity itself, but the changes
in demand (Shift in Demand) is related to increase or decrease in demand due to due to changes in non-price factors such as
income, taste & preference, price of related goods etc.
In case of the changes in quantity demanded it can be shown on original demand curve by moving upward or downward on the
curve itself. But, in case of change or shift in demand, whole demand curve shift to the left or right from its previous location.
CHANGES IN QUANTITY DEMANDED

CHANGE OR SHIFT IN DEMAND

Price
D

Contraction
of Demand

3
(A)

Price

Expansion of
Demand

Px

D1
D

1
10
O

20

30

QD

D1 Increase in dd
D2 decrease in dd.

D2

D
X

Q.D.

LAW OF DEMAND
Law of demand:Inverse Relation
between Price and Demand
10
8

Price

Law of Demand: Law of demand states that there is a negative or inverse

relationship between the price and quantity demanded of a commodity,
other things remaining constant.
Other things include other determinants of demand, viz., consumers
income, price of the substitutes and complements, taste and preferences of
the consumer, etc. But, these factors remain constant only in the short run.
In the long run they tend to change. The law of demand, therefore, holds
only in the short run. Law of demand is an empirical law, i.e., this law is
based on observed facts and can be verified with new empirical data.

6
4

EXCEPTIONS TO THE LAW OF DEMAND

Veblen Effect
Giffen Effect
Expectations regarding further prices
Speculative Demand
Veblen Effect:
Veblen has pointed out that there are some goods (known to be Veblen Goods after him) demanded by very rich people for their
social prestige. When price of such goods rise, their use becomes more attractive and their demand increases. Such goods are
termed as Veblen Goods. Examples of Veblen Goods are Luxury cars(Rolls-Royce phantom), apartments etc.
Giffen Effect:
Sir Robert Giffen discovered that when price of, an inferior good increases, income remaining the same, poor people cut the
consumption of the superior substitute so that they may buy more of the inferior good in order to meet their basic need. Such
Inferior goods is known as Giffen Goods. Example of Giffen Goods is potato in vegetables.
Expectations regarding further prices
If consumers expect a rise in the price of a storable commodity or durable goods, they would buy more of it at its current price
with a view to avoiding the pinch of price-rise in future.
Speculative Demand:
The law also does not hold true in case of speculative demand. Stock markets are the fine examples of speculative demand.

By Pashupati Nath Verma

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FACTORS BEHIND THE LAW OF DEMAND

2
Substitution Effect
Income Effect
0
Utility-Maximizing Behavior
0
200
400
600
800
Substitution Effect: Consumers substitute their demand from one
Demand
commodity to another related commodity in case of change in price of
original commodity.
Income Effect: Price changes also effects real income of the consumer, which in turns affect the demand for the commodity.
Utility-Maximizing Behavior: The utility-maximizing behavior of the consumer under the condition of diminishing marginal utility
is also responsible for increase in demand for a commodity when its price falls.

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

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SUMMARY

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

ELASTICITY OF DEMAND
The concept of elasticity of demand was introduced by Alfred Marshall. According to him the elasticity (or responsiveness) of
demand in a market is great or small according as the amount demanded increases much or little for a given fall in price, and
diminishes much or little for a given rise in price.
The law of demand explains that demand will change due to a change in the price of the commodity. But it does not explain the
rate at which demand changes to a change in price. The concept of elasticity of demand measures the rate of change in demand.
TYPES OF ELASTICITY OF DEMAND
Price elasticity of demand;
Income elasticity of demand; and
Cross-elasticity of demand
PRICE ELASTICITY OF DEMAND
Price elasticity of demand is generally defined as the responsiveness or sensitiveness of demand for a commodity to the changes
in its price. More precisely, elasticity of demand is the percentage changes in demand as a result of one per cent in the price of
the commodity.
Percentage Change in Quantity Demanded
Percentage Change in Price
Q / Q
Symbolically, e p
P / P

Price elasticity of demand

INCOME ELASTICITY OF DEMAND

Income elasticity of demand is the degree of responsiveness of demand to the change in income.

Percentage Change in Quantity Demanded

Percentage Change in Income
Q / Q
Symbolically, eY
Y / Y

Income elasticity of demand

CROSS-ELASTICITY OF DEMAND
The responsiveness of demand to changes in prices of related goods is called cross-elasticity of demand (related goods may be
substitutes or complementary goods). In other words, it is the responsiveness of demand for commodity x to the change in the
price of commodity y.

Percentage Change in Quantity Demanded of X

Percentage Change in Price of related Commodity Y
QX / QX
Symbolically, ec
PY / PY
Depending on how the demand changes, when price changes we can classify all demand curves in the following five categories:
Perfectly inelastic demand(ep=0)
Relatively Inelastic demand (ep<1)
Unitary elastic demand (ep=1)
Relatively Elastic demand (ep>1)
Perfectly elastic demand (ep=)
Cross - elasticity of demand

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What will be the implication of elasticity of demand on Total Revenue (TR)?

If ep=1 TR will not change with prices
If ep<1 TR will move in same direction with higher rate
If ep>1 TR will move in opposite direction at higher rate

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BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

FACTORS INFLUENCING ELASTICITY OF DEMAND

Nature of commodity - These who have no substitute goods will have an inelasticity of demand. The consumers will buy
almost a fixed demand whether the price is higher or lower. Demand for luxuries, on the other hand, is elastic in nature.
2. Different uses of the commodity- A commodity that has several kinds of uses is apt to be elastic in demand. For each single
use demand may be inelastic so that when price of the commodity goes down only a little more is purchased for every use.
3. Availability of substitute goods- When there exists a class substitute in the relevant price range, its demand will tend to be
elastic. But in respect of commodities having no substitutes, their demand will be the same inelastic.
4. Consumers income - Generally larger the income, the overall demand for commodities tends to be relatively inelastic. The
redistribution of income in favour of low income people may tend to make demand for some goods relatively inelastic.
5. Proportion of expenditure- Items that constitute a smaller amount of expenditure in a consumers family budget tend to
have a relatively inelastic demand, e.g., a person who watches a film every fort night is not likely to give it up when the ticket
rates are raised. But one who watches a film every alternate day perhaps may cut down his number of films. So is the case
with matches, sugar etc.
6. Durability of the commodity- In the case of durable goods, the demand generally tends to be inelastic in the short run, e.g.,
furniture, bicycle radio, etc. In the perishable commodities, on the other hand, demand is relatively elastic, e.g., milk ,
vegetables, etc.
7. Influence of habit and customs- There are certain articles which have a demand on account of conventions, customs or habit
and in these cases, elasticity is less, e.g., Mangal Sutra to a Hindu bride or cigarettes to a smoker have inelasticity of demand.
8. Complementary goods- Goods which are jointly demanded have less elasticity, e.g., ink, petrol have inelastic demand for
this reason.
9. Recurrence of demand- If the demand for a commodity is of a recurring nature, its price elasticity is higher than that of a
commodity which is purchased only once. For instance, bicycle, tape recorders, radios, etc. are purchased only once, hence
their price elasticity will be less. But the demand for cassettes or tape spools would be more price elastic.
10. Possibility of postponement- When the demand for a product can be postponed, it will tend to be price elastic. In the case
of consumption goods which are urgently and immediately required, their demand will be inelastic.
1.

IMPORTANCE OF ELASTICITY OF DEMAND

IMPORTANCE TO PRODUCER: A producer has to consider elasticity of demand before fixing the price of a commodity. The concept
of elasticity of demand also influences the determination of the rewards for factors of production in a private enterprise economy.
If the demand for labour on a particular industry is relatively inelastic, it will be easier for the trade union to get their wages raised.
The same remarks apply to other factors of production whose demands are relatively inelastic.
The concept of elasticity, also, provides a guideline to the producers for the amount to be spent on advertisement. If the demand
for a commodity is elastic, the producers shall have to spend large sums of money on advertisements for increasing the sales.
IMPORTANCE TO GOVERNMENT: If elasticity of demand of a product is low then government will impose heavy taxes on the
production of that commodity and vice versa. The concept of elasticity of demand also helps the government in fixing an
appropriate foreign rate of exchange for its domestic currency in relation to the currencies of other countries. Before deciding to
devalue or revalue domestic currency in relation to foreign currencies the government has to study carefully the elasticites of
demand for its imports and exports.
IMPORTANCE IN FOREIGN MARKET: If elasticity of demand of a produce is low in the international market then exporter can
charge higher price and earn more profit. It is possible to calculate the terms of trade between two countries only by taking into
account the mutual elasticities of demand for each others products.
The rate of foreign exchange is also considered on the elasticity of imports and exports of a country.
IMPORTANCE TO BUSINESSMEN: The concept of elasticity is of great importance to businessmen. When the demand of a good is
elastic, they increases sale by towering its price. In case the demand' is inelastic, they are then in a position to charge higher price
for a commodity.

Page13

IMPORTANCE TO TRADE UNION: The trade unions can raise the wages of the labor in an industry where the demand of the
product is relatively inelastic. On the other hand, if the demand, for product is relatively elastic, the trade unions cannot press for
higher wages.

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

MEASUREMENT OF PRICE ELASTICITY OF DEMAND

We may use two measures of elasticity:
(a) Arc elasticity, measures elasticity of demand between any two points on a demand curve. It is known as arc elasticity.
(b) Point elasticity, measures elasticity of demand for a marginal change at some specific point on demand curve.
Important methods for calculating price elasticity of demand are
1) Percentage Method
2) Graphical Method
3) Mathematical Method
4) Total outlay Method
5) Arc method
PERCENTAGE METHOD
Prof. Flux tries to measure the price elasticity of demand with the help of percentage. This is measured as the relative change in
demand divided by relative change in price (or) percentage change in demand divided by percentage change in price.
Formula is
Percentage Change in Quantity Demanded
Price elasticity of demand
Percentage Change in Price
%Q
Symbolically, e p
%P
Illustration1: Yesterday, the price of envelopes was $3 a box,
and Julie was willing to buy 10 boxes. Today, the price has gone
up to $3.75 a box, and Julie is now willing to buy 8 boxes. Is
Julie's demand for envelopes elastic or inelastic? What is Julie's
elasticity of demand?
Solution:
% Change in Quantity
(%Q) = (8-10)/(10)=-0.20=-20% or 20% (omit negative sign )
% Change in Price
(%P) = (3.75-3.00)/(3.00) = 0.25 = 25% .

Illustration2 : If Neil's elasticity of demand for hot dogs is

constantly 0.9, and he buys 4 hot dogs when the price is $1.50
per hot dog, how many will he buy when the price is $1.00 per
hot dog?
Solution:
In the case of John let the new demand is X, %Change in
Quantity = (X 4)/4.
% Change in Price = (1.00 - 1.50)/(1.50) = -33%
Therefore:
Elasticity = 0.9 =%Q/(%P=(X 4)/4/(33%)
0.9 =(X 4)/4)/(0.33)
((X - 4)/4) = 0.33/.9
(X - 4)/4=0.37
X-4=1.47
X=5.47

Elasticity (eP) =%Q/%P= (-20%)/(25%) = 0.8

Julie's elasticity of demand is inelastic, since it is less than 1.

GRAPHICAL OR POINT METHOD

We can calculate the price elasticity of demand at a point on a demand curve by drawing a tangent on that point extended to both
the axis. Formula to find out ep through point method is,

Length of Lowert Segment

of Tangent
Price elasticity of demand
Length of Upper Segment
of Tangent
Illustration3:In the adjacent case ep at point P will be given by

Price elasticity of demand

PM
PR

MATHEMATICAL METHOD
If we have given Demand function in the form of Q=f(P) then price elasticity will
be given by
dQ P

dP Q

Page14

ep

Illustration4: If the equation for an item is Q 18 10 p - 3p , determine the price elasticity of demand at p=1.
Solution: At p=1, Q=18+10-3=25,
Further, dQ/dp=-6P+10, thus putting the value Q=25, p=1 and dQ/dp=6p+10 we will get elasticity at p=1

ep

p
dQ P
6 p 10
(6 *1 10) *1/ 25 16 / 25
dP Q
Q p1,Q25
By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

TOTAL OUTLAY METHOD
Prof. Alfred Marshal tries to measure the price elasticity of demand with the help of total outlay method and he also says that e=1
and e=0 does not exist in practical life and e>1,e=1 & e<1 have practical approach. Under this method elasticity will be of three
types:I E> 1 elasticity of demand:- When there is inverse relation between price and total outlay it means that when price increases
total outlay decreases and vice versa , it is known as e>1 elasticity of demand ie elastic demand.
II E=1 elasticity of demand:- Even if price increases or decreases but total outlay is constant, then it is known as e=1 or a unit
elasticity of demand or unitary elastic.
III E<1 elasticity of demand:- When there is positive or direct relationship between price total outlay it means as the price
increase total outlay increase & vice versa is known as E<1 elasticity of demand or inelastic demand.
Illustration5:
Price Per Unit ($)
Quantity Demanded
Total Expenditure / Total Outlay
20
10 Pens
200.0
10
30 Pens
300.0
The figure shows that at price of $20 per pen, the quantity demanded is 10 pens, the total
expenditure OABC ($200). When the price falls down to $10, the quantity demanded of
pens is 30. The total expenditure is OEFG ($300).
Since OEFG is greater than OABC, it implies that change in quantity demanded is
proportionately more than the change in price. Hence the demand is elastic (more than
one) E > 1.
Price Per Pen ($)
Quantity Demanded
Total Expenditure/Total Outlay
10
30
300
5
60
300
The figure shows that at price of $10 per pen, the total expenditure is OABC ($300). At a
lower price of $5, the total expenditure is OEFG ($300).
Since OABC = OEFG, it implies that the change in quantity demanded is proportionately equal
to change in price. So the price elasticity of demand is equal to one, i.e., E = 1.

Price Per Pen ($)

5
2

Quantity Demanded
60
100

Total Expenditure /Total Outlay

300
200

ARC METHOD
When we measure elasticity between any two particular points of the demand curve, it is known
as ARC elasticity of demand. When there is a major change in price or in a demand then ARC
elasticity of demand method is appropriate for the economist .
Original Quantity - New Qunatity/Original Quantity New Qunatity
Price elasticity of demand
OriginalPrice - New Price/Original Price New Price
Q P1 P2
Symbolically, e p
X
P Q1 Q2
Where P1 & Q1 are price and quantity at first point (say, original price and quantity) and
P2 & Q2 are price and quantity at second point (say, new price and quantity)
Illustration6: Given the following Demand Schedule, price elasticity of demand between prices
9 to 11 will be calculated as follows:
Demand schedule
PRICE QUANTITY
9
164
10
160
11
156

ep

Q P1 P2 164 156 164 156 12 320

X

X
202.11 (Ignore Sign)
P Q1 Q2
9 10
9 10
1 19

By Pashupati Nath Verma

Page15

In the fig at a price of $5 per pen the quantity demanded is 50 pens. The total expenditure is
OABC ($300). At a lower price of $2, the quantity demanded is 100 pens.
The total expenditure is OEFG ($200). Since OEFG is smaller than OABC, this implies that the
change in quantity demanded is proportionately less than the change in price. Hence price
elasticity of demand is less than one or inelastic.

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

Example 1: You are given market data that says when the price of pizza is $4, the quantity demanded of pizza is 60 slices and the
quantity demanded of cheese bread is 100 pieces. When the price of pizza is $2, the quantity demanded of pizza is 80 slices and
the quantity demanded of cheese bread is 70 pieces. Can the Price-Elasticity of Demand be calculated for either good? If so,
calculate the PED.
Example 2: Consider the markets for widgets and cogs. You study survey data and observe that if widgets cost $5, then 100 widgets
are demanded. You also observe that if widgets cost $3, then 150 cogs are demanded and if widgets cost $4 then 100 cogs are
demanded. If cogs cost $2, then 125 cogs are demanded. Can the Price-Elasticity of Demand be calculated for either good? If
so, calculate the PED.
Example 3: Consider the market for widgets and cogs . You study survey data and observe that if widgets cost $5, then 100 widgets
are demanded and 60 cogs are demanded. You also observe that if widgets cost $3, then 200 widgets are demanded and 100 cogs
are demanded. If cogs cost $2, then 125 cogs are demanded. Can the Price-Elasticity of Demand be calculated for either good?
If so, calculate the PED.
Example4: Calculate the elasticity coefficient from the data above for the interval where price changes from 8 to 7. Where is the
range of unit price elasticity of demand for the following demand curve?
Price
8
7
6
5
4
3
Quantity
3
4
5
6
7
8

Example5: If the price of good X decreases by 2.1% and the price elasticity of demand is 0.4, find the percentage change in quantity
demanded and the percentage change in revenue. If you want to increase revenue should you increase or decrease the price in
this case?
Case Study: Problem: Highway Blues
Ratan Sethi opened a petrol-pump cum retail store on Delhi Agra Highway about two-hour drive from Delhi. His store sells typical
items needed by highway travelers like fast foods, cold drink, chocolates, hot coffee, childrens toys etc. He charges higher price
compared to the sellers in Delhi, yet he is able to maintain brisk sales particularly of Yours Special Pack (YSP) consisting of soft
drink in a disposable plastic bottle and a packer of light snacks. The Highway travellers prefer to stop at his store because, while
their cars wait for with some other item in the store). Each year he could substantially enhance his sales by providing Special
Summer Price on YSP which is almost half of its regular price.
Last year while returning from Delhi, Ratan found that a new, big and modern grocery shop has come up 15 kms from Delhi on
the National Highway. It has affected his sales but only marginally. But last month another large convenience store has opened
just 5 km away from his store. He knows that the challenge has come to his doorsteps and he expects to be adversely affected by
the existence of these two stores. He needs to meet this challenge and decides to use the pricing strategy which he has been
using quite effectively till recently. He now permanently reduces the price of YSP to half of its existing price. But at the end of the
year Ratan finds that his sales in general and of YSP in particular had declined by 20 percent.

Where has Ratan Sethi gone wrong?

Q2.

If he was a managerial economist, how do you think he would have handled the situation?

Page16

Q1.

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

DEMAND FORECASTING
Large numbers of firms produce for a future anticipated demand. Accurate demand forecasting is necessary in order to produce
right quantities at the right time and arrange well in advance for the various factors of production like raw materials, equipment,
machine accessories, labor and building. These forecasting based decisions will influence current level of production, which is
dependent upon anticipated future demand.
Demand forecasting reduces the uncertainties associated with business. A forecast is a prediction or estimation of a future event.
Accuracy of a forecast is determined by its nearness to the actual value in future.

NEED FOR FORECASTING

1. Long Range Strategic Planning for corporate objectives such as profit, market share, Return on Capital Employed (ROCE),
strategic acquisitions, international expansion, etc.
2. Annual Budgeting for operating plans such as annual sales, revenues, profits
3. Annual Sales Plans for regional and product specific targets.
4. Resource Needs Planning for HRM, Production, Financing, Marketing, etc
TYPE OF DEMAND FORECASTING
1.

LONG TERM DEMAND (forecast are related to the need for capacity expansion or reduction depending upon the demand in
the long run ie more than 5 years)

2.

MEDIUM TERM FORECAST (deals with business cycles that usually last for periods from two to five years.)

3.

SHORT TERM DEMAND (forecast is done for production schedules of less than one year; It is done to deal with annual
variations in sales).

APPROACHES TO FORECASTING

3.
4.

JUDGMENTAL APPROACHES: the forecast is based upon the judgment and expertise of experts.
EXPERIMENTAL APPROACHES: A demand experiment is conducted among a small group of consumers who are adequately
representative of characteristics of general population. This type of approach is adopted when the product being introduced
is new, and there is no pre-existing data available.
RELATIONAL CAUSAL APPROACHES: Interviews and other methods are used to determine the reasons why consumers
purchase a particular product. Once these reasons are clear, the forecast can be done.
TIME SERIES APPROACHES: Sales and other data for different markets, for different periods of time is analyzed to get a general
trend or pattern in sales.

Page17

1.
2.

By Pashupati Nath Verma

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

METHODS FOR DEMAND FORECASTING OF AN ESTABLISHED PRODUCT

Demand forecasting for an established product is easier than a new product as at least we have some historical data
in case of established product. Various techniques used in this case are discussed below in some detail.
The methods used may be divided broadly into two categories, qualitative and quantitative. Demand forecasting is full of
uncertainties due to changing conditions. Consumer behavior is unpredictable as it is motivated and influenced by a multiplicity
of forces. Every method developed for forecasting has its advantages and disadvantages and selection of the right method is
crucial to make as accurate as possible forecast. A right combination of quantitative and qualitative methods is to be used.

QUALITATIVE TECHNIQUES
Qualitative techniques are generally used when there is insufficient data available for quantitative analysis. They are also known
as subjective methods as they are dependent upon intuition based on experience, intelligence, and judgment. They are also
preferred for giving a quick estimate and cost savings.
Some of these techniques are as follows
OPINION POLE METHODS: As the name suggest, forecast in this method is subjected to opinion of respondent. Respondents
may be either of the Consumers or Sales-force or Experts. On the basis of respondent we can further classify this category as
follows:
1. Consumers Survey or Survey of Buyers Intention
2. Sales force opinion
3. Experts Opinion
CONSUMERS SURVEY OR SURVEY OF BUYERS INTENTION: Under this category consumers are surveyed (in personal or by phone
or by post or using internet) to know the consumers buying intention about the product during a specific time period. While
surveying, there are three main methods for the interviews.
Complete Enumeration method: All the Sample Survey Method: A sample of End use Method: Information about the
consumers of the product are consumers is interviewed.
end use of the product is collected from
interviewed and their future plans for Advantage: Low Cost
the industrial users to calculate the
product is ascertained.
Disadvantage: Requires expertise.
demand in industries, exports etc.
Advantage: First hand unbiased
Advantage: Useful in case of
information
intermediate product
Disadvantage: High Cost,
Disadvantage: Not useful in case of, too
many end uses
SALES FORCE OPINION METHODS: This method is based on gathering opinion of sales personnel who are closer to customers.
Method can be used to forecast competitive technologies that are emerging in the market.
Advantage: Low Cost, Fast, May be used for new product.
Disadvantage: Not useful for long range forecast, Correction and Adjustment factor needed.

Delphi Method is one of the formalized technique of Experts Opinion Method:

Delphi Method: A qualitative forecasting technique in which panel of experts working separately and not meeting, arrive at a
consensus through the summarizing of idea by a skilled coordinator. This is similar to jury opinion, but also incorporates a
structured process to minimize the undesirable aspects of group interactions and improve reliability and accuracy, It Reduces
group-think and it is effective method of long-range forecasting, Sometimes there may not be any consensus among experts
Procedure of Delphi Method:
1. Choose the experts to participate representing a variety of knowledgeable people in different areas
2. Through a questionnaire (or E-mail), obtain forecasts (and any premises or qualifications for the forecasts) from all
participants
3. Summarize the results and redistribute them to the participants along with appropriate new questions
4. Summarize again, refining forecasts and conditions, and again develop new questions
5. Repeat Step 4 as necessary and distribute the final results to all participants

By Pashupati Nath Verma

Page18

EXPERTS OPINION METHODS: This is a qualitative forecasting technique in which a panel of experts working together in a
meeting arrives at a consensus through discussion & ranking the ideas. Subjective estimates of experts are identified. Method
emphasize on group exercise. It involves key stakeholders: company executives, dealers, distributors, suppliers, marketing
consultants, professional association members.
Advantage: Easy and Quick method of forecasting
Disadvantage: Too much weight to executives opinions truth telling??

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

QUANTITATIVE TECHNIQUES
TREND PROJECTION: Time series analysis in statistics provides techniques by which all trend components, cyclic component &
Seasonal Component and their effects on demand are isolated and identified. Techniques used for measuring the trend are:
Graphical Method
Method of Semi-Averages
Method of Moving Averages
Method of Least Square
Annual Sales data is Entire set of historical data is In this method an averaging period By the method of least square a
plotted on paper and divided in to two parts. A is selected and forecast for the next functional relation between
trend line is drawn trend line is drawn through period is the arithmetic average of demand and its determinant is
through the points for the averages of the two halves the AP most recent actual developed by the use of this
making
for making forecast.
demands.
functional relation demand is
projection/forecast.
This technique is useful only in This technique is useful when there forecasted.
This method is simple case of linear trend
is a cyclic variation the demand. Functional relation by this
and less expensive.
Sometimes weighted MAs also method may be a polynomial or
used.
an exponential relation.
METHOD OF REGRESSION ANALYSIS: Regression analysis establishes a relationship between a dependent variable and one or
more independent variables. In simple linear regression analysis there is only one independent variable. Simple linear regression
can also be used when the independent variable X represents a variable other than time. Multiple regression analysis is used when
there are two or more independent variables.
An example of a multiple regression equation is:
Y = 50.0 + 0.05X1 + 0.10X2 0.03X3
where:
Y = firms annual sales ($millions)
X1 = industry sales ($millions)
X2 = regional per capita income ($thousands)
X3 = regional per capita debt ($thousands)

BOX JENKINS METHOD: Box Jenkins Method also known as ARIMA(Auto-Regressive Integrated Moving Average) models, this is
an empirically driven method of systematically identifying, estimating, analyzing and forecasting time series. This method is used
only for short term predictions since it is suitable only for demand with stationary time series sales data, i.e. the one that does not
reveal the long term trend.
The models are designated by the level of auto regression, integration and moving averages (P,d,q) where P is the order of
regression, d is the order of integration and q is the order of moving average.
There are 3 components of the ARIMA process:
AR(Autoregressive) process.
MA(Moving Average) process.
Integration process.
AR process: Of order p, generates current observations as a weighted average of the past observations over p periods,
together with a random disturbance in the current period.
Yt=+a1Yt-1+a2Yt-2+.+apYt-p+et

LEADING INDICATORS METHOD

If there are frequent turning points then trend method cannot explain the relationship fully between time and sales as there is
negative relationship sometimes, while at other it is positive. Therefore some other indictor is used which shows a similar variation
as the commodity. It can be GNP, personal income, bank rate, WPI, Industrial production, Employment Rate etc. There might be
some time lag or lead in case of these indictors affecting the demand of the product. After identifying the product, one may use
the regular least square approach to get the sales forecast. This is also known as barometric method as indicator is used as a
barometer to forecast the demand.

By Pashupati Nath Verma

Page19

MA process: Order q, each observation of Yt is generated by the weighted average of random disturbances over the past q
periods.
Yt= +et-c1et-1-c2et-2+.-cqet-q
Integrated Process: Ensures that the time series used in the analysis is stationary. The previous 2 equations are combined to
form:
Yt=a1Yt-1+a2Yt-2+...+apYt-p++et-c1et-1-c2et-2+-cqet-q

BBA104: ECONOMICS FOR MANAGERIAL DECISIONS: UNIT-I

METHODS FOR DEMAND FORECASTING OF AN NEW PRODUCT

Page20

To forecast demand for new products, we can use either of the following four methods:
1. Survey of Buyers Intention
2. Test Marketing
3. Life Cycle segment Analysis
4. Historical Analogy Method
5. Bounding curves Method
SURVEY OF BUYERS INTENTION: Discussed earlier.
LIFE CYCLE SEGMENT ANALYSIS: Sales curve of any commodity eventually turns out
to be S shaped. This is known as product life cycle. The first stage is Research and
Development, where product is market tested. No sales occur but a lot of
expenditure is incurred. In Introduction stage product is launched and commercial
exploitation and marketing begins. Sales grow in the next two stages of market
development and exploitation. Intensive advertising and sales promotion is done.
At this optimum level of resource utilization the firm gets maximum profit here. As
similar products by competitors flood the market, growth rate of sales decline in
the maturity stage. Price elasticity is very high, and in the later saturation stage
the high cross elasticity between different brands makes rate of sales growth zero.
Marketing becomes ineffective, but firms maintain quality, services etc to maintain
market share. Eventually this leads to the phase of decline the product life comes
to an end. In this method forecasting is done on the basis of stage of PLC it is running in the industry.
TEST MARKETING: It involves selecting a test area which can be regarded as true sample of total market. The product is launched
in that area in the same manner in which it is intended to be used when product is launched nationally. All marketing devices are
selected with this in mind. The sales data of the product in the test area is then used to forecast the demand for the product
nationally.
This method is costly and time consuming. Considerable energy and effort goes as all marketing devices are used for a small area.
Selection of an appropriate test area is also difficult. The test needs to be run for a long period of time, to be sure about the sales
data. Also differences in sociological and psychological characteristics need to be taken into account for this data. The launch if
product in a test area gives competitors to prepare for the imitation of the product or prepare their own strategies to deal with
the product.
HISTORICAL ANALOGY METHOD: This method is used for forecasting demand for a new product or an existing product when
introduced in a new area. When it is an existing product, then its sales data for a previous place (which has similar socio-economic
conditions as the place where the product is being introduced) is taken for studying and estimating the future demand. In such
cases one has to carefully account for sociological and psychological differences. Generally, places which are as similar as possible
are taken for studying. If the product has not been used anywhere, then the past consumption pattern of some other similar
product is taken as basis for forecasting the demand for the product.
The process is difficult as it is tough to find very similar locations, account for all the differences or find a similar product.

By Pashupati Nath Verma