Consumer Behavior

• We have already seen and used an individual’s

demand curve. Now, want to explain in more detail
why it slopes downward

• Why do people demand goods and services?

• Receive satisfaction or pleasure from consuming the good.
• Economists terms this satisfaction utility.
 Introduction
• In economics, we are not try to explain why people
get utility from certain goods. We take that as a
given.

• Example:
• Some people like jazz, others hate it.
• Economists say given an individual’s preferences about
jazz, how many jazz music CD’s might they purchase.
 Utility
The concept of utility can be looked upon from
two angles—from the commodity angle and
from the consumer’s angle. Looked at it from
a commodity angle, utility is the want-
satisfying property of a commodity. Looked at
it from a consumer’s angle, utility is the
psychological feeling of satisfaction, pleasure,
happiness or well-being which a consumer
derives from the consumption, possession or
the use of a commodity.
 Total Utility

Assuming that utility is measurable and additive,

total utility may be defined as the sum of the
utilities derived by a consumer from the various
units of goods and services he consumes.
Suppose a consumer consumes four units of a
commodity, X, at a time and derives utility as u1,
u2, u3 and u4. His total utility (TUx) from
commodity X can be measured as follows.
• TUx = u1 + u2 + u3 + u4
 Marginal Utility

Marginal utility is another most important concept used in

economic analysis. Marginal utility may be defined may be
defined as the addition to the total utility resulting from the
consumption (or accumulation) of one additional unit.
Marginal Utility (MU) thus refers to the change in the Total
Utility (i.e., ΔTU) obtainedobtained from the consumption
of an additional unit of a commodity. It may be expressed as
MU = ^TU/^Q
where TU = total utility, and ÄQ = change in quantity
consumed by one unit.
Another way of expressing marginal utility (MU), when the
number of units consumed is n, can be as follows.
MU of nth unit = TUn – TUn–1
 Total and Marginal Utility
• Total Utility (TU) - relates consumption of a good to
the utility derived from consuming a good. (This
could be many units of a good)

• Marginal Utility (MU) - the change in total utility

when consumption of a good changes by one unit.
• MU = DTU / D Q consumed of a good
 Diminishing marginal utility
The law of diminishing marginal utility is one of the
fundamental laws of economics. This law states that as
the quantity consumed of a commodity increases, the
utility derived from each successive unit decreases,
consumption of all other commodities remaining the
same. In simple words, when a person consumes more
and more units
of a commodity per unit of time, e.g., ice cream, keeping
the consumption of all other commodities constant,
the utility which he derives from the successive units of
consumption goes on diminishing. This law applies to
all kinds of consumer goods— durable and non-durable
sooner or later.
 Law of Diminishing Marginal Utility

• Law of Diminishing Marginal Utility -

eventually, a point is reached where the
marginal utility obtained by consuming
additional units of a good starts to decline,
ceteris paribus.
 Law of Diminishing Marginal Utility

• Example
• If I’m really hungry, I get a lot of satisfaction
from first slice of pizza.
• If I keep eating pizza, the satisfaction from the
8th slice would be much less than that of the
first slice.
 Law of Diminishing MU

Notes about the Law of Diminishing MU

• Time period must be specified for law.
• Law tells us that eventually the marginal utility
curve will be downward sloping.
• Law tells us that eventually the total utility curve
will become “flatter.”
• Slope of the total utility curve is equal to marginal
utility
 Marginal Utility

MU

MU
Q
 Shape of MU
• Eventually downward sloping
• Law of diminishing marginal utility

• Positive always
• Rational behavior
• Consumer only purchases a good if they get some
positive utility from it.
 Assumptions
The law of diminishing marginal utility holds only under certain conditions.
These conditions are referred to as the assumptions of the law. The
assumptions of the law of diminishing marginal utility are listed below.

First, the unit of the consumer good must be a standard one, e.g., a cup of
tea, a bottle of cold drink, a pair of shoes or trousers, etc. If the units are
excessively small or large, the law may not hold.
Second, the consumer’s taste or preference must remain the same during
the period of consumption.
Third, there must be continuity in consumption. Where a break in continuity
is necessary, the time interval between the consumption of two units
must be appropriately short.
Fourth, the mental condition of the consumer must remain normal during
the period of consumption.
Given these conditions, the law of diminishing marginal utility holds
universally
 Total Utility

TU

TU
DTU
DQ
DTU
DQ
Q
 Shape of TU
• Positive slope
• Consumer only purchases a good if gets some
positive amount of utility (rational behavior)

• Slope gets flatter as Q increases

• Law of diminishing marginal utility
 Consumer Equilibrium

Now that we understand the concepts of

utility theory - we will use them to explain
how consumers make decisions about what
to buy
 Consumer Equilibrium
• For instance, I would much rather have a Jaguar
instead of my Honda
• If I want to maximize my utility, why don’t I buy a
Jaguar?
– Because it costs a lot more than the Honda
• So if I want to maximize my utility, I don’t just pick
the thing that gives me the most pleasure. I have to
weigh the price of the good in my decision as well
 Consumer Equilibrium
So how can I compare a Jaguar and a Honda? It’s
like comparing apples and oranges. Instead, I
need to somehow make them both
comparable.
 Consumer Equilbrium
In order to do that I will need to convert utility
to utility per dollar. This way, I can see that
even though the Jag gives me more utility, I
get more utility per dollar from the Honda. So
if I want to spend my money wisely, I buy the
thing that gives me more utility per dollar.
 Consumer Surplus
• Consumer Surplus - the difference between the price
buyers pay for a good and the maximum amount
they would have paid for the good.

• Example:
• I’m willing to pay $6 for a case of soda
• Soda is on sale for $5 a case
• Consumer surplus = $1
 Consumer Surplus

This is the Consumer

P Surplus for the
second case of soda S
$9
$7
$5

D
0 Q
1 2 3
Consumer Surplus

Here is the generally

accepted method of finding the
total Consumer Surplus in
a market
 Consumer Surplus

The area of this

P triangle is the total
Consumer Surplus S

P*

D
0 Q
Q*
 The Theory of Consumer Behavior

The principle assumption upon which the

theory of consumer behavior and demand is
built is: a consumer attempts to allocate
his/her limited money income among
available goods and services so as to
maximize his/her utility (satisfaction).
 Theories of Consumer Choice

• The Cardinal Theory

– Utility is measurable in a cardinal sense
• The Ordinal Theory
– Utility is measurable in an ordinal sense
 The Cardinal Approach

Nineteenth century economists, such as

Jevons, Menger and Walras, assumed that
utility was measurable in a cardinal sense,
which means that the difference between two
measurement is itself numerically significant.
UX = f (X), UY = f (Y), …..
Utility is maximized when:
MUX / MUY = PX / PY
 The Ordinal Approach
Economists following the lead of Hicks,
Slutsky and Pareto believe that utility is
measurable in an ordinal sense--the utility
derived from consuming a good, such as X,
is a function of the quantities of X and Y
consumed by a consumer.
U = f ( X, Y )
 Assumptions of the Ordinal Utility
Approach

• Complete Ordering;
• More is Preferred to Less;
• Transitivity or Consistency;
• Substitutability or Continuity; and
• Optimality
 Tools of the Ordinal Approach

• The Budget Line

– Budget line illustrates the consumer’s income
constraint by showing all of the combinations of
quantities of X and Y that the consumer can buy.
• The Indifference Curves
– Indifference curves reveal consumer’s
preferences for X and Y by identifying the
combinations of X and Y which yield the same
level of total utility.
Indifference Curve Analysis
 Sophie’s Choice
• Sophie eats chocolate bars and drinks soda.
• She wants to maximize her utility given a
budget constraint.
 Graphing the Budget Constraint
• Chocolate bars cost $1 and sodas cost 50
cents each.
• Sophie has $10 to spend.
• She can buy 10 chocolate bars or 20 sodas or
some combination of each.
Graphing the Budget Constraint
 Graphing the Budget Constraint
• The slope of the budget constraint is the ratio
of the prices of the two goods.

n The slope changes when the prices

change.
 Graphing the Indifference Curve
• Indifference curve – a curve that shows
combinations of goods among which an
individual is indifferent.
• The slope of the indifference curve is the ratio
of marginal utilities of the two goods.
 Graphing the Indifference Curve
• The absolute value of the slope of an
indifference curve is called the marginal rate
of substitution.
 Graphing the Indifference Curve
• Marginal rate of substitution – the rate at
which one good must be added when the
other is taken away in order to keep the
individual indifferent between the two
combinations.
 Graphing the Indifference Curve
• Indifference curves are downward sloping and
bowed inward.
 Graphing the Indifference Curve
• Law of diminishing marginal rate of
substitution – as you get more and more of a
good, if some of that good is taken away, then
the marginal addition of another good you
need to keep you on your indifference curve
gets less and less.
Graphing the Indifference Curve
 A Group of Indifference Curves
• Sophie will have a whole group of indifference
curves, each representing a different level of
happiness.
 A Group of Indifference Curves
• If she prefers more to less, she is better off
with the indifference curve that is farthest to
the right.
A Group of Indifference Curves
Why Indifference Curves Cannot Cross
• If indifference curves crossed, it would violate
the “prefer-more-to-less” principle.
 Indifference Curves and Budget
Constraints
• Sophie will maximize her utility by consuming
on the highest indifference curve as possible,
given her budget constraint.
 Indifference Curves and Budget
Constraints
• The best combination is the point where the
indifference curve and the budget line are
tangent.
 Indifference Curves and Budget
Constraints
• The best combination is the point where the
slope of the budget line equals the slope of
the indifference curve.

PS MU S MU C MU S
 so that 
PC MU C PC PS
Indifference Curves and Budget
Constraints
 Deriving a Demand Curve from the
Indifference Curve
• Demand is the quantity of a good that a
person will buy at various prices.
 Deriving a Demand Curve from the
Indifference Curve
• The point of tangency of the indifference
curve and the budget line gives the quantity
that a person would buy at a given price.
 Deriving a Demand Curve from the
Indifference Curve
• By varying the price of one of the goods while
holding the price of other constant, the points
of tangency will change.

n This gives alternative price/quantity

combinations.
Deriving a Demand Curve from the
Indifference Curve
Characteristics of Indifference Curves

Indifference Curves are:

• Continuous and Everywhere Dense;
• Negatively Sloped;
• Convex from the Origin; and
• Indifference Curves Do Not Intersect.
 Preference Theory
The main merit of the revealed preference
theory is that the ‘law of demand’ can be
directly derived from the revealed preference
axioms without using indifference curves and
most of the restrictive assumptions.
What is needed is simply to record the observed
behaviour of the consumer in the market. The
consumer reveals his behaviour by the basket
of goods a consumer buys at different prices
 Assumptions
1. Rationality. The consumer is assumed to be a rational being. In his order of
preferences, the prefers a larger basket of goods to the smaller ones.
2. Transitivity. Consumer’s preferences are assumed to be transitive. That is,
given alternative baskets of goods, A, B and C, if he considers A > B and B > C,
then he considers A > C.
3. Consistency. It is also assumed that during the analysis consumer’s taste
remains constant and consistent. Consistency implies that if a consumer, given his
circumstances, prefers A to B he will not prefer B to A under the same
conditions.
4. Effective Price Inducement. Given the collection of goods, the consumer can
be induced to buy a particular collection by providing him sufficient price
incentives. That is, for each collection, there exists a price line which makes it
attractive for the consumer.
The Elasticity of Demand
 The Concept of Elasticity
• Elasticity is a measure of the responsiveness
of one variable to another.
• The greater the elasticity, the greater the
responsiveness.
 The Concept of Elasticity
• Elasticity is a measure of the responsiveness
of one variable to another.
• The greater the elasticity, the greater the
responsiveness.
 Price Elasticity
• The price elasticity of demand is the
percentage change in quantity demanded
divided by the percentage change in price.

Percentage change in quantity demanded

ED =
Percentage change in price
 Sign of Price Elasticity
• According to the law of demand, whenever
the price rises, the quantity demanded falls.
Thus the price elasticity of demand is always
negative.

• Because it is always negative, economists

usually state the value without the sign.
 What Information Price Elasticity
Provides
• Price elasticity of demand and supply gives
the exact quantity response to a change in
price.
 Classifying Demand and Supply as
Elastic or Inelastic
• Demand is elastic if the percentage change in
quantity is greater than the percentage
change in price.

E>1
 Classifying Demand and Supply as
Elastic or Inelastic
• Demand is inelastic if the percentage change
in quantity is less than the percentage change
in price.

E<1
 Elastic Demand
• Elastic Demand means that quantity changes
by a greater percentage than the percentage
change in price.
 Inelastic Demand
• Inelastic Demand means that quantity doesn't
change much with a change in price.
 Defining elasticities
• When price elasticity is between zero and -1
we say demand is inelastic.
• When price elasticity is between -1 and
- infinity, we say demand is elastic.
• When price elasticity is -1, we say demand is
unit elastic.
 Elasticity Is Independent of Units
• Percentages allow us to have a measure of
responsiveness that is independent of units.
• This makes comparisons of responsiveness of
different goods easier.
 Calculating Elasticities
• To determine elasticity divide the percentage
change in quantity by the percentage change
in price.
 The End-Point Problem
• The end-point problem – the percentage
change differs depending on whether you
view the change as a rise or a decline in price.
 Price Elasticity: Supply
• Price elasticity of supply is the percentage
change in quantity supplied divided by the
percentage change in
ES = % change in Quantity Supplied
% change in Price
• This tells us exactly how quantity supplied responds to a
change in price
• Elasticity is independent of units
 Price Elasticity: Supply
• Supply is elastic if the percentage change in
quantity is greater than the percentage
change in price
Elastic supply is when ES > 1
• Supply is inelastic if the percentage change in quantity is less
than the percentage change in price

Inelastic supply is when ES < 1

7-72
 Calculating Elasticity

Q 2  Q1
%DQ 2 (Q 1  Q 2 )
1
E 
%DP P2  P1
2 (P1  P2 )
1
Perfectly Inelastic Demand Curve

Perfectly inelastic
demand curve

0
Quantity
Perfectly Elastic Demand Curve

Perfectly elastic
demand curve

0
Quantity
 Demand Curve
Shapes and Elasticity
• Perfectly Elastic Demand Curve
– The demand curve is horizontal, any change in price can and
will cause consumers to change their consumption.

• Perfectly Inelastic Demand Curve

– The demand curve is vertical, the quantity demanded is totally
unresponsive to the price. Changes in price have no effect on
consumer demand.

• In between the two extreme shapes of demand curves are the

demand curves for most products.
 Demand Curve
Shapes and Elasticity
 Elasticity Along a Demand Curve
Ed = ∞
Elasticity declines along demand
$10 curve as we move toward the
9 quantity axis
8 Ed > 1
7
6 Ed = 1
Price

5
4
3 Ed < 1
2
1 Ed = 0
0 1 2 3 4 5 6 7 8 9 10 Quantity
The Price Elasticity of Demand Along a
Straight-line Demand Curve
 Substitution and Elasticity
• As a general rule, the more substitutes a good
has, the more elastic is its supply and demand.
 Substitution and Demand
• The less a good is a necessity, the more elastic
its demand curve.

• Necessities tend to have fewer substitutes

than do luxuries.
 Substitution and Demand
• Demand for goods that represent a large
proportion of one's budget are more elastic
than demand for goods that represent a small
proportion of one's budget.
 Substitution and Demand
• Goods that cost very little relative to your
total expenditures are not worth spending a
lot of time figuring out if there is a good
substitute.

• It is worth spending a lot of time looking for

substitutes for goods that take a large portion
of one’s income.
 Substitution and Demand
• The larger the time interval considered, or the
longer the run, the more elastic is the good’s
demand curve.
– There are more substitutes in the long run than in
the short run.
– The long run provides more options for change.
 Determinants of the
Price Elasticity of Demand
• The degree to which the price elasticity of
demand is inelastic or elastic depends on:
– How many substitutes there are
– How well a substitute can replace the good or
service under consideration
– The importance of the product in the consumer’s
total budget
– The time period under consideration
Price Change: Income and
Substitution Effects
 THE IMPACT OF A PRICE CHANGE
• Economists often separate the impact of a
price change into two components:
– the substitution effect; and
– the income effect.
 THE IMPACT OF A PRICE CHANGE
• The substitution effect involves the substitution of
good x1 for good x2 or vice-versa due to a change in
relative prices of the two goods.
• The income effect results from an increase or
decrease in the consumer’s real income or
purchasing power as a result of the price change.
• The sum of these two effects is called the price
effect.
 THE IMPACT OF A PRICE CHANGE
• The decomposition of the price effect into the
income and substitution effect can be done in
several ways
• There are two main methods:
(i) The Hicksian method; and
(ii) The Slutsky method
 THE HICKSIAN METHOD
• Sir John R.Hicks (1904-1989)
• Awarded the Nobel Laureate in Economics
(with Kenneth J. Arrrow) in 1972 for work
on general equilibrium theory and welfare
economics.
 THE HICKSIAN METHOD
Optimal bundle is Ea, on indifference curve I1.
X2

Ea

I1

xa
X1
 THE HICKSIAN METHOD
A fall in the price of X1
X2 The budget line pivots out from P

*
P

Ea

I1

xa
X1
 THE HICKSIAN METHOD
The new optimum is Eb on I2.
X2 The Total Price Effect is xa to xb

Eb
Ea I2

I1

xa xb
X1
 THE HICKSIAN METHOD
• To isolate the substitution effect we ask….
“what would the consumer’s optimal bundle be if
s/he faced the new lower price for X1 but
experienced no change in real income?”
• This amounts to returning the consumer to the
original indifference curve (I1)
 THE HICKSIAN METHOD
The new optimum is Eb on I2.
X2 The Total Price Effect is xa to xb

Eb
Ea I2

I1

xa xb
X1
 THE HICKSIAN METHOD
Draw a line parallel to the new budget line
X2 and tangent to the old indifference curve

Eb
Ea I2

I1

xa xb
X1
 THE HICKSIAN METHOD
The new optimum on I1 is at Ec. The movement
X2 from Ea to Ec (the increase in quantity
demanded from Xa to Xc) is solely in response
to a change in relative prices

Eb
Ea I2
Ec I1

xa xc xb
X1
 THE HICKSIAN METHOD
This is the substitution effect.
X2

Eb
Ea I2
Ec
I1

X1
Xa Substitution Effect Xc
 THE HICKSIAN METHOD
• To isolate the income effect …
• Look at the remainder of the total price effect
• This is due to a change in real income.
 THE HICKSIAN METHOD
The remainder of the total effect is due to a
change in real income. The increase in real
X2 income is evidenced by the movement from I1
to I2

Eb
Ea I2
Ec
I1

X1
Xc Income Effect
Xb
 THE HICKSIAN METHOD
X2

Eb
Ea I2
Ec
I1

xa xc xb
X1
Sub Effect
IncomeEff
ect
 THE SLUTSKY METHOD
• Eugene Slutsky (1880-1948)
• Russian economist expelled from the
University of Kiev for participating in
student revolts.
• In his 1915 paper, “On the theory of the
Budget of the Consumer” he introduced
“Slutsky Decomposition”.
 THE SLUTSKY METHOD
Optimal bundle is Ea, on indifference curve I1.
X2

Ea

I1

xa
X1
 THE SLUTSKY METHOD
A fall in the price of X1
X2 The budget line pivots out from P

*
P

Ea

I1

xa
X1
 THE SLUTSKY METHOD
The new optimum is Eb on I2.
X2 The Total Price Effect is xa to xb

Eb
Ea I2

I1

xa xb
X1
 THE SLUTSKY METHOD
• Slutsky claimed that if, at the new prices,
– less income is needed to buy the original bundle
then “real income” has increased
– more income is needed to buy the original
bundle then “real income” has decreased
• Slutsky isolated the change in demand due only to
the change in relative prices by asking “What is the
change in demand when the consumer’s income is
adjusted so that, at the new prices, s/he can just
afford to buy the original bundle?”
 THE SLUTSKY METHOD
• To isolate the substitution effect we adjust the
consumer’s money income so that s/he
change can just afford the original
consumption bundle.
• In other words we are holding purchasing
power constant.
 THE SLUTSKY METHOD
The new optimum is Eb on I2.
X2 The Total Price Effect is xa to xb

Eb
Ea I2

I1

xa xb
X1
 THE SLUTSKY METHOD
Draw a line parallel to the new
X2 budget line which passes through
the point Ea.

Eb
Ea I2

I1
xa xb
X1
 THE SLUTSKY METHOD
The new optimum on I3 is at Ec. The
movement from Ea to Ec is the
X2 substitution effect

Eb
Ea I2

Ec
I3

xa xc xb
X1
 THE SLUTSKY METHOD
The new optimum on I3 is at Ec. The
movement from Ea to Ec is the
X2 substitution effect

Eb
Ea I2

Ec
I3

xa xc
X1
Substitution Effect
 THE SLUTSKY METHOD
The remainder of the total price
effect is the Income Effect.
X2 The movement from Ec to Eb.

Eb
Ea I2

Ec
I3

xc xb
X1
Income Effect
THE SLUTSKY METHOD for NORMAL GOODS

• Most goods are normal (i.e. demand increases

with income).
• The substitution and income effects reinforce
each other when a normal good’s own price
changes.
THE SLUTSKY METHOD for NORMAL GOODS
The income and substitution effects
reinforce each other.
X2

Eb
Ea I2

Ec
I3
xa xc xb
X1
THE SLUTSKY METHOD for NORMAL GOODS

• Since both the substitution and income effects

increase demand when own-price falls, a
normal good’s ordinary demand curve slopes
downwards.
• The “Law” of Downward-Sloping Demand
therefore always applies to normal goods.
 GIFFEN GOODS
• In rare cases of extreme inferiority, the income
effect may be larger in size than the
substitution effect, causing quantity
demanded to rise as own price falls.
• Such goods are Giffen goods.
• Giffen goods are very inferior goods.
Demand forecasting
 Definition
 Is a process by which an individual or a firm predicts
future demand for product or products

 Accurate forecasting-enables these firms to produce

required quantities at the right time and arrange
well in advance for the various factors of production

 Better planning and allocation of national

resources.
 Factors Influencing DF
 How far ahead?

 Short term
 Long- term

 Should forecast be general or specific

 Problems and methods

 Classification of goods
- consumer
- durable
- consumer goods and services
 Factors
 Forecasting at different levels

– Macro

– Industrial

– Firm-level
 Purposes of forecasting

 Purposes of short-term forecasting

 Purposes of long –term forecasting

 Short-term forecasting
 Production scheduling

 Reducing cost of purchasing raw materials

 Determining appropriate price policy

 Setting sales targets and establishing controls and

incentives

 Evolving a suitable advertising and promotion programme

 Forecasting short-term financial

 Long-term forecasting

 Planning of a new unit or expansion of an existing

unit

 Planning of long-term financial requirements

 Planning of man-power requirements

 Criteria for a good forecasting
 Accuracy

 Plausibility

 Simplicity

 Economy

 Availability

 Durability
 Methods of demand forecasting
 Survey or buyer’s intention  Smoothing techniques

 Delphi method  Analysis of time series and

trend projections

 Expert opinion
 Use of economic indicators

 Collective opinion
 Controlled experiments

 Naïve models
 Judgmental approach
Survey or buyers method
 Direct method of estimating sales in the near future

 Asking customers what the buyer’s are planning to buy

Known as opinion survey

 The burden of forecasting goes to buyer

 Method is best when bulk of sales is made.

 Customers may misjudge or mislead or may be uncertain about

quantity

 Not useful in case of house old customers

 Does not measure and expose the variables under managements

control
 Methods of demand forecasting
 Survey methods
- experts opinion
- consumer survey
- complete enumeration
- sample survey
- end- use
- Delphi method
 Methods of demand forecasting
- market experimentation
- stimulated market method
- actual market method

 Statistical method
- trend analysis
- heading indicator analysis
- regression method
- simultaneous equation
 Survey Methods

 conducted by sales agencies

 a direct method of addressing people

 helps in gaining first hand information

 Expert’s opinion
 business firm prefers to depend on survey of
experts

 Experts are those who have the feel about the

product

 opinion poll is conducted among experts

 Sometimes this method is also called the “hunch

method”
 Advantages

 This method is very easy and less costly to carry

out.

 This method produces quick results

 When a firm intends to bring a new product, this

method is very useful to elicit the opinion of experts
on its marketing plans
 Disadvantage
 The experts must have wide knowledge and
experience otherwise their opinion may be
personal based on guess work.

 Experts opinion may be biased for a number of

reasons.
 Consumer survey
 interviewing the consumers directly to get
information about their purchase plans at a number
of possible prices over a particular period of time.

 information collected through questionnaire

 The data will have to be classified and tabulated for

systematic presentation and analysis.
 Complete enumeration method/
census method:
 All consumers of a product are contacted and they
are interviewed to know their probable demand for
the forecast period.

 This individual probable demand is added to

ascertain the demand forecast for the firm’s
product.

 For example there are N consumers, each

demanding commodity X, then the total demand
forecast would be EN * n. where n=1.
 Advantages
 This method simply records the data and
aggregates; it does not introduce any value
judgment of his own.

 The demand forecast through this method is

likely to be more accurate than many other
methods.
 Disadvantages

 It is time consuming and costly method

 There can be large number of errors in the data

collection, as it is a tedious and cumbersome
process.
 Sample survey
 Only few consumers are selected by using some
appropriate sampling technique.

 They are interviewed to ascertain their probable demands

for the product for the forecast period.

 Their average demand is then calculated.

 This average demand for the sample is multiplied by the

total number of consumers to obtain the aggregate
demand forecast for the product in question.
 Advantages

 It is a direct method of collecting data from

consumers. The information obtained is first hand,
it is more reliable.

 This method saves time, cost and energy. It is

economical, if information is collected by postal
questionnaire.
 Disadvantages
 There may be sampling error. The smaller the size of
the sample, the larger the sampling error.

 This method provides scope for errors. The

consumer may not understand the significance of
the questions asked, they may be dishonest,
reluctant or shy to reply or they may be either
vague or imaginary replies. This reduces the
usefulness of information collected.
 End-use Method
 the demand for a product is forecasted through a survey of
its users.

 A product may be used for final consumption by house old

sector and government and as an intermediate product by
different industries as well as may be exported and
imported.

 purposes can be obtained through a survey of all or

selected consumers, exporters and importers and
industries using it as an input thus the total demand
forecast can be obtained as the sum of the demand
forecast of all three components.
 Advantages
 It provides use-wise or sector-wise demand
forecasts.

 This method is used now as a standard tool in

economic analysis and are extensively used by
governmental and no-governmental agencies.
 Disadvantages
 This method assumes that technical structure of
production remains unchanged overtime, which is
not true. Because with economic development
technical innovations continue to take place and
lead to technological changes in the industrial
structure.

 This method needs extensive information on the

probable demands of the final goods sector. No
company how so ever large can hope to possess this
information.
 Delphi method

 In this method an attempt is made to arrive at a

consensus in an uncertain area by questioning a
group of experts repeatedly until some sort of
unanimity is arrived among all experts.

 These meetings help to narrow down different

views of experts.
 Advantages

 In this method it is possible to pose the problem to

experts directly

 It generates a reasonable opinion in place of

unstructured opinion.

 It is a cheap method, save time and resources.

 Disadvantages

 The success of this method depends upon wide

knowledge and experience of experts.

 It could be tedious and costly method if the experts

are not too large and are cooperative and forecaster
has the necessary funds and ability to perform the
task.
 Statistical method

 Time series data: Refers to data collected over a

period of time recording historical changes in
variables like price, income, etc. that influenced
demand for a commodity Time series analysis
relate to determination of change in variable in
relation to time.
 Statistical method
 Cross sectional :Is undertaken to determine the
effect of changes in variables like price, income, etc.
on demand for a commodity at a point of item. In
cross sectional analysis, different levels of sales
among different income groups may be compared
at a specific point of time and income elasticity is
then estimated on the basis of these differences.
 Statistical methods
 Trend analysis: A firm which has been in existence for a
long time will have accumulated data on sales pertaining
to different time periods.
 When such data is arranged, chronologically it is know as
“Time Series”.
 A typical time series has four components, trend, cyclical
fluctuations, seasonal variations and random or irregular
fluctuations.
 This method is highly subjective and considerably
depends on the bias of the person drawing the curve.
 The main advantage of this method is that it does not
require the formal knowledge of economic theory and the
market, it only needs the time series data.
 Regression method
 involves a study of the dependence of one variable
on the other variables.

 In demand forecasting demand is estimated with

the help of a regression equation where in demand
is the dependent variable and price, advertising
expenditure, consumer’s income, etc is the
independent variable.