Managerial Economics

Section –A

1- (a)
Managerial Economics –

Managerial Economics is a branch of economics that studies application of principles of

economics to various business situations.

A Business organization is essentially a group of people who have come together for attaining
certain common objectives. These objectives are largely material in nature – eg. profits, salaries,
production for the purpose of consumption, etc. The behavior of this group of people is therefore
a subject matter of study for economics.

A Business Manager is responsible for leading this group of people in the direction of attainment
of the objectives. In this capacity she has to take several decisions during the course of her day-
to-day operations. An understanding and application of principles of economics would help the
Business Manager to take appropriate decisions under various situations.

Scope of Managerial Economics –

Principle of Economics can help a Manager in taking decisions in various business situations.
These can be summarized with the help of the following diagram –

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Business Decisions are primarily centered around Production and Sales. In addition to this, the
environment in which a business organization operates has an impact on the Business Decisions.
Various topics in Economic Theory help Business Managers in their functions.

(i) Sales, Marketing and Advertising – Sales, marketing and advertising related decision need
an in-depth understanding of the Consumer Behavior. We need to understand the reasons for
consumption, factors affecting consumption, constraints faced by the consumers, the decision-
making process of the consumer as regards price to be paid, quantity to be purchased, allocation
of resources between different needs, etc.

Theory of Demand helps in developing an understanding between Price and quantity demanded.

Price Elasticity helps us understand the ability and willingness to pay of different categories of
consumers. This also helps us in Market segmentation.

Cross Price Elasticity helps in identifying competitors which may not be essentially within the
same product category – eg. Should soft-drinks manufacturers be seen as competitors for Tea?

Theory of Consumer’s Equilibrium helps in understanding how a consumer allocates his

income between different needs.

Having understood the various factors that affect demand for a product and the decision-making
process of a consumer helps business managers in devising more effective sales, marketing and
advertising strategies.

(ii) Production – Production is perhaps the most important activity in a business organization.
A Business Manager has to take several decisions regarding production – eg. What to produce,
what should be the plant capacity, what should be the capacity utilization, which technology to
use, etc.

While organizing of production activity, Business Managers have to take several factors into
consideration, such as –

(a) Objective of the Firm – To begin with the firm has to decide its objective. A Firm could
have various objectives such as profit maximization, sales maximization, maximization of
market share, etc. Economics helps us to understand what impact these different objectives will
have on key variables such as Sales, Production, Prices, Costs, Profits, etc. Organization
Economics, a branch of economics helps us in understanding relationship between firm
objectives and internal dynamics of an organization.

(b) Profit Maximization – In traditional theory we examine a firm that has profit maximization
as its central objective. In order to maximize profits a firm has to minimize costs and maximize
its revenues. Thus, a deeper understanding of the Costs and Revenues is required for achieving
this objective.

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(c) Revenues – Revenues of a firm depend on the demand scenario and the competitive scenario
in the market. The understanding of the above two would be essential for a business manager to
predict the revenues that the business will be able to generate.

(d) Demand scenario – To decide on the plant capacity and capacity utilization, an
understanding of quantity demanded in the market in different time periods is important

(e) Market Structures – In addition to the quantity demanded, one has to understand the
competitive scenario. How many players are competing for the given market demand? What is
the market structure and how will it impact the firm’s own sales?

(f) Costs – In order to maximize profits, a firm needs to minimize costs. Costs are impacted by
several factors. Primary among them are quantity of production and factor prices.

(g) Technology – Technology has multi-dimensional impact on costs. On one hand technology
determines what combination of various factors is to be used – eg. capital-intensive technology
or labor intensive technology.

Technology also determines the levels of production possible – both in terms of optimum
capacity as also in terms of range of capacities at which a plant can operate. This in turn has an
impact on the costs. – eg. The most efficient level of operation of a certain plant may be at 1000
units per day (where cost of production is lowest). However, it would be possible to operate the
same plant within a range of 500 units per day to 1200 units per day (though may not be at same
levels of efficiencies – i.e. it may result in higher costs).

Thus while taking a decision to select technology for production; its impact on costs will have to
be kept in mind. Quite often the most advanced technology may not be the best choice in terms
of its impact on costs.

(h) Factor Pricing – Technology dictates a certain combination of factors that need to be used.
One has to check whether it would be affordable for business to employ those factors in the
given quantities. Often prohibitively high price of factors would dictate choice of technology.

Thus, while taking important decisions regarding the production activity, understanding of
Economics would be essential at every step.

(iii) Business Environment – Finally, businesses operate in a given social, political and
economic environment. There is a symbiotic relationship between the business and its
environment. A business organization, through its operations, causes an impact on the
surrounding socio-economic conditions. So also, the socio-economic environment prevailing in
the outer world has an impact on the business. From time to time, Business Managers are
required to foresee the changes in the outer world, analyze their likely impact on their business
and take necessary corrective actions. Events from the economic environment such as changes in
government policies, tax structures, trade regulations, changes in key variables such as interest
rates, inflation, etc., business cycles and growth projections are some of the important events that
directly or indirectly impact every business activity. Knowledge of macroeconomics is quite

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often required to be able to predict these events in the economy and understand the likely impact
of these changes on business.

Other Analytical Tools

Apart from these, economics equips the Business Manager with important analytical tools that
help him in performing his functions in the following aspects :

(iv) Fundamental Principles of Behavior – As pointed out earlier, a Business Manager deals
with a group of human beings plating different roles – eg. consumers, suppliers, share-holders,
workers, etc. Economics studies the fundamental motivating factors behind behavior of these
different economics agents. This knowledge would thus help the Business Manager in
influencing behavior of these economic agents in a manner that enables the business to achieve
its objectives.

(v) Decision Criterion – An important part of study of economics is to understand the decision
criterion of different economic agents such as consumers, firms, workers, etc. Economics aims at
arriving at a logical method of arriving at a decision given the objectives that the economic agent
has to achieve and the constraints within which she operates. This technique is helpful to a
Business Manager in taking the numerous decisions that she is required to take during the course
of her work.

(vi) Resource Allocation – The above techniques of decision-making studied in economics can
be used for taking a wide range of decisions including those regarding allocation of resources,
capital management, distribution and logistics, etc. – eg. If a decision has to be taken for
distributing a capital of Rs. 1 million between various used A, B and C, the technique of
Marginal Analysis tells us that the Capital should be distributed in such a manner that the
marginal returns from each use is equal.

(vii) Designing of Management Information Systems (MIS) – The decision criteria tells
what information would be required so as to enable us to take the right decision. One can use this
input in designing a proper MIS that is relevant and useful – eg. In the above case the MIS
should be designed to give the manager information about marginal returns. Instead, if the MIS
gives information about average and total returns, it would not help in the decision-making
process.

(viii) Economic v/s Accounting Decisions – Economics introduces us to certain differences

between good accounting decisions and good business decisions. It tells us how a result which
may seemingly be good and proper in accounts may, in-fact be a wrong business decision – eg. it
may not be taking into account opportunity costs or replacement costs.

(ix) Cost-Benefit Analysis – Economics helps Business Managers in enlarging their scope of
Cost-Benefit Analysis. Economics informs us that the C-B Analysis should not be looked at from
the narrow perspective of immediate increase in profitability to business. Along with this a more
comprehensive Social Cost-Benefit Analysis is also essential to understand the long-term
implications of business on the economy and the society. Such an understanding can also be

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leveraged to enhance the overall profitability of business – eg. Ability of business to generate
employment in the economy can be used as leverage in extracting tax concessions from the
government.

1- (b)

A person, group or organization that has interest or concern in an organization. Stakeholders

can affect or be affected by the organization's actions, objectives and policies. Some
examples of key stakeholders are creditors, directors, employees, government (and its
agencies), owners (shareholders), suppliers, unions, and the community from which the
business draws its resources. Not all stakeholders are equal. A company's customers are
entitled to fair trading practices but they are not entitled to the same consideration as the
company's employees. An example of a negative impact on stakeholders is when a company
needs to cut costs and plans a round of layoffs. This negatively affects the community of
workers in the area and therefore the local economy. Someone owning shares in an business
such as Microsoft is positively affected, for example, when the company releases a new
device and sees their profit and therefore stock price rise.

1- (c)

The law of demand does not apply in every case and situation. The circumstances when
the law of demand becomes ineffective are known as exceptions of the law. Some of these
important exceptions are as under.

1. Giffen goods:

Some special varieties of inferior goods are termed as Giffen goods. Cheaper varieties of this
category like bajra, cheaper vegetable like potato come under this category. Sir Robert Giffen or
Ireland first observed that people used to spend more their income on inferior goods like potato
and less of their income on meat. But potatoes constitute their staple food. When the price of
potato increased, after purchasing potato they did not have so many surpluses to buy meat. So the
rise in price of potato compelled people to buy more potato and thus raised the demand for
potato. This is against the law of demand. This is also known as Giffen paradox.

2. Conspicuous Consumption:

This exception to the law of demand is associated with the doctrine propounded by Thorsten
Veblen. A few goods like diamonds etc are purchased by the rich and wealthy sections of the
society. The prices of these goods are so high that they are beyond the reach of the common man.
The higher the price of the diamond the higher the prestige value of it. So when price of these
goods falls, the consumers think that the prestige value of these goods comes down. So quantity
demanded of these goods falls with fall in their price. So the law of demand does not hold good
here.

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3. Conspicuous necessities:

Certain things become the necessities of modern life. So we have to purchase them despite their
high price. The demand for T.V. sets, automobiles and refrigerators etc. has not gone down in
spite of the increase in their price. These things have become the symbol of status. So they are
purchased despite their rising price. These can be termed as “U” sector goods.

4. Ignorance:

A consumer’s ignorance is another factor that at times induces him to purchase more of the
commodity at a higher price. This is especially so when the consumer is haunted by the phobia
that a high-priced commodity is better in quality than a low-priced one.

5. Emergencies:

Emergencies like war, famine etc. negate the operation of the law of demand. At such times,
households behave in an abnormal way. Households accentuate scarcities and induce further
price rises by making increased purchases even at higher prices during such periods. During
depression, on the other hand, no fall in price is a sufficient inducement for consumers to
demand more.

6. Future changes in prices:

Households also act speculators. When the prices are rising households tend to purchase large
quantities of the commodity out of the apprehension that prices may still go up. When prices are
expected to fall further, they wait to buy goods in future at still lower prices. So quantity
demanded falls when prices are falling.

7. Change in fashion:

A change in fashion and tastes affects the market for a commodity. When a broad toe shoe
replaces a narrow toe, no amount of reduction in the price of the latter is sufficient to clear the
stocks. Broad toe on the other hand, will have more customers even though its price may be
going up. The law of demand becomes ineffective.

1- (d)

Economists can gain a lot of information about different types of goods based on how
consumer's demand for different goods increases or decreases in response to a change in the
consumer's income. For example, new car retailers may be interested in how the quantity
demanded for new cars in a specific area is changing. In a case like this, we can look at
consumer's income. If the area is growing, and incomes are increasing, we can assume that more
new cars will be demanded. On the other hand, if incomes are decreasing, we can anticipate that
more people will buy secondhand automobiles or take public transportation.

Of course, we have to remember that an increase in income does not increase the quantity

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demanded for all goods; BMWs are very different types of goods than Ramen Noodles.
Therefore, by looking at the income elasticity, we can measure the responsiveness of the quantity
demanded for a good due to a change in income. We can then classify the good as normal,
inferior, luxury, or necessity.

Income Elasticity measures the responsiveness of demand due to an increase or decrease in

consumer income.

E = change in quantity demanded

change in income

E = Income Elasticity of Demand

Example:

Suppose Frankie Lee's income rises 10% and his consumption of Titleist golf balls increases 5%.
Calculate the Income Elasticity as follows...

Income Elasticity of Demand = 5/10 = .5

Characterizing Income Elasticity

Normal Goods (E>0). These are goods whose consumption increases with an increase in
income.

- A good example of a normal good is the type of clothes you buy. While you are in college and
your income is low, you may shop at Wal-Mart for your clothing. However, after you complete
your degree, and you are making a lot of money as an economist, you are more likely to buy
more expensive clothes from retailers in a shopping mall. In other words, your consumption
increases as your income increases as you buy more expensive clothing.

Necessity (E<1). These are goods whose consumption increases an amount smaller than an
increase in income.

-An example of a necessity is drinking water. While you may upgrade to Dasani from Sam's
Choice with an increase in income, however, it is unlikely that your consumption of water will
increase an amount more than your increase income. For instance, if your income were to
increase by 25 percent, you will probably not consume 25 percent more drinking water.

Luxury Good (E>1). These are goods whose consumption increases an amount larger than an
increase in income.

-An example of a luxury good is a round of golf. With low income, your consumption of rounds

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of golf will likely be zero. However, once your income rises enough to afford to play, your
increase in rounds of golf will probably be higher than the increase in income. In other words,
once you make enough money to play the first round of golf, your increase in round of golf
consumption will be 100 percent while the increase in income may have only been 15 percent.

Inferior Good (E<0). These are goods whose consumption decreases with an increase in
income.

- A classic example of an inferior good is Ramen Noodles. The idea here is that you will
consume fewer Ramen Noodles as your income increases. For example, after you graduate from
college, you may have higher quality (more expensive) Chinese takeout instead of Ramen
Noodles for some of those quick, late night, meals.

1(e)-

A benefit, profit, or value of something that must be given up to acquire or achieve

something else. Since every resource (land, money, time, etc.) can be put to alternative uses,
every action, choice, or decision has an associated opportunity cost.Opportunity costs are
fundamental costs in economics, and are used in computing cost benefit analysis of a project.
Such costs, however, are not recorded in the account books but are recognized in decision
making by computing the cash outlays and their resulting profit or loss.

1. The cost of an alternative that must be forgone in order to pursue a certain action. Put
another way, the benefits you could have received by taking an alternative action.
2. The difference in return between a chosen investment and one that is necessarily passed
up. Say you invest in a stock and it returns a paltry 2% over the year. In placing your
money in the stock, you gave up the opportunity of another investment - say, a risk-free
government bond yielding 6%. In this situation, your opportunity costs are 4% (6% -
2%).

1- (f)

oligopoly
An oligopoly is a market dominated by a few large suppliers. The degree of market concentration
is very high (i.e. a large % of the market is taken up by the leading firms). Firms within an
oligopoly produce branded products (advertising and marketing is an important feature of
competition within such markets) and there are also barriers to entry.Another important
characteristic of an oligopoly is interdependence between firms. This means that each firm must

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take into account the likely reactions of other firms in the market when making pricing and
investment decisions. This creates uncertainty in such markets - which economists seek to model
through the use of game theory.

Economics is much like a game in which the players anticipate one another's moves.

Game theory may be applied in situations in which decision makers must take into account the
reasoning of other decision makers. It has been used, for example, to determine the formation of
political coalitions or business conglomerates, the optimum price at which to sell products or
services, the best site for a manufacturing plant, and even the behavior of certain species in the
struggle for survival. The ongoing interdependence between businesses can lead to implicit and
explicit collusion between the major firms in the market. Collusion occurs when businesses agree
to act as if they were in a monopoly position.

KEY FEATURES OF OLIGOPOLY

* A few firms selling similar product

* Each firm produces branded products

* Likely to be significant entry barriers into the market in the long run which allows firms to
make supernormal profits.

* Interdependence between competing firms. Businesses have to take into account likely
reactions of rivals to any change in price and output

THEORIES ABOUT OLIGOPOLY PRICING

There are four major theories about oligopoly pricing:

(1) Oligopoly firms collaborate to charge the monopoly price and get monopoly profits

(2) Oligopoly firms compete on price so that price and profits will be the same as a competitive
industry

(3) Oligopoly price and profits will be between the monopoly and competitive ends of the scale

(4) Oligopoly prices and profits are "indeterminate" because of the difficulties in modelling
interdependent price and output decisions

THE IMPORTANCE OF PRICE AND NON-PRICE COMPETITION

Firms compete for market share and the demand from consumers in lots of ways. We make an
important distinction between price competition and non-price competition. Price competition
can involve discounting the price of a product (or a range of products) to increase demand.

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Non-price competition focuses on other strategies for increasing market share. Consider the
example of the highly competitive UK supermarket industry where non-price competition has
become very important in the battle for sales

 Mass media advertising and marketing

 Store Loyalty cards
 Banking and other Financial Services (including travel insurance)
 In-store chemists / post offices / creches
 Home delivery systems
 Discounted petrol at hyper-markets
 Extension of opening hours (24 hour shopping in many stores)
 Innovative use of technology for shoppers including self-scanning machines
 Financial incentives to shop at off-peak times
 Internet shopping for customers

PRICE LEADERSHIP IN OLIGOPOLISTIC MARKETS

When one firm has a dominant position in the market the oligopoly may experience price
leadership. The firms with lower market shares may simply follow the pricing changes prompted
by the dominant firms. We see examples of this with the major mortgage lenders and petrol
retailers.

1-(f)

Dual Pricing is the technique in which different prices are offered for the same product in
different markets. These different prices for the same products are called dual prices.
Manufacturers use dual prices mostly in different countries having different currencies. The
objective of dual pricing can be to enter a new market with one’s product by offering low prices
in a foreign country. Generally, dual pricing is not termed as an illegal process, but if it is done
with the intention of dumping it can be considered illegal. The practice of setting prices at
different levels depending on the currency used to make the purchase. Dual pricing may be used
to accomplish a variety of goals, such as to gain entry into a foreign market by offering unusually
low prices to buyers using the foreign currency, or as a method of price discrimination. Dual
pricing can also take place in different markets that use the same currency. This is closer to price
discrimination than when dual pricing is implemented in foreign markets and different

10
currencies. Dual pricing is not necessarily an illegal pricing tactic; in fact, it is a legitimate
pricing option in some industries. However, dual pricing, if done with the intent of dumping in a
foreign market, can be considered illegal.

1- (h)

The interconnected characteristics of a market, such as the number and relative strength
of buyers and sellers and degree of collusion among them, level and forms of competition, extent
of product differentiation, and ease of entry into and exit from the market. Four basic types of
market structure are (1) Perfect competition: many buyers and sellers, none being able to
influence prices. (2) Oligopoly: several large sellers who have some control over the prices. (3)
Monopoly: single seller with considerable control over supply and prices. (4) Monopsony: single
buyer with considerable control over demand and prices.

In economics, market structure is the number of firms producing identical products which are
homogeneous. The types of market structures include the following:

 Monopolistic competition, also called competitive market, where there is a large number
of firms, each having a small proportion of the market share and slightly differentiated
products.
 Oligopoly, in which a market is by a small number of firms that together control the
majority of the market share.
o Duopoly, a special case of an oligopoly with two firms.

 Monopsony, when there is only one buyer in a market.

 Oligopsony, a market where many sellers can be present but meet only a few buyers.
 Monopoly, where there is only one provider of a product or service.
o Natural monopoly, a monopoly in which economies of scale cause efficiency to
increase continuously with the size of the firm. A firm is a natural monopoly if it
is able to serve the entire market demand at a lower cost than any combination of
two or more smaller, more specialized firms.
 Perfect competition, a theoretical market structure that features no barriers to entry, an
unlimited number of producers and consumers, and a perfectly elastic demand curve.

The imperfectly competitive structure is quite identical to the realistic market conditions where
some monopolistic competitors, monopolists, oligopolists, and duopolists exist and dominate the
market conditions. The elements of Market Structure include the number and size distribution of
firms, entry conditions, and the extent of differentiation.

These somewhat abstract concerns tend to determine some but not all details of a specific
concrete market system where buyers and sellers actually meet and commit to trade. Competition

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is useful because it reveals actual customer demand and induces the seller (operator) to provide
service quality levels and price levels that buyers (customers) want, typically subject to the
seller’s financial need to cover its costs. In other words, competition can align the seller’s
interests with the buyer’s interests and can cause the seller to reveal his true costs and other
private information. In the absence of perfect competition, three basic approaches can be adopted
to deal with problems related to the control of market power and an asymmetry between the
government and the operator with respect to objectives and information: (a) subjecting the
operator to competitive pressures, (b) gathering information on the operator and the market, and
(c) applying incentive regulation

Section-B

2 (a)

Managerial decisions are an important cog in the working wheel of an organization.

The success or failure of a business is contingent upon the decisions taken by managers.
Increasing complexity in the business world has spewed forth greater challenges for
managers. Today, no business decision is bereft of influences from areas other than the
economy. Decisions pertinent to production and marketing of goods are shaped with a view
Of the world both inside as well as outside the economy. Rapid changes in technology,
greater focus on innovation in products as well as processes that command influence over
marketing and sales techniques have contributed to the escalating complexity in the
business environment. This complex environment is coupled with a global market where
input and product prices are have a propensity to fluctuate and remain volatile. These
factors work in tandem to increase the difficulty in precisely evaluating and determining the
outcome of a business decision. Such evanescent environments give rise to a pressing
need for sound economic analysis prior to making decisions. Managerial economics is a
discipline that is designed to facilitate a solid foundation of economic understanding for
business managers and enable them to make informed and analyzed managerial decisions,
which are in keeping with the transient and complex business environment. The discipline of
managerial economics deals with aspects of economics and tools of analysis, which are
employed by business enterprises for decision-making. Business and industrial enterprises
have to undertake varied decisions that entail managerial issues and decisions. Decision-
making can be delineated as a process where a particular course of action is chosen from a
number of alternatives. This demands an unclouded perception of the technical and
environmental conditions, which are integral to decision making. The decision maker must

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possess a thorough knowledge of aspects of economic theory and its tools of analysis. The
basic concepts of decision-making theory have been culled from microeconomic theory and
have been furnished with new tools of analysis. Statistical methods, for example, are pivotal
in estimating current and future demand for products. The methods of operations research
and programming proffer scientific criteria for maximizing profit, minimizing cost and
determining a viable combination of products.
Decision-making theory and game theory, which recognise the conditions of uncertainty and
imperfect knowledge under which business managers operate, have contributed to
systematic methods of assessing investment opportunities. Almost any business decision
can be analysed with managerial economics techniques. However, the most frequent
applications of these techniques are as follows:
•Risk analysis: Various models are used to quantify risk and asymmetric information and to
employ them in decision rules to manage risk.
•Production analysis: Micro economic techniques are used to analyse production efficiency,
optimum factor allocation, costs and economies of scale. They are also utilised to estimate
the firm's cost function.
•Pricing analysis: Micro economic techniques are employed to examine various pricing
decisions. This involves transfer pricing, joint product pricing, price discrimination, price
elasticity estimations and choice of the optimal pricing method.
•Capital budgeting: Investment theory is used to scrutinize a firm's capital purchasing
Decisions.
Managerial Economics is also closely related to accounting, which is concerned with recording the
financial operations of a business firm. Indeed, accounting information is one of the principal sources of
data required by a managerial economist for his decision making purpose. For instance, the profit and
loss statement of a firm tells how well the firm has done and the information it contains can be used by
managerial economist to throw significant light on the future course of action - whether it should
improve or close down. Of course, accounting data call for careful interpretation. Recasting and
adjustment before they can be used safely and effectively. It is in this context that the growing link
between management accounting and managerial economics deserves special mention. The main task
of management accounting is now seen as being to provide the sort of data which managers need if they
are to apply the ideas of managerial economics to solve business problems correctly; the accounting

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data are also to be provided in a form so as to fit easily into the concepts and analysis of managerial
economics.

2-(b)
Economics through, variously defined is essentially the study of logic, tools and techniques of
making optimum use of the available resources to achieve the given ends. Economics thus
provides analytical tool and technique that managers need to achieve the goals of the
organization they manage. First one of the most important! Unexpected End of Formula things
which the economic theories can contribute to the management science is building analytical
models which help to recognize the structure of managerial problems, eliminate the minor
details which might obstruct decision making and help to concentrate on the main issue.
Secondly, Economic theory contributes to the business analysis & set of analytical methods
which may not be applied directly to specific business problems, but they do entrance the
analytical capabilities of the business analyst. Thirdly, Economic theories offer clarity to the
various concepts used in business analysis, which enables the the managers to avoid
conceptual pitfalls. The areas of business issues to which economics theories can be directly
applied may be broadly divided into two categories :

1. Operational or internal issues and

2. Environmental or external issues Operational problems are of internal nature. They include all
those problems which arise within the business organization and fall within the preview and
control of the management. Some of the basic internal issues are
1. choice of business and the nature of product i.e. what to produce;
2. choice of size of the firm i.e.. how much to produce
3. choice of technology i.e. choosing the factor contribution ;
4. choice of price i.e. how to price the common;
5. how to promote sales;
6. How to face price competition
7. How to decide on new investment;
8. How to manage profit and capital;

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9. How to manage inventory i.e. stock of both finished goods and material.
The Microeconomic Theories which deals most of these questions include:
1. Theory of demand.
2. Theory of production and production decisions.
3. Analysis of market structure and pricing theory.
4. Profit analysis and profit management.

The Theory of decision-making is a new field of knowledge grown in the second half of this century.
Most of the economic theories explain a single goal for the consumer i.e., Profit maximization for the firm.
But the theory of decision-making is developed to explain multiplicity of goals and lot of uncertainty. As such
this new branch of knowledge is useful to business firms, which have to take quick decision in the case of
multiple goals. Viewed this way the theory of decision making is more practical and application oriented than
the economic theories.

3 (a) - Demand Forecasting:-

The activity of estimating the quantity of a product or service that consumers will purchase. Demand
forecasting involves techniques including both informal methods, such as educated guesses, and
quantitative methods, such as the use of historical sales data or current data from test markets. Demand
forecasting may be used in making pricing decisions, in assessing future capacity requirements, or in
making decisions on whether to enter a new market.
(A) Survey Methods:-
Survey methods are generally used where purpose ultimate short run forecast of demand. Under these
methods servings are conducted to correct information about consumer intentions and their future
purchase planes further survey and end use method. In complete enumeration methods these are some
limitations- (i) It can be successfully used in case of their products whose consumers are concentrated in
certain region or locality (ii) This method can't be used in wide spread markets sample survey method
has also disadvantages such (i) sometime, reliability of data is missing. (ii) It can be of greater use in
forecasting where quantifications of variables is not possible and behaviour is subject to change.
In opinion polls methods, there are three methods more
(a) Expert opinion methods:-
Expert opinion method is simple and inexpensive but has some limitations (i) estimates provided by sales
representatives are reliable only to extent of cheers skill to analyze the market (ii) Demand estimates
may more the subjective judgment of the assessor which may lead to over or under estimation (iii) The
assessment of market demand based on inadequate information available to sales representations.
(b) Delphos method:-
This technique is an extension of simple expert opinion pole method there experts may revise estimates
of forecast of other experts along with other assumptions. Here, the unconstructed opinions of the
experts may conceal the fact that information used by experts in expressing their forecasts may be based
on sophisticated techniques.
(c) Market Studies and Experiments:-

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Here, firms select some areas of the representative markets having similar features population income
levels etc. Then market experiments are carriedout. But this method had few disadvantages (i)
Experimental methods are very expensive and cannot be carried by small firms (ii) These methods are
based on short term and controlled conditions markets and results may not be applicable (iii) Tinkering
with price increases may cause a permanent loss of customers to competitive brands that might have
been tried.
(B) Statistical Methods:-
Statistical methods are considered to be superior techniques of estimation of demand due to reasons as
(i) method of estimation is scientific (ii) estimates are relatively reliable (iii) the element of subjectivity is
minimum (iv) estimation involves smaller costs statistical methods of demand projection include the
following techniques.

3-(b)
Predictions of future demand for a firm's product or products are called demand forecasts.
Demand forecasting is the method of predicting the future demand of a firm's product.

Forecasts are necessary for

1. Fulfilment of objective of the plan.
2. Preparation of a Budget
3. Stabilisation of employment and productiopn.
4. Expansion of Firms
5. Other Uses

Factors Influencing Demand Forecasts

A number of factors affect the demand forecats. Each of these factors has to be studied together
with the other factors while forecating demand. They are as follows.

1) Time Period

Forecats can be for a short period, long period or very long (secular) period.
a) Short period: These forecats are for a period of one year and based on the judgement of
experienced staff of the firm. Within this period the sales promotion policies of the firm or the
tax policies of the government do not change. Short period forecats are important for deciding
the production policy, price policy, credit policy and marketing and distribution of the firm's
product.
b) Long period forecats:These are forecats for a period of 5 to 10 years and are based on sientific
analysis and statistical methods. Long period forecats are important to decide about whether a
new factory is to be established, new product can be introduced, or capital needs are to be raised.
c) Very Long Period: There are for a period of over 10 years. Secular factors like growth of
population, development of the economy, the political situation in the country, the changes in the
international trade, sociological factors like, age, marriage, have to be considered for forecating
the demand over a very long period.

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2) Level of Forecasts

Forecasts can be made at the level of the firm or the industry or the nation.
a) A Firm : A firm forecasts the sales of its products.

b) An Industry: Forecasts at this level are prepared bye the trade association. These are based on
statistical data and market survey. These forecasts are available to all the forms of the country.
c) The Nation: These forecats are national level forecasts and are based on indices such as
national income and national expenditure.

3) Genaral and specific forecasts: General forecats giving a total picture of the demand for all the
products of a firm or demand from all the markets of the firm's product. Specific demand
forecats give specific information.

4) Established Products and New Products: Established goods, are goods which are already
established in the market. New products are the those whioch are yet to be introduced in the
market, information about these production is not known.. Thus depending on whether the
product is an established or new product, differewnt methods are used for forecating demand.

5) Product Classification: For the purpose of Demand Forecating products can be classified as:
a) Capital Goods and Consumer goods
b) Durable goods and Perishable goods.
The demand for capital goods is a derived demand. It is derived from demand for the product
produced by the capital goods. The demand for consumer goods depends on the incomes of the
consumer. The demand for durable goods can be postponed. The demand for perishable goods
like vegetables and fruits depends on the current incomes and current demand.

6) Other Factors: The level of uncertanity, the nature of competition, the number of substitutes to
a product, the elasticities of demand for the product are important factors which have to be
considered while forecating the demand for a product.

Methods of Forecasting Demand

The methods opf forecating demand depend upon whether the product is an established good or a
new good, and on the level of forecats, that is macro or micro level.
Macro level forecats are used in national economic planning. These are forecats about general
business conditions, and these forecasts make use of information regarding the macro variables
like govt expenditure, savings etc.

1. Methods of Forecasting demand for Established Goods

There are two basic methods of forecasting the demand for established goods
A) Interview and survey approach (Short period forecasts)
B) Projection Approach (Long period forcasts)

The interview and survey approach, tries to collect information in different way. Depending on
how this information is collected, we have different sub methods.

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a) Opinion - polling Method: This method tries to collect information directly or indirectly from
the prospective consumers.. This is possible through the market research department of the firm
or through the wholesalers and retailers. This method is useful when the product and consumers
come into direct contact or when the number of consumers is small. This method is also useful
when the consumer is another firm.

b) Collective Opinion Method: Large firms have an organised sales department. The salesman
have technical training about how to collect the information from the buyers. These forecasts are
based on information which is more certain and thus forecasts based on this information may be
more accurate.

c) Sample Survey Method: The total number of consumers for firm's product is called the
population. When the number of consumers is very large, it is not possible to contact each and
every consumer. A few consumers are contacted , this forms the sample. Therefore in this method
information is collected from the consumers in the sample and forecasts are based on this
information, which inturn generalised for the whole population.

d) Panel of Experts: Panel of experts consisits of either persons from within the firm or from
outside. These experts come together and forecast the demand for the firm's product..

e) Composite Management Opinion: The opinions of the experienced persons with the firm are
collected and a committee or the general manager of the firm analyses this information and
forecats the demand for the firms product. This method is quick, easy and saves time and cost,
but it is not based on scientific analysis and thus may not give very accurate results.

(B) Projection Approach: In this method, the past experience is projected into the future. This can
be done with the help of statistical methods.

(a) Correlation and Regression Analysis

(b) Time eries Analysis

2) Methods of Demand Forcating for new Products

(a) Evolutionary Method: The demand forcasts of such new goods can be based on the
information about the already established goods from which it is evolved.

(b) Substitution Method:

(c) Growth pattern method
(d) Opinion polling method
(e) Sample survey method
(f) Indirect Opinion Polling method.

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