Unit – III

Managerial Ecomomics For Engineering

Chapter – 1 Introduction to Managerial Economics

Chapter – 2 Demand Analysis

Chapter – 3 Supply Analyses

Chapter – 4 Pricing Decisions

Unit – III

Chapter – 1

Introduction to Managerial Economics

Synopsis:

Introduction

Meaning of Managerial Economics

Definition of Managerial Economics

Scope of Managerial Economics

Importance of Managerial Economics

INTRODUCTION

Managerial economics draws on economic analysis for such concepts as cost,

demand, profit and competition. Managers can take Decision for a business related problems

based on Economic concept.

MEANING OF MANAGERIAL ECONOMICS

Managerial Economics is a discipline that combines economic theory with managerial

practice.

DEFINITION OF MANAGERIAL ECONOMICS

According to Spencer and Seigelman Managerial Economics is defined as the

integration of economic theory with business practices for the purpose of facilitating decision

making and forward planning by management.

IMPORTANCE OF MANAGERIAL ECONOMICS

Helps to achive firm’s objectives

Helps to make a decision for business related problems

Helps to allocate the resources ( man, Money, materials ect.,)

SCOPE OF MANAGERIAL ECOMOMICS

Managerial Economics consist of two branches

1. Micro Economics

2. Macro Economics

1. Micro Economics

Micro economics studies the economic behavior of individual decision making units such as

consumers, producers/firms and resource owners. Scope of Managerial Economics Are

a) Demand Analysis and forecasting

b) Production and Cost Analysis

c) Market structure

d) Pricing Decisions, policies and practices

e) Profit management and Profit Analysis. ‡

f) Investment and Capital Management

2. Macro Economics

a) Employment

b) National income

c) Foreign Trade

d) Inflation

e) Economic Growth

f) Government Economic policies

Unit – III

Chapter – 2

Demand Analysis

INTRODUCTION

Synopsis

Introduction

Meaning of Demand

Definition of Demand

Types of Demand

Determinants or Factors affecting Demand

Law of Demand

Meaning of law of Demand

Assumption of Law of Demand

Exemption to Law of Demand

Demand Function

Elasticity of Demand f Elasticity of Demand

Meaning of Elasticity of Demand

Types of Elasticity of Demand

Factors affecting Elasticity of Demand

Measuring methods of Elasticity of Demand

Demand Forecasting

Meaning of Demand Forecasting

Techniques or methods of Demand Forecasting

Demand Analysis is very important to the managers to take production related

decision. Based on Demand Analysis, the managers have to prepare a production schedule,

budget, purchasing required raw materials and machineries ect.,

MEANING OF DEMAND

Demand for a commodity refers to the quantity of the commodity which an individual

household is willing to purchase per unit of time at a particular price.

Desire to buy a commodity

Willingness to purchase a commodity

Ability to purchase a commodity

DEFINITION OF DEMAND

According to Bober Demand is defined as the various quantities of a

given commodity or service which consumers would buy in one market in

a given period of time at various prices or at various incomes or at various

prices of related goods.

TYPES OF DEMAND

a) Consumer goods Demand and Industrial Goods Demand

Goods and services used for final consumption are called consumer

goods. These include, goods consumed by human-beings, animals, birds

etc.

Producer goods refer to the goods used for production of other goods,

like plant and machines, factory buildings, services of employees, raw

materials etc.

Ex: Consumer goods – Toothpaste, cloth ect.,

Producer goods – Raw materials, machinery

ect.,

b) Perishable and durable goods demand

Perishable goods become unusable after sometimes, others are durable goods.

Precisely, perishable goods are those which can be consumed only once while in durable

goods, their services only are consumed.

Durable goods pose more complicated problems for demand analysis than do non-

durables. Sales of non-durables are made largely to meet current demands which depend on

current conditions. In contrast, sales of durable goods go partly to satisfy new demand and

partly to replace old items.

c) 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 demands for all

producer goods are derived demands as they are needed to obtain consumer or producer

goods. So is money because of its purchasing power. However, 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. Thus the autonomous and derived demands vary in

degree more than in kind.

Ex: Autonomous Demand - all type of consumer goods like car, DVD Player

Derived Demand - all type of industrial goods like cement, cotton

d) Individual’s Demand and Market Demand

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 represents cumulative demand of all the buyers in a market.

Ex:

Price of a Individual Demand Market

B1 B2 B3

Ex: Perishable goods – Fruits, Vegetables, Dairy products

Durable goods – Furniture, TV, Fridge

Product Demand

8 6 8 5 19

10 4 6 3 13

6 8 10 7 25

e) 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. (All firms producing a

particular good constitute an industry engaged in the production of that good).

Ex: Firms Demand - demand for Honda car alone

Industry Demand - demand for all kinds of cars like, Maruti, Ford, Honda, Toyota ect.,

f) Demand by Market Segments and by Total Market

If the market is large in terms of geographical spread, product uses, distribution

channels, customer sizes or product varieties, and if any one or more of these differences

were significant in terms of product 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.

DETERMINANTS OR FACTORS AFFECTING DEMAND

a) Price

Demand is inversely proportional to price. When price increases demand

decreases and vice versa

b) Income of the consumer

A rise in income would result in the people demanding more of normal goods.

in case of inferior goods rise in income causes a fall in demand. demand for godds of

necessities remains the same with change in price.

c) Price of related goods

Related goods may be in the form of substitute or complementary goods

Substitute goods: These goods satisfy the same type of demand and hence can be

used in place of each other ex: tea and coffee. With a rise in price of tea people will

shift their consumption to the relatively cheaper coffee. Hence demand for coffee will

rise. They have a positive relationship

Complementary goods: These goods are jointly used or consumed together ex: pen

and ink. Increase in the price of ink would cause a decrease in the demand for pen.

Hence the price of ink has a negative relationship with the quantity demanded of pen.

d) Tastes and preferences

These depend upon the social customs, habits and general lifestyle. Some of

these like fashion keep on changing as a result their demand keeps on changing. For

ex : the craze of being fit has increased the demand for cycles

e) Consumer's expectations

If consumers expect a rise in price of goods in future the demand for these

goods will increase, similarly if they expect a rise in income they will buy more

f) Consumer credit facility:

With the availability of credit sand loans from banks consumers have been

able to afford commodities they would have otherwise not purchased. The demand for

cars has increased due to bank loans.

g) Size and composition of Population

Larger the population larger will be the number of consumers. Also the

composition of population has an effect on the demand. ex: A higher number of

females will have an increased demand for sarees. These are the demographic effects

on demand for the commodities.

h) Government policy

If government imposes taxes on commodities their price will increase and

demand will decrease while in case if granting subsidies the price will decrease and

hence the demand will increase.

i) Advertisement:

This factor has gained tremendous importance in the modern

days. When a product is aggressively advertised through all the

possible media, the consumers buy the advertised commodity even

at a high price and many times even if they don’t need it.

j) Season and weather

Based on weather and climate condition the demand of the product will

increase. Demand for woolen clothes goes up in winter whereas their demand is

extremely less in summer.

LAW OF DEMAND

Meaning of Law of Demand

Law of Demand states that the demand of the commodity increase when its price falls

and decrease when its price increases.

The Law of Demand expresses the inverse relationship between quantity demanded

and price. But there are some exceptional situations under which there may be a direct

relationship between price and quantity demanded.

P1

Price

P

Q1 Q

Quantity Demanded

Assumptions of the 'law of demand'

The law of demand in order to establish the price-demand

relationship makes a number of assumptions as follows:

a. Income of the consumer is given and constant.

b. No change in tastes, preference, habits etc.

c. Constancy of the price of other goods.

d. No change in the size and composition of population.

Exception to Law of Demand

a) Giffen paradox or inferior goods:

These are those inferior goods on which the consumer spends a large part of his

income and the demand for which falls with a fall in their price. The demand curve for these

has a positive slope. The consumers of such goods are mostly the poor. a rise in their price

drains their resources and the poor have to shift their consumption from the more expensive

goods to the giffen goods, while a fall in the price would spare the household some money for

more expensive goods. Which still remain cheaper. These goods have no closely related

substitutes; hence income effect is higher than substitution effect.

b)Veblen goods or Prestige goods:

Goods which serve ' status symbol ' do not follow the law of demand. These are goods of '

conspicuous consumption '.they give their possessor utility in the sense of their ownership.

Rich buy diamond as their possession is prestigious. When their price raises the prestige

value goes up.

a) Speculative goods

If the price of a commodity is rising and is expected to rise in future the demand for the

commodity will increase. Ex: Share

b) Fear of scarcity

At times of war, famine etc. consumers have an abnormal behavior. If they expect

shortage in goods they would buy and hoard goods even at higher prices. In depression they

will buy less at even low prices.

c) Quality-price relationship

Some people assume that expensive goods are of a higher quality then the low priced

goods. In this case more goods are demanded at higher prices.

d) Basic necessities:

These goods are necessity goods to human being. Price of these good increases even

though customers must have to buy these goods for their survival. Ex: Foods, water ect.,

DEMAND FUNCTION

The demand for a commodity arises from the consumer’s willingness and ability to

purchase the commodity. The Demand Theory postulates that the quantity demanded of a

commodity is a function of or depends on not only the price of a commodity, but also

income, price of related goods—both substitutes and complements, taste of consumer, price

expectation and all other factors. Demand function is a comprehensive formulation which

specifies the factors that influence the demand for the product.

Dx = D (Px, Py, Pz, B, A, E, T, U)

where Dx = Demand for item X

Px = Price of substitutes

Pz = Price of complements

B = Income of consumer

E = Price expectation of the user

T = Taste or preference of user

U = all other factors.

ELASTICITY OF DEMAND

Meaning of Elasticity of Demand

Elasticity of demand refers to the degree of change in quantity demanded or the

degree of responsiveness of the quantity to a change in any one of the determinants of

demand, the other determinants remaining constant.

Types of Elasticity of Demand

I. Price Elasticity of Demand

II. Income Elasticity of Demand

III. Cross Elasticity of Demand

IV. Promotional Elasticity of Demand

I. Price Elasticity of Demand

Price elasticity of demand (Ed) measures the degree of responsiveness of quantity

demanded of a product to changes in its own price. In mathematical form it is expressed as:

Ed = Percentage change in quantity demanded

where

Q = change in quantity demanded

P = change in price

Q = Original quantity demanded

P = Original Price

Types of price Elasticity of Demand

The concept of price elasticity reveals that the degree of responsiveness of demand to

the change in price differs from commodity to commodity. Demand for some commodities is

more elastic while that for certain others is less elastic. Using the formula of elasticity, it

possible to mention following different types of price elasticity:

a. Perfectly inelastic demand (ep = 0)

b. Inelastic (less elastic) demand (e < 1)

c. Unitary elasticity (e = 1)

Percentage change in price

d. Elastic (more elastic) demand (e > 1)

e. Perfectly elastic demand (e = ∞)

a) Perfectly inelastic demand (ep = 0)

This describes a situation in which demand shows no response to a change in

price. In other words, whatever be the price the quantity demanded remains the same.

It can be depicted by means of the alongside diagram. The vertical straight line

demand curve as shown alongside reveals that with a change in price (from OP to

Op1) the demand remains same at OQ. Thus, demand does not at all respond to a

change in price. Thus ep = O. Hence, perfectly inelastic demand ( see Fig a).

b) Perfectly elastic demand (e = ∞)

This is experienced when the demand is extremely sensitive to the changes in

price. In this case an insignificant change in price produces tremendous change in

demand. The demand curve showing perfectly elastic demand is a horizontal straight

line. (See Fig b)

c) Unitary elasticity demand (e = 1)

When the percentage change in price produces equivalent percentage change

in demand, we have a case of unit elasticity. The rectangular hyperbola as shown in

the figure demonstrates this type of elasticity. In this case percentage change in

demand is equal to percentage change in price, hence e = 1. (See Fig c)

d) Relatively Elastic (more elastic) demand (e > 1)

In case of certain commodities the demand is relatively more responsive to the

change in price. It means a small change in price induces a significant change in,

demand. This can be understood by means of the alongside figure. It can be noticed

that in the above example the percentage change in demand is greater than that in

price. Hence, the elastic demand (e>1) (see Fig d ).

e) Relatively Inelastic (less elastic) demand (e < 1)

In this case the proportionate change in demand is smaller than in price. The

alongside figure shows this type. In the alongside figure percentage change in demand

is smaller than that in price. It means the demand is relatively c less responsive to the

change in price. This is referred to as an inelastic demand (see Fig e ).

.

II. Income Elasticity of Demand

Price is not the only determinant of demand. Demand for a commodity changes in

response to a change in income of the consumer. In fact, income effect is a constituent of

the price effect. The income effect suggests the effect of change in income on demand.

The income elasticity of demand explains the extent of change in demand as a result of

change in income. In other words, income elasticity of demand means the responsiveness

of demand to changes in income. Thus, income elasticity of demand can be expressed as:

EY = [Percentage change in demand / Percentage change in income]

Types of income elasticity of Demand

1.Zero income Elasticity (EY=0)

Changes in income has no effect on the quantity demanded ( fig - (a))

2.Positive income Elasticity

Positive income elasticity may be dived into 3 types

(i) Income Elasticity of Demand Greater than One: When the percentage change in

demand is greater than the percentage change in income, a greater portion of income is

being spent on a commodity with an increase in income- income elasticity is said to be

greater than one.

(ii) Income Elasticity is unitary: When the proportion of income spent on a commodity

remains the same or when the percentage change in income is equal to the percentage

change in demand, EY = 1 or the income elasticity is unitary.

(iii) Income Elasticity Less Than One (EY< 1): This occurs when the percentage

change in demand is less than the percentage change in income. 4. Zero Income

Elasticity of Demand (EY=o): This is the case when change in income of the consumer

does not bring about any change in the demand for a commodity.

3. Negative Income Elasticity of Demand (EY< o): It is well known that income effect

for most of the commodities is positive. But in case of inferior goods, the income effect

beyond a certain level of income becomes negative. This implies that as the income

increases the consumer, instead of buying more of a commodity, buys less and switches

on to a superior commodity. The income elasticity of demand in such cases will be

negative.

III. Cross Elasticity of Demand

While discussing the determinants of demand for a commodity, we have observed that

demand for a commodity depends not only on the price of that commodity but also on the

prices of other related goods. Thus, the demand for a commodity X depends not only on the

price of X but also on the prices of other commodities Y, Z….N etc. The concept of cross

elasticity explains the degree of change in demand for X as, a result of change in price of Y.

This can be expressed as:

EC = [Percentage Change in demand for X / Percentage change in price of Y]

The relationship between any two goods is of two types. The goods X and Y can be

complementary goods (such as pen and ink) or substitutes (such as pen and ball pen).

In case of complementary commodities, the cross elasticity will be negative. This means

that fall in price of X (pen) leads to rise in its demand so also rise in t) demand for Y (ink)

On the other hand, the cross elasticity for substitutes is positive which means a fall in

price of X (pen) results in rise in demand for X and fall in demand for Y (ball pen).

If two commodities, say X and Y, are unrelated there will be no change i. Demand for X

as a result of change in price of Y. Cross elasticity in cad of such unrelated goods will then be

zero.

In short, cross elasticity will be of three types:

1. Negative cross elasticity – Complementary commodities.

2. Positive cross elasticity – Substitutes.

3. Zero cross elasticity – Unrelated goods.

IV. Elasticity of Demand with Respect to Advertisement and promotion

It is the ratio of percentage change in the quantity demanded of a commodity (Q) to

Percentage in the advertisement outlay on the commodity (A). It is also called

promotional elasticity and plays an important role in the context of marketing

management.

This is defined as the percentage change in the level of future prices (Pt+1) expected

as a result of a change in the level of current prices (P1).

It measures the ratio of the percentage rise in expected future prices to the percentage

rise in its current price. When an increase in current price is expected to result in future

prices then E= 1, if increase in future price is more than proportional to current price rise,

then E is greater than one, for less the proportional increase, E is less than one.

FACTORS DETERMINING ELASTICITY OF DEMAND

1.Luxury or necessity goods:

Luxury goods tend to have an elastic demand, while necessity goods have an inelastic

demand. Purchasers can stop buying the luxury goods when their prices rise.

2. Percentage of income: Big items in a budget tend to have a more elastic demand than

small items. For example, consumers may be affected by 1 per cent rise or fall in price of a

flat but are insensitive to such fluctuations in prices of pens.

3. Substitutes: Items that can be substituted easily have a more elastic demand than those

that do not.

4. Time: The demand for a product becomes more elastic the longer the time period under

consideration. It takes time to decide about other p product before buying it as one develops a

habit of using a particular product.

Measurement methods of Elasticity of Demand

For practical purposes, it is essential to measure the exact elasticity of demand. By

measuring the elasticity we can know the extent to which the demand is elastic or inelastic.

Different methods are used for measuring the elasticity of demand.

1. Percentage Method: In this method, the percentage change in demand and percentage

change in price are compared.

ep = [Percentage change in demand / Percentage change in price]

In this method, three values of ‘ep’ can be obtained. Viz., ep = 1, ep > 1, ep > 1.

1.If 5% change in price leads to exactly 5% change in demand, i.e. percentage change in

demand is equal to percentage change in price , e = 1, it is a case of unit elasticity. 2.If

percentage change in demand is greater than percentage change in price, e > 1, it means the

demand is elastic. 3.If percentage change in demand is less than that in price, e > 1, meaning

thereby the demand is inelastic.

2. Total Outlay Method: The elasticity of demand can be measured by considering the

changes in price and the consequent changes in demand causing changes in the total amount

spent on the goods. The change in price changes the demand for a commodity which in turn

changes the total expenditure of the consumer or total revenue of the seller.

1. If a given change in price fails to bring about any change in the total outlay, it is the case of

unit elasticity. It means if the total revenue (price x Quantity bought) remains the same in

spite of a change in price, ‘ep’ is said to be equal to 1

2. If price and total revenue are inversely related, i.e., if total revenue falls with rise in price

or rises with fall in price, demand is said to be elastic or e > 1. 3. When price and total

revenue are directly related, i.e. if total revenue rises with a rise in price and falls with a fall

in price, the demand is said to be inelastic pr e < 1.

DEMAND FORECASTING

Meaning of Demand Forecasting

Forecasts are needed to aid in determining what resources are needed, scheduling

existing resources, and acquiring additional resources. Accurate forecasts allow scheduler to

use machine capacity efficiently, reduce production times, and cut inventories.

Forecasting methods may be based on mathematical models using historical data available,

qualitative methods drawing on managerial experience, or a combination of both.

Forecasting demand in such situations require uncovering the underlying patterns from

available information.

Importance of Demand Forecasting

Determining the sales territories.

Helpful in deciding to enter a new market or not.

Helpful in determining how much capacity to be built up.

In deciding the number of salesmen required to achieve the sales objective.

Assessing the effect of a proposed marketing programme.

Product mix decisions.

Deciding the channels of Distribution

Methods or Techniques of Forecasting

The two general types of forecasting techniques used for demand forecasting are: Qualitative

methods and Quantitative methods

Sales force opinion Linear Regression

Executive opinion Time Series

Delphi Technique simple Average

Market Research Weighted Average

Customer survey Exponential smoothing

Techniques of Demand Forecasting

Qualitative or Judgemental Method

Quantitative or causal Method

I. Judgement or Qualitative Methods

Qualitative methods include judgement methods, which translate the opinions of

managers, expert opinions, consumer surveys and sales force estimates into quantitative

estimates.

When adequate historical data are lacking, as new product is introduced or technology is

expected to change, firms rely on managerial judgment and experience to generate forecasts.

a) Sales Force Estimate

Sales force estimates are forecasts compiled from estimates of future demand made

periodically by members of a company’s sales force. This approach has several

advantages.

The sales force is the group most likely to know which products or services customers

will be buying in the near future, and in what quantities.

Sales territories often are divided by district or region. Information broken down in

this manner can be useful for inventory management, distribution, and sales force

staffing purposes.

The forecasts of individual sales force members can be combined easily to get

regional or national sales.

But it also has several disadvantages.

Individual biases of the sales people may taint the forecast; moreover, some people

are naturally optimistic, other more cautious.

Sales people may not always be able to detect the difference between what a

customers “wants” (a wish list) and what a customer “needs” (a necessary purchase).

If the firm uses individual sales as a performance measure, salespeople may

underestimate their forecasts so that their performance will look good when they

exceed their projections or may work hard only until they reach their required

minimum sales.

b) Executive opinion

Executive opinion is a forecasting method in which the opinions, and technical

knowledge of one or more managers are summarized to arrive at a single forecast. As

we will discuss later, executive opinion can be used to modify an existing sales

forecast to account for unusual circumstances, such as a new sales promotion or

unexpected international events. Executive opinion can also be used for technical

forecasting. This method of forecasting has several disadvantages. Executive opinion

can be costly because it takes valuable executive time. Although that may be

warranted under certain circumstances, it sometimes gets out of control. In addition, if

executives are allowed to modify a forecast without collectively agreeing to the

changes, the resulting forecast will not be useful.

c) Market research

Market research is a systematic approach to determine consumer interest in a

product or services by creating and testing hypotheses through data-gathering surveys.

Conducting a market research study includes

1. Designing a questionnaire that request economic and demographic information from

each person interviewed and asks whether the interviewee would be interested in the

product or services;

2. Deciding how an administrative sample of household to survey, whether by telephone

polling, mailings, or personal interviews;

3. Selecting a representative sample of households to survey, which should include a

random selection within the market area of the proposed product or service; and

4. Analyzing the information using judgment and statistical tools to interpret the

responses, determine their adequacy, make allowance for economic or competitive

factors not included in the questionnaire, and analyze whether the survey represents a

random sample of the potential market.

Market research may be used to forecast demand for the short, medium, and long

term. Accuracy is excellent for the short term, good for the medium term, and only fair

for the long term.

d) Delphi method

The Delphi method is process of gaining consensus from a group of experts while

maintaining their anonymity. This form of forecasting is useful when there are no historical

data from which to develop statistical models and when managers inside the firm have no

experience on which to base informed projections. A coordinator sends a question to each

member of the group of outside experts, who may not even know who else, is participating.

The Delphi method can be used to develop long-range forecasts of product demand and new

product sales projections. It can also be used for technological forecasting. The Delphi

methods can be used to obtain a consensus from a panel of experts who can devote their

attention to following scientific advances, changes in society, government regulations, and

the competitive environment.

The Delphi method has some shortcomings, including the following major ones.

The process can take a long time (sometime a year or more). During that time the

panel of people considered to be experts may change, confounding the results or at

least further lengthening the process.

Responses may be less meaningful than if experts were accountable for their

responses.

There is little evidence that Delphi forecasts achieve high degrees of accuracy.

However, they are known to be fair- to- good in identifying turning points in new

product demand.

Poorly designed questionnaires will result in ambiguous or false conclusions.

e) Customer survey Method

Survey conducted about the intention of consumer, opinion of marketexperts

through questionnaire

Merits:

Direct sources from customer

No personal bias of surveyor

Simple method

Save time and coat

Demerits

Sometimes consumers are not answered

Possible for sample error

Information used only for short period

II.Quantitative Methods

Quantitative methods include casual methods and time series analysis.

Casual method based historical data on independent variables, such as promotional

campaigns, economics conditions, and competitors’ actions, to predict demand. Time series

analysis is a statistical approach that relies heavily on historical demand data to project the

future size of demand and recognize trends and seasonal patterns.

a) Linear regression

In linear regression, one variable, called a dependent variable, is related to one or more

independent variables by a linear equation.

In the simple linear regression models, the dependent variable is a function of only one

independent variable, and therefore the theoretical relationship is a straight line:

Y=a + bX

Where Y = dependent variable

X = independent variable

a = Y-intercept of the line

b = slope of the line.

The objectives of linear regression analysis is to find values of a and b that minimize the sum

of squared deviations of the actual data points from the graphed line.

The sample correlation coefficient, r, measures the direction and strength of the relationship

between the independent variable and the dependent variable. The value of r can range from –

1.00 to + 1.00.

b) Time series methods

Simple Moving Averages: The simple moving average method is used to estimate

the average of demand time series and thereby remove the effects of random fluctuation. It is

most useful when demand has no pronounced trend or seasonal influences.

Specially, the forecast period t + 1, can be calculated as

Ft+1 = sum of last n demands = Dt + Dt+1 + Dt-2 +…..Dt-n+1

n n

where Dt = actual demand in period t

n = total number of periods in the average

Ft+1 = forecast for period t + 1

Weighted Moving Averages: In the simple moving average method, each demand has the

same weight in the average --namely, 1/n. In the weighted moving average method; each

historical demand in the average can have its own weight. The sum of the weight equal 1.0.

The advantage of a weighted moving average method is that it allows you to emphasize

recent demand over earlier demand. The forecast will be more responsive than the simple

moving average forecast to changes in the underlying average of the demand series.

Nonetheless, the weighted moving average forecast will still lag behind demand because it

merely averages past demands. This lag is specially noticeable with a trend because the

average of the time series is systematically increasing or decreasing.

c) Exponential smoothing.

The exponential smoothing method is a sophisticated weighted moving average

method that calculates the average of a time series by giving recent demands more weight

than earlier demands. It is the most frequently used formal forecasting methods because of its

simplicity and the small amount of data needed to support it.

Ft+1 =a(Demand this period) + (1-a) (Forecast calculated last period)= aDt+(1-a)Ft

Ft+1 =Ft + a(Dt-Ft)

Larger a values emphasize recent levels of demand and result in forecasts more

responsive to changes in the underlying average. Smaller a values treat past demand more

uniformly and result in more stable forecasts.

Exponential smoothing requires an initial forecast to get started. There are two ways

to get this initial forecast: Either use last period’s demand or, if some historical data are

available, calculate the average of several recent periods of demand. The effect of the initial

estimate of the average on successive estimate of the average diminishes over time because,

with exponential smoothing, the weights given to successive historical demands used to

calculate the average decay exponentially.

Exponential smoothing has the advantages of simplicity and minimal data

requirements. It is inexpensive to use and therefore very attractive to firms that make

thousands of forecasts for each time period. However, its simplicity also is disadvantage

when the underlying average is changing, as in the case of a demand series with a trend.

Unit - III

Chapter – 3

Supply Analysis

Synopsis

Introduction

Meaning

Definition

Factors Affecting Supply

Law of Supply

MEANING OF SUPPLY

It is the amount of good the producer is willing and able to offer at a certain period of

time,.

Assumptions made are that producers aim is to maximize profits and that ceteris paribus

holds.

DEFINITION OF SUPPLY

Supply can be defined as the quantity of a commodity offered for sale at a price

during a given period of time

FACTORS AFFECTING SUPPLY

Price of the good itself

Number of sellers

Technology

Resource Prices

Taxes and subsidies

Expectations of producers

Prices of other goods the firm could produce

1. Price of the commodity

Higher the price of a commodity larger will be the quantity supply and vice – versa.

Higher prices always bring profit to producers.

2. Prices of related commodities

A change in the price of another commodity also affects the supply of a commodity.

For instance, if the price of good A rises, , the producer of good B may produce less

of good B and switch over to the production of good A in order to sell more to make

an profit.

3. Prices of factors of production

If price of factors of production increases – (labour and capital) – cost of production

increases and output will decline.

The reverse will happen in the case of a fall in the price of a factor.

4. Goal of Producers

If a producer aims at maximizing profit, he will produces less of commodity and will

involve large risks.

A producer who aims at maximizing his sales will produce and sell more.

5. State of Technology

If new and improved methods of production are are used – they tend to increase the

supply of used – of commodities.

6. Number of firms and sellers existence

Supply in a market depends on the no. of firms/sellers producing

and selling in the market.

When producer/sellers are few – supply will be will be small and vice

– versa.

7. Cost of Production

The cost of production is an important item affecting the supply.

Wages, rate of interest, price of machinery and equipment, raw-

material etc influences on cost of production.

8. Future Expectation

Seller sells the commodity or supplies on the basis of the prevailing

prices.

If he feels that future prices will be higher, he will reduce the

present supply of the product.

If he feels that future prices may fall will be tempted to sell more at

the current prices.

9. Change in Government Policy

Any change in government policy will affect the supply.

A fresh tax or levy of excise duties on commodity will affect the

price of the commodity and as a result the supply will get affected.

An increase in tax will reduce the supply and granting of subsidy

and incentive will increase the supply

LAW OF SUPPLY

Meaning of Law supply

Law of supply states that the supply for commodity increases when its price increases

and falls when its price decreases, other things remaining constant

price P1

P

Q Q1

Quantity supplied

Unit - III

Chapter – 4

Pricing Decision

Synopsis

Introduction

Meaning of Price and Pricing

Definition of pricing

Objectives of pricing

Pricing methods

INTRODUCTION

Price involves the cost of the product. The manager have to fix a reasonable price for

a product based demand, marker structure and cost of production

MEANING OF PRICE

The amount of money charged for a product or service, or the sum of the values that

consumers exchange for the benefits of having or using the product or service

MEANING OF PRICING

Pricing is the process of fixing the value for the product attributes expressed in

monetary terms which a consumer pays or is expected to pay in exchange for a product or

service.

DEFINITION OF PRICING

According to W.J. Stanton “Price is the amount of money which is needed to acquire

a product.

OBJECTIVES OF PRICING

Profit maximization in the short run, and profit optimization in the long run.

Assured minimum return on investment or sales turnover.

Ensure a specified targeted sales volume or market share.

Make entry into new market share.

Maintain price leadership or price parity with competitors.

Launch price war to check competitors activity or keep competitors out of the race.

Improving cash flow through faster sales.

Liquidation of accumulated inventory of products

METHODS OR TYPES OF PRICING

1. Mark-up pricing

Firms fix a selling price on the products they produce, which normally exceeds the

costs incurred in producing these products .In this type of pricing, a marketer adds a mark-up

on its cost of the product. Mark-up pricing involves fixing a price for a product by adding

(marking up) a margin to its cost price

2. Target returns pricing

The target return pricing is set by marketers to achieve a specified rate of return on

their investments. A marketer can fix the price of his products on the investment with the

help of following formula

Target return pricing = Unit cost + (desired cost * invested) / Unit sales

Suppose a marketer produces a product and the cost of each unit is 200. He made an

investment of Rs. 100,000 to set up his business. He expects that he will be able to sell 500

units, and obtain 15 % return on investment. He will price his product at

200 + 0.15 *100,000/500 = 230 Price = 230 Rs.

3. Perceived value pricing

In this type (perceived value) of pricing, marketers set the prices of the products on

the basis of their perceived value in the minds of customers’ .Marketer normally use

advertising and sales promotional activities to enhance the perceived value of the product in

the market. If the marketer overestimates the value of the product, the customer will not buy

the product and will be difficult for him to survive in market.

4. Going rate pricing

Going rate pricing is a simple method in which a company simply follows the prevailing

pricing patterns in the market. The company adopts the pricing strategy similar to those

adopted by the major players in the market or slightly adjust its price to suit the company’s

system and process. Generally, in this method, marketers give importance to price changes

made by the market leader and alter their own prices accordingly

5. Sealed bid pricing

In some markets, business is carried out on the basis of sealed bids rather than on the

basis of openly setting prices for products. This type of pricing is more suitable for industrial

products. Many companies compete in this process, where the price of the product or service

is usually quoted in a sealed cover. The sealed bid method is usually followed by government

organizations. Whenever a government organization needs to purchase a product or service, it

is required to call for bids and several companies are invited to quote their prices in a sealed

form. After receiving the sealed bids, the organization will normally purchase the product or

service from the company, which has bid the least price.

6. Differentiated pricing

In different pricing, marketers adopt different prices for the same product at different

locations or for different types of customers.

7. Value pricing

This kind of pricing means companies charge a fairly low price for a high-quality

offering so that the price should represent a high value to the customer.

Ex: Declining prices of computers, P&G

Value pricing is a method in which marketers offer low prices for high quality

products or services.

8. Skimming Pricing

In skimming pricing, the objective is to skim the market and take the cream, by

pricing the new product high and concentrating on market segment which are not price

sensitive. This strategy will bring in high profits which would ploughed back for further

market development and promotion. There are two ways of skimming - rapid skimming and

slow skimming. Later, the company could reduce the price while going in for mass markets

which are more price sensitive.

This strategy involves setting a price which is higher than expected price. May be

used in Monopoly situation.

9. Market Penetration Pricing

Under this a low initial price is set for the product in order to reach a mass market &

capture it then later the can increase the price .

10. Odd pricing or Psychological pricing

To get a customer to respond on an emotional, rather than rational basis

Ex: Rs. 99 not Rs. 100 price point perspective

At the retail level it is commonly used, It was originally adopted by the FOOTWEAR

Industry.

Ex: Setting Odd Amounts Such as 499.95, 299, 199.

Retailers believe that this will result in larger sales and would give an impression to

buyers that price calculations are accurate

11. Geographical pricing

Different prices for customers in different parts of the world. Include shipping costs, or place

Ex: Petrol and diesel price in india