Managerial Economics

WHAT IS ECONOMICS?
Economics is the study of how society uses scarce resources to produce valuable commodities and distribute them among different people (or) Economics is a social science, which studies human behavior in relation to optimizing allocation of available resources to achieve the given ends.

WHAT IS MANAGERIAL ECONOMICS?

Managerial economics is the science of directing scarce resources to manage cost effectively. Application: Managerial economics applies to Businesses, Old economy and new economy, Global & local markets. Scope: Microeconomics- Microeconomics is a Greek word which means small. Microeconomics is the study of specific individual units, particular firms, particular household, individual prices, wages, and income. It is economic theory in a microscope. Managerial economies- It is the application of microeconomics to managerial issues ( a scope more limited than microeconomics). Macroeconomics- The term macro is derived from the Greek word uakpo which means large. Macro-economics the other half of economics is the study of the behavior of the economy as a whole in other words macroeconomics deals with total or big aggregates such as national income out and employment, total consumption saving and investment and the general level of price.

WHAT IS DEMAND?
The term DEMAND, in economics, refers to desire for a commodity backed by ability and willingness to pay. A desire for a commodity exists when there is a want. Ability means the income or purchasing power of the person who desires the commodity. Willingness refers to the readiness of the person to spend money. Thus the desire for a commodity backed by the ability in terms of income and the willingness to spend the income becomes demand. Mere desires are not demand. Thus, Demand = Desire + Ability to pay + Willingness to spend Hence, DEMAND can be defined as Demand means the desire backed by ability and willingness to pay for the commodity at the given point of time and at a given price.

WHAT ARE THE DETERMINANTS OF MARKET DEMAND?

Price of the product: Price of the commodity is the most important factor influencing demand. Usually a large quantity is demanded at a lower price and smaller quantity is demanded at a higher price. Income of the consumer: Income of the consumer is another important factor affecting demand. Usually income and demand are directly related. Higher the income greater is the demand and vice- versa. Tastes & Preference: The demand for the commodity is greatly affected by the tastes and preferences of the consumers. If the consumer begins to dislike the commodity its demand falls even though its price remains same and vice- versa. Price of the substitutes: When more than one commodity satisfies the same want then those commodities are called close substitutes of each other. For e.g. Tea and coffee, Ink pen and ball pen, etc. The demand for the commodity depends upon the relative prices of its substitutes. When the price of the commodity rises, the demands for its substitutes will increases and vice versa. Price of complimentary goods: When in order to satisfy a want two or more goods are required then these goods are called as complimentary goods. For e.g. Pen and Ink, Tea and Sugar, etc. The demand for commodity is also affected by prices of its complimentary products. When price of a commodity falls the demand for its complimentary product will rise and vice- versa. Advertisement and Salesmanship: Advertisement plays an important role in determining demand. More effective advertisement will bring more demand and most effective salesmanship leads to have more demand. Size and Composition of population: Demand for goods also depends on the size and composition of population. Larger the number of people larger will be the demand for goods. Age composition also influences the demand for the goods. A larger number of children in the country will increase the demand for the baby food and toys.

Consumers Expectation about future prices: The consumers expectation abouth the future prices also influences the demand. If at the time of falling prices, he expects price to fall further, he will postpone his purchase, so he will demand less even at lower price. If he expects price to rise he will demand more even at higher prices. Weather / Climatic conditions: Demand for a certain goods depends on weather conditions. For e.g. in summer there is a greater demand for cold drinks, air coolers, etc. during monsoon the demand for raincoats and umbrella rises. Customs: Demand for certain goods are determined by social customs, festivals, etc for e.g, during Diwali festivals there is a great demand for sweets and crackers and during Christmas cakes are in more demand. Inventions and Innovations: Introduction of the new goods as a result of inventions and innovations tends to adversely affect the demand for the existing products, which become obsolete. For e.g. invention of computers has made typewriter obsolete. Utility: The demand for a commodity depends on its utility. When a person finds no utility in a commodity, he will not demand it. For e.g. there is no demand for cigarettes from a non smoker. Availability of a credit: Demand for expensive and durable goods depends on availability of credit. Greater the availability of credit, larger will be the demand and vice- versa. Distribution of Income and Wealth in the country: If wealth is more equally distributed, there will be more demand for necessaries and comforts, whereas if wealth is concentrated in the hands of the rich, demand for luxuries increases.

EXPLAIN LAW OF DEMAND

Introduction: The law of demand is given by rof. Alfred Marshall. The law of demand explains the relationship between price of commodity and its quantity demanded. It explains the normal behavior of the customer in response to variation in price of the commodity. i.e. It indicates whether the consumer will buy more or less of the commodity when its prices falls or rises. The law of demand is generalized statement of relationship between price of the commodity and its quantity demanded. Though demand depends upon many factors but price is the most important factor. So demand is function of price. Symbolically it can be expressed as D = F (P) Statement of Law: According to Marshall, Law of Demand states that Other things being equal, the quantity demanded rises with the fall in price and diminishes with the rise in price. Explanation of the Law: The law of demand proves that there is inverse relationship price and demand i.e. more is demanded at less price and less at high price. The law of demand can be explained with the following illustration:

Demand Schedule Price per unit (Rs Per Unit) 5 4 3 2 1 Quantity Demanded (per day) 10 20 30 40 50

5 4
Price (R.s)

3 2 1
10 20 30 40 D X 50

Quantity of X demanded

Explanation of Diagram and Schedule: The law of demand states that there is a inverse relationship between price and demand. Here if you see in the diagram and schedule as when the price of unit of commodity is Rs. 1 the quantity demanded is 50 units but as the price increases the demand falls. It is a combination or a group of firms producing identical product. Industry can employ its own resources in the above diagram on Y- axis Price is mentioned and on X- axis Quantity is mentioned. By plotting the points and by joining them we get total demand curve i.e. DD. The demand curve slopes downwards from left to right, which shows the relationship between price and quantity demanded. Assumptions: No change in consumers income: The consumers income should remain same. If there is an increase in consumers income, he will buy more even at high prices and then the law of demand will not operate. No change in consumers taste and preference: The law of demand assumes that the tastes and preference of the consumers remain the same. If there is any change, the law of demand will not operate. For e.g. if people prefer coffee to tea, then they will buy coffee even its price rises. No change in fashion: It is assumed that there is no change in fashion because if a commodity goes out of fashion the buyers may not buy even if its price is reduced. No change in the price of the related goods: The law of demand assumes that the prices of the related goods like substitutes and complimentary goods will remain same. If the prices of related goods change, the law of demand will not be applicable. No change in population: It is assumed that size, age, composition and sex ratio of population remain same because they also affect demand. No change in weather conditions: It is assumed that there is no change in weather conditions because of certain commodities like umbrellas, woolen clothes, etc demand depends upon weather conditions.

No expectations about future prices: The law assumes that there is no expectation about the changes in the future prices. Because if a consumer expects a further fall in the price he will not buy more at present and vice versa. No introduction of new product: It is also assumed that there is no introduction of new product in the market, which may disturb the consumers preference. No change in taxation: It is assumed that there is no change in taxation policy of the government throughout the operation of law. No change in technology: The law assumes that there is no change in prevailing technology. No new technology should be introduced, otherwise that may affect the habit, and preference of the consumers. Normal goods: Marshall assumes that this law is applicable only on Normal goods. This law cannot be proved in case of giffens goods, prestige goods and necessary goods. No change in advertisement: Effective and extensive advertisement of the product will affect consumers preferences. Thus, advertisement is assumed to remain constant. Conclusion: The law of demand indicates the inverse relationship between price and quantity demanded. The law of demand while explaining the relationship between the price and quantity demanded expects all factors other than the price to remain constant.

WHAT ARE THE EXCEPTIONS TO THE LAW F DEMAND?

Y

The law of demand states that the price of commodity and its quantity demanded varies inversely i.e. more is demanded at less P1 price and vice- versa. Economic laws are not universally applicable. Following are the exceptions of Law Of Demand where P the law is not applicable.

Giffens goods (giffens paradox):

Q1

Giffen good is an inferior god which is purchased less at a lower price and more at a higher price. The terms giffen goods is named after Sir Robert Giffen an economist of 19th century who observed the behavior of the poor who purchased more inferior quality of bread when its prices went up. Inferior goods refer to potatoes, bread, rice, etc. the more quantity is demanded even at higher prices. Lord Robert Giffens observed that there was an increase in the price of the bread, than too the consumer continued to purchase the same quantity of bread, which was used by them consuming together with meat. Meat is superior good as compared to bread. Hence with the rise in the price of inferior goods the consumption of superior goods is reduced, where as the consumption of inferior goods remain same or increased. It is because amount spend on superior goods is diverted towards purchasing inferior goods. In the diagram, it can be seen that the demand curve slopes upwards from left to right, which is called as Exceptional Demand Curve, which represents direct relationship of price and demand for a commodity. Prestige Goods: Prestige goods such as diamonds, costly furniture, etc are purchased by the rich people to maintain their standard in the society. Hence even at high prices, the demand for such commodities from the rich people would be high. Price illusion: When the price of a commodity falls, the consumer feels that its quality is lowered (reduced), so the demand for it would decrease and vice versa. Ignorance (Lack of Knowledge) If the price of the commodity falls and the consumers does not have the idea about the fall in price of commodity, he will not buy more.

Quality Goods: The consumers purchase more quantity of quality goods even at high prices and vice versa. For e.g. Raymond Suiting, Sarees of Bombay Dyeing are demanded even at higher prices due to their better quality. Fashions: If a commodity has gone out of fashion, it will not be demanded even at the lower price and viceversa. Necessaries (Essential Commodities): In the case of necessaries like wheat, rice, vegetable, etc. even if the price rises, the demand with not fall. Expectation Regarding Future Changes in Price: The law does not apply when consumer expects changes in the prices of the commodity in a near future. Hence, if there is fall in price at present, but consumer expects a future fall in price in future, he will purchase less quantity at present price. Share Market: If the prices of a companys shares goes up in the market, its demand goes up, in the anticipation of high profits in the future that is why the law is not applicable to share market.

WHAT IS A ELASTICITY OF DEMAND?

Demand for a commodity extends or contracts with the full and all rise in price of the commodity. It is observed in the market that a change in price leads to in demand but not always proportionate. To explain the response of demand to the change in price, Prof. Alfred Marshall introduced the concept of Elasticity of Demand in the Micro Economics theory. According to Marshall, The elasticity or responsiveness of the demand in the market is or small accordingly the quantity demanded increases much or little for a given fall in the price and diminishes much or little for given rise in price In simple words, elasticity of demand is the proportionate change in quantity as a result of proportionate change in price. Thus it is a degree of responsiveness of quantity demanded to a change in price of commodity.

Types Of elasticity of demand: The elasticity of demand is of three types: 1. Price Elasticity 2. Income Elasticity 3. Cross Elasticity Price Elasticity: It refers to the extent of change of demand for a commodity to a given change in price. It can be measured with the following formula: Price Elasticity of Demand = Income Elasticity: Income elasticity refers to extent of changes in demand for a commodity to a given change in income of consumer. It can be measured with the following formula: Income Elasticity of Demand = Cross Elasticity: It refers to change in a demand for commodity to a given change in the price of related or substitute commodity i.e. change in the demand of coffee due to change in the price of tea. It can be measured with the following formula: Cross Elasticity =

WHAT ARE THE TYPES OF PRICE ELASTICITY OF DEMAND?

There are five types of price elasticity of demand namely: 1. 2. 3. 4. 5. Unitary elastic demand Relatively inelastic demand Relatively elastic demand Perfectly inelastic demand Perfectly elastic demand

Unit/Unitary elastic demand (ED = 1 )

When a change in the price of the commodity brings about an exactly equal change in demand of that commodity is known as unit elasticity of demand. Unit elasticity of demand is always equal to one. E.g. If prices falls by 10% and quantity demanded rises by 10% then

Ed =

Ed =

ED = 1

Relatively inelastic demand ( ED < 1 )

When the change in the price brings about less then proportionate change in quantity demanded the demand is relatively inelastic. In other words, great change in price brings a very less change in quantity demanded then the Ed is less than one. Here, DD curve is steeper E.g. if the price falls by 10 % and quantity demanded rises by 5% then,

Ed =

Ed =

= = 0.5 < 1

Relatively elastic demand ( ED > 1 )

When a small change in the price of commodity brings about a more than proportionate change in the demand for it. Then demand is relatively elastic or we can say that Ed is greater than one. Here, DD curve flatter. E.g. if a price falls by 10% and the quantity demanded rises by 20 %, then

Ed =

Ed =

=2

Perfectly inelastic demand:

When the change in the price has no effect on quantity demanded then demand is perfectly inelastic or Ed is zero. Here, demand curve is vertical. E.g. if price changes by 10% and demand does not change at all, then, Ed = Perfectly elastic demand ( Ed = ) Ed = =0

This is also known as infinite elasticity of demand. This is a situation where a slight change in the price of commodity brings about an infinite change in the quantity demanded. In this type, demand curve is horizontal.

WHAT ARE THE TYPES OF INCOME ELASTICITY OF DEMAND?

Zero income elasticity of demand: When a change in income does not bring about any change in demand, it is called zero income elasticity of demand. In this case income elasticity is equal to zero. This is shown in the diagram. In the above diagram income demand curve is parallel to OY axis. Though income increases from OP and OP1 there is no change in demand.
Y P1 P 10

Infinite income elasticity of demand: When a small change in income causes an infinite change in demand, it is called infinite income elasticity of demand. In this case income elasticity is equal to infinity. This is shown in the diagram. In the diagram income demand line is parallel to X-axis.
Y

10

Unitary income elasticity of demand: If a change in income brings exactly the same proportionate change in demand, it is called unitary income elasticity of demand. In this case, income elasticity is equal to one. This is shown in the diagram. In the diagram the change in income and change in demand are equal.
Y 10 P1 P

X M M1

More than one income elasticity of demand: If a change in income brings more than proportionate change in demand, it is called more than one elasticity of demand. Generally, the income elasticity for luxuries will be more than one. This is shown in the diagram. In the diagram the change in demand is more than the change in income.

Y 10 P1 P

X M M1

Less than one income elasticity of demand: If a change in income brings less than proportionate change in demand, it is called less than one income elasticity of demand. Generally, the income elasticity for necessaries will be negative. This is shown in the diagram. In the diagram the change in demand is less than the change in income.
Y 10 P1 P

X M M1

Negative income elasticity of demand: If an increase in income causes a decrease in demand, it is called negative income elasticity of demand. In the case of inferior goods, the income elasticity of demand will be negative. This is shown in the diagram. In the given diagram an increase in income causes a decrease in demand. Hence, income elasticity is less than zero.
Y P1 P 10

X M M1

WHAT ARE THE TYPES OF CROSS ELASTICITY OF DEMAND?

Positive cross elasticity of demand: If the two commodities such as tea and coffee are so related that change in price of coffee bring about change in demand for tea in the same direction then cross elasticity of demand is positive. Tea and coffee are substitute goods. Therefore in case substitutes the cross elasticity of demand is positive.
Y D1

xy > 0

Negative cross elasticity of demand: If change in the price of one commodity brings about change in demand for another commodity in opposite direction then cross elasticity of demand is negative. Complementary goods have negative cross elasticity of demand.
Y xy < 0

D2 0 X

Zero cross elasticity of demand: When change in the price of one commodity will have no effect on demand for other commodity, then cross elasticity of demand will be zero. Unrelated goods have zero cross elasticity of demand.
Y D3

xy = 0

WHAT IS PROMOTIONAL ELASTICITY OF DEMAND?

Promotional elasticity of demand refers to the degree of responsiveness of change in sales to changes in advertising and promotional expenditure. Promotional elasticity of demand is a ratio between sales and advertising expenditure. It is also known as advertising elasticity of demand. The expansion of the demand by means of advertising and other promotional efforts may be measured by advertising elasticity of demand also called promotional elasticity. EA =
Y S

WHAT ARE THE EXPENDITURE?

FACTORS

AFFECTING

ADVERTISEMENT

Stage of market development of the product: The advertising elasticity of demand depends on whether the product is new or it has established market or growing market. If the product is new, the advertising elasticity of demand is relatively elastic. If the product is old and established, the advertising elasticity demand is relatively inelastic. Competitors reaction: If the competitors react by further advertisement or increased sales efforts then the advertisement elasticity of demand of the companys product is affected adversely. Quality and quantity, past and present advertisement: The quality and quantity of the companys past and present advertising relative to that of competitors will affect the elasticity of demand for its product. For example, company A may increase its expenditure on advertisement. But if its competitor company B changes its mode of advertisement from local press to cinema slides then company Bs sales would increase affecting company As sales and advertisement expenditure. The companys past advertisement would affect its current and future sales.

WHAT ARE THE DETERMINANTS OF ELASTICITY OF DEMAND?

Availability of substitutes: The demand for a product having a close substitute is relatively elastic. For example, lux soap. But the demand for commodity having no close substitute is inelastic. For example, salt. Necessaries, comforts and luxuries: The demand for necessaries is relatively inelastic whereas the demand for comforts and luxuries is relatively elastic. Nature of use: Commodities having several uses tend to have more elastic demand. For example, electricity. While a commodity having a specific use tends to have less elastic demand or relatively inelastic demand. For example, chalk. Income of the consumer: A rich consumers demand will be inelasticity even at high prices of goods. While poor consumer has more elastic demand for goods in general.

Level of prices: High priced commodities have generally relatively elastic demand. For example, car. On the other hand a low priced commodity like match box will have a relatively inelastic demand. Habits and customs: The demand for goods purchased out of habits will be relatively inelastic. Also when certain goods are purchased due to social customs and traditions, the demand for them would be relatively inelastic and vice versa. Durability of the commodity: If the commodity is durable, the demand for that commodity will be relatively inelastic. If the commodity is perishable, the demand for that commodity will be relatively elastic. Urgency and postponement: If the demand for a commodity can be postponed or if it is not urgent, the demand for it is said to be relatively inelastic. Time period: In a short period, the demand for the goods is relatively inelastic. But during the long run, the demand is relatively elastic. Jointly demanded or complementary goods and joint products: The demand for a commodity used jointly with other commodities to satisfy a single want is relatively inelastic. Thus, above are the main determinants of elasticity of demand.

PRODUCTION POSSIBLITY FRONTIER / CURVE

The concept of production possibility curve is given by the famous economist Prof. Samuelsson. It explains the basic subject matter of economics namely scarcity of resources. The resources like land, labour, capital, technology, etc available to any economy is limited. Hence they have to be utilized in the best possible manner to produce the maximum output. The question of efficiency arises only when there is scarcity. An economy is said to be efficient when the maximum output is produced at minimum cost of production. This output is also termed as the least cost output. The production possibility frontier can be illustrated by an example. Let us suppose an economy has certain amount of resources which can be used for producing two goods namely rifles and bread. While the former is a defence good, the latter is a civilian good. If all the resources are used for producing war tanks then production of bread is impossible and vice versa. The

economy is supposed to produce a combination of both the goods. The various production possibilities of both the goods can be depicted through a table and a diagram. Production Possiblities Possibilities A B C D E F Bread (thousands) 0 1 2 3 4 5 Rifles 20 19 17 14 10 0

In the above possibilities, if all the resources are used for the production for rifles, then production of bread will be zero. On the other hand if the resources are entirely used for the production of rifles will be nil. In between these two extremes, there are a number of other possibilities. When the production of bread is increased the production of rifles will come down and vice versa. The production possibilities can be vividly explained with the following diagram:

15 12 9 6 3 0 X .1 .U

In the above diagram PP1 is the production possibility curve. It shows the schedule along which the two goods can be substituted for each other. If all the resources are used for the production of bread, production of rifles will be nil and vice versa. Points B,C,D,E represent the combination of both the goods. If combination B is selected more of rifles and less of bread will be produced. On the other hand, combination E signifies production of more bread and less of rifles. PPF shows the maximum amount of the two goods that can be produced given the inputs and technology. In other words, PPC is nothing but the menu available to the society regarding goods and services.

The production possibility curve has two properties: 1. It slopes downwards from left to right 2. It is concave to the origin The first property implies that the PPC has negative slope. i.e. when the production of one commodity is increased production of the other has to be reduced. In the above diagram, if the production of bread has to be increased from 3000 to 4000, production of rifles has to be reduced from 14 to 10. This feature indicates the problem of scarcity. The curve is concave to the origin due to the operation of law of increasing cost. When resources are employed in a particular operation, they become efficient over a period of time. They know the method of working and the operation is done smoothly. When the resources are shifted to some other work they take some time to adapt themselves. More inputs are required to produce a certain level of output. Hence the cost of production will increase. This makes the PPC a concave shaped curve. This concept of PPF is useful to an economy in a number of ways. Certain problems are central to every economy. They are: 1. 2. 3. 4. 5. What to produce How to produce Whom to distribute How to achieve full employment How to achieve optimum utilization of resources, etc.

PPC helps to find out solutions for such problems. The first problem is to decide about the combination of goods to be produced. If the economy is a peace loving one, more civilian goods will be produced and production of military goods will be less. On the other hand, if there is a dictatorship form of government, then military goods will be preferred to civilian goods. According to the preference, resource allocation will be done. At present even the peace loving countries have to spend a huge amount on defence due to various compulsions. This definitely affects the production of other goods and services. The problem of the scarcity and concept of opportunity cost are well brought out by production possibility frontier. In any economy the resources are limited. With the given resources, the combination of goods has to be produced. If the production of one good is increased then the production of the other has to be reduced. Opportunity cost is the next best alternative that is foregone. In the above diagram when production of rifles increases, a certain amount of bread production has to be sacrificed. Here the opportunity cost is the quantity of bread that is sacrificed. PPF also indicates the level of efficiency attained by an economy in resource utilization. While it is not possible to select a combination outside the frontier, combinations inside the frontier implies that the economy has not attained productive efficiency. There is under utilization and

inefficient distribution of resources. There is a need for up gradation of technology and reallocation of resources.

WHAT IS DEMAND FORECASTING?

Forecasting means expectations above the future course of developments. Demand forecasting may be defined as: The process of finding values for demand in future time periods. Demand forecasting is also known as business forecasting Demand forecasting is useful for managerial decisions making and for effective and efficient planning. It is also helpful in better planning and allocation of national resources.

WHAT ARE THE METHODS OF DEMAND FORECASTING?

Demand forecasting is nothing but an estimate of the future. It cannot be cent percent true but it gives a reliable approximation regarding the possible outcome with reasonable accuracy. In modern business production is often made in anticipation of demand. Here, the demand forecasting explains expectation above the future course of the market demand for a product. Methods of demand forecasting: Forecasting involves future, which is uncertain. There is no easy method or formula, which enables the business or individuals to predict the future with certainty. There are several methods for demand forecasting basically for three reasons: a) No method is accurate and no method is useless. b) No method is best under all circumstances. c) The best method may not be available in a particular situation, due to constraints from data on resources ( time and money ). Survey methods or direct methods: Survey methods are used to forecasts demand for new products. Forecasting through this method is based on personal judgment and experience. Consumers survey: This is the most sophisticated and direct method of demand forecasting. In this method consumers are directly asked about their future consumption plan. In this method questionnaires are prepared to find out buyers intension. This is recorded through personal interview, mail or post surveys and telephone interviews. Questionnaires should not be difficult. Sample survey method:

Sample survey method is more popular than complete enumeration method. In this method only a few consumers are selected from potential consumers, and they are interviewed. It is possible to calculate average demand on the basis of sample survey method. The aggregate demand for the product is estimated by multiplying this average demand with total number of consumers. Experts opinions survey method: Besides consumer survey method a firm can not conduct opinion survey method. There are group of specialist who know the market. These are salesman, market consultants, professional experts, etc. These people have studied the market trend and consumers responses for years. They know the consumers reaction to new products, demand for rival products, future plans of the consumer, etc. In this method help of marketing managers, managerial economists, production managers, sales managers, and other top executives may be taken to conduct expert opinion survey. This method is also known as collective opinion method because its forecast is based on aggregate opinion of the experts in the fields. Simulated market situation: In this method an artificial market situation is created and participants are selected. These are called consumer clinic. These selected participants are given a selected sum of money and asked to spend in an artificial departmental store. Different promotional are put up or different prices are set up for different group of participants. They are asked to spend competing products. The responses of the participants are observed. Accordingly necessary decisions about price and promotional efforts are undertaken Controlled market experiments: In this method a firm may conduct the same experiments of simulated markets situation in actual market. A firm may reduce the price of the commodity in the actual market and observe the consumers reactions and compare the sales with price. A firm can fix up different prices in different market and observe the responses of the consumers. If the responses of consumers are positive then firm may take the risk of spending more amounts on such campaigns. Statistical or indirect methods: Demand forecasting also uses statistical methods. This method is useful for long run forecasting for the existing products. In this method some statistical method and mathematical techniques are used to estimate future demand. Trend projection method: This method is based on the analysis of the past sales pattern. This method is used in case of sales data of the firm under consideration relates to different time period i.e. it is a time series

data. The time series shows effective demand for the product during the period of the past 10 to 15 years. There are five main techniques of trend projection method. Least square method: These days least square method is widely in use. It is a mathematical device which helps one to fit the trend line to the data. The trend line is estimating equation which can be used for forecasting the demand. This method is based on the assumption that past rate of change of the variable will continue in future. Time series: This method attempt to build seasonal and cyclical variations into estimating equations. Time series refers to the data over a period of time during which time fluctuations may occur. Time series analysis relate to the determination of change in a variable in relation to time. Moving average method: Either 3 yearly, 4 yearly or 5 yearly moving average is calculated. The trend so obtained is plotted on a graph. A free hand curve is drawn through the points. The direction of this curve determines the trend. By extending this curve for years ahead demand is forecasted. This method is popular because it is simple and inexpensive. Exponential waited moving average methods: In this method recent observation is given higher weight as compared to past observation. These weights will be properly chosen. Once a smooth time series is obtained either through moving average or exponential weighted moving averages, the trend method can be applied to this series to generate demand forecasts. Regression method: The regression method is most popular method of demand forecasting. It is a tool to estimate the known values of another variable. Simple regression is used when we consider relation between two variables, one dependent variable (sales) and other independent variable (price). Multiple regressions are used to estimate demand as a functional of two or more independent variable that vary simultaneously. Conclusion: There is no unique method for demand forecasting or for forecasting any other variable. The forecaster may use any method depending upon the objective, availability of data, type of product, etc. Since no method is perfect, and so more than one method can be used in practice.

WHAT ARE THE CRITERIA OF A GOOD FORECASTING METHOD?

Accuracy: Forecasting should be accurate. It is necessary to check the accuracy of the past forecast against the present performance and present forecast against the future performance. Forecasting method which gives high returns than its costs should be selected. Reliability: The management executives must have faith in the forecasting method. They must examine what the specialists are doing in estimating demand for the product. Durability: Durability of the forecasts depends upon the reasonableness and simplicity. The functional relationship measured in the demand function should be stable. Forecasting should be valid over a period of time. Flexibility: Not only the forecast is to be maintained up to date, there should be possibility of changes to be incorporated in the forecast procedure from time to time. Availability: The technique used to forecast should give immediate result and that are required to management must be available easily. The demand function is worked out on the basis of data published by the government agencies.

WHAT IS COST?
Cost means expenditure incurred on producing a commodity. Obliviously, this is constituted of the payment made to the different factors for obtaining there services. Every rupee of the cost reduces the firms profit. The term cost of the product means the expenditure incurred on producing the commodity which consists of rewards to four factors of production in the firm of rent, wages, interests and profit which may be paid either in cash or in kind.

WHAT IS REAL COST?

The concept of real cost was involved by Alfred Marshall. Real cost refers to physical quantities of inputs in production and sacrifice by labourers. It signifies the aggregate of real productive resources observed in the production of a commodity or a service. Real cost is defined by Marshall as: The excertion of all the different kinds of labour that are directly or indirectly involved in making it together with the abstinences or rather the waiting required, for saving the capital used in making it all, all these efforts and sacrifices together will be called the real cost of production of a commodity Major deficiency associated with the concept of real cast is that, it is not possible to precisely measure it in objective terms. This is because it is primarily a subjective concept. How can one add, subtract and calculate the sacrifices or pains and exertions. This difficulty greatly reduces the economic significance of the concept. It does not, however, mean that the concept is a useless one. In fact, it is this concept of real cost that provides the basis for the calculation of money coast at least indirectly.

WHAT IS MONEY COST?

Money cost refers to the money expenditure incurred by the firm for producing a certain level of output. Expenditure in monetary terms has to be incurred on various items such as wages, interest, rent, raw material, power, etc. this money cost can be classified into the explicit and implicit cost. Explicit costs Explicit cost refers to the direct contractual payments made to the factors purchased or hired by a firm from others. Explicit cost includes 1. 2. 3. 4. 5. 6. 7. 8. Rent of factory premises Wages and salaries Interest on capital invested Cost of raw materials Power charges Transport, marketing and advertisement costs Insurance premiums License fees, property tax, etc.

These explicit money costs are known as accounting costs.

Implicit costs Implicit costs are the opportunity cost of the use of factors that a firm does not buy or hire but already owns. Implicit money costs are imputed payments which are not actually paid out by the firm. Implicit costs arise when the entrepreneur supplies certain factors owned by him. Implicit money costs includes the following a) b) c) d) Rent of land and premises owned by the entrepreneur. Wages of labour rendered by the entrepreneur. Interest on capital supplied by the entrepreneur himself. Normal profits which the entrepreneur should get for his organization and management.

These items must be valued at the current market rates for estimating the implicit money cost. Economic Profit = Total Revenue Total Economic Costs Economic Costs = Accounting Cost (or Explicit Cost) + Implicit Cost

WHAT IS OPPORTUNITY COST OR ALTERNATIVE COST?

The concept of opportunity cost lies in two facts 1. The resources are scarce and 2. They have alternative uses. The alternative use of resources implies that the same resources can be used in different ways. However, their employment in one use implies that the other possible alternatives i.e. opportunities have to be sacrificed e.g. labour can be used for producing either commodity A or commodity B . When employed in the production A the opportunity of producing B is lost. Thus, the loss of B is the opportunity cost of production A.

WHAT IS FIXED COST?

Fixed costs remain fixed irrespective of the level of output in the short run. Fixed costs are those costs that are incurred as a result of the use fixed factors inputs. Fixed costs are called overhead costs because they are to be incurred even if firm is shut down and the current production is nil. Fixed cost are also known as unavoidable contractual costs which occur even if, there is no output, and fixed costs include: 1. 2. 3. 4. 5. 6. Payment of rent Wages of labour Insurance premium Depreciation and maintenance allowance Administrative expenses, salaries of managerial and office staff, etc. Property and business taxes, license fees, etc.

WHAT IS VARIABLE COST?

Variable costs vary directly with the output. Variable costs are those costs that are incurred by the firm as a result of the use of variable factor inputs. They are dependent on the level of output. Variable costs include: 1. 2. 3. 4. 5. Prices of raw materials Wages of labour Fuel and power charges Excise duties, sales tax, etc. Transport expenditure, etc

The distinction between fixed and variable costs emerge only in short run because in the long run all costs are variable.

EXPLAI N THE VARIOUS TYPES OF PRODUCTION COSTS?

In economic analysis relating to cost of production we can come across with seven types of costs which a firm has to incur when it organizes and undertakes production in the short run. These seven types are: Total cost (TC) Total cost is the aggregate expenditure incurred by a firm in producing a given level of output. Total cost refers to the total explicit and implicit money costs including normal profits.

TC = f (Q)

Which means total cost varies with output Total cost is arrived at only by multiplying the quantities of all the factors inputs by their respective unit prices and making their total. In the short period, total cost consists of total fixed cost and total variable costs. TC = TFC + TVC

Total fixed cost (TFC) Total fixed cost refers to the total expenditure incurred on fixed factors in the short run. It is obtained by summing up the product of quantities of the fixed factors multiplied by their respective unit prices. TFC remains the same at all the levels of output in short run. Total variable cost (TVC) Total variable cost refers to the total expenditure incurred on variable factors in short run. It is obtained by summing up the product of quantities of variable factor inputs multiplied by their prices. TVC = f (q) Which means total variable cost is an increasing function of output.

Average fixed cost (AFC) Average fixed cost is the fixed cost per unit of output. Average fixed cost is the total fixed cost divided by the total units of output. AFC = Where Q stands for the number of units of the product. Average variable cost (AVC) Average variable cost is the variable cost per unit of output. Average variable cost is the total variable cost divided by the total units of output. AVC = Where Q stands for the number of units of the product. Average total cost (ATC or AC) Average total cost is the total cost per unit. Average total cost is the total cost divided by the total units of the output. ATC = Where Q stands for the number of units of the product. ATC = ATC = AFC + AVC Marginal cost (MC) Marginal cost is the addition made to the total cost by producing one more unit of output MCN= TCN TCN-1 i.e. the marginal cost of the nth unit of output is the total cost of producing N units minus the total cost of producing N-1 units of output.

Symbolically, MC = Where, TC denotes a small change in total cost Q denotes a change in output by 1 unit only. Marginal cost is the cost of producing an extra unit of output. It indicates a change in total cost by producing an additional unit. MC measures the changes in variable cost only and not fixed cost in short run.