CONSUMER DECISION MAKING Chapter 2

LAW OF DEMAND
Most important law of economic theory Other things being equal If the price of a commodity falls, qty. demanded will rise If the price of a commodity rises, its quantity demanded will decline Inverse relationship between price and quantity Constancy of other factors is an important assumption

of law of demand

FACTORS INFLUENCING DEMAND

Price of the commodity- Ceteris paribus- other things being equal,

the demand of a commodity is inversely related to is price. A rise in price of a commodity brings about a fall in its purchase and vice versa Price of Related Commodities
Complementary goods (Tea and Sugar; automobile and petrol; printer and ink) Competing goods or Substitutes (Tea and Coffee)

Level of Income of Households Impact on

Necessaries Comforts & Luxuries Inferior commodities

Tastes of Households Size of Population Composition of Population Distribution of Income Sociological Factors Weather Conditions

Demand: Managerial Implications

The market for a firms product cannot be analysed without reference

to the demand conditions For a firm or an industry consisting of several firms, the extent of demand determines the size of market Successful business firms, therefore, spend considerable time, energy and effort in analysing the demand for their products Without a clear understanding of consumer behaviour and a clear knowledge of the market demand conditions, the firm is handicapped in its attempt towards prfoit planning or any other business strategy planning Estimating present demand and forecasting future demand constitutes the first step towards measuring and determining the flow of sales revenue and profits which generate internal resources to finance business. The stability and growth of business is linked to size and structure of demand

Demand: Managerial Implications

Economists treat Demand and Consumption separately. Business uses these two terms interchangeably Demand and Consumption are organically related. Consumption is an economic activity whereby the use value of item

consumed exhausts. A household consumer demands the items of goods for final consumption; an intermediate consumer like a factory owner demand item of services from factors of production like land, raw materials and labour; these are required towards processing inputs into fiscal output. It is observed that all consumers have limited budget and therefore; while demanding items they are careful to get the best return on their resources spent and thats rationality A combination of rationality and optimality is reflected in consumer behaviour

Demand: Managerial Implications

Consumers Behaviour can be better understood with reference to different types of business:
Industrial Vs. Market Demand
Market Segment Vs. Total market demand Company Vs. Industry demand

Domestic Vs. National demand

Direct Vs. Derived demand Autonomous Vs. Induced demand New Vs. Replacement demand Short run Vs. Long run demand Household Vs. Corporate Vs. Government Demand

DEMAND ELASTICITIES: LESSONS FOR A MANAGER

Elasticity of Demand is a measurement of the extent of

change in demand for a given change in price. This can be measured against many variables other than price like price of other related goods, income etc. Lets have a quick recap: Price Elasticity of Demand: Measures the responsiveness of quantity demanded of a product to changes in its own price. Cross-price elasticity of Demand: This measures the responsiveness of quantity demanded to changes in the prices of other goods (both complements and substitutes) Income elasticity of Demand: Measures the responsiveness of demand to a change in the real income of consumers

DEMAND ELASTICITIES: LESSONS FOR A MANAGER

The terms elastic and inelastic are referred to describe different

degrees of elasticity
Products with a price elasticity of demand of less than 1 are said to have a

relatively inelastic demand with respect to price they are said to be price inelastic Products with a price elasticity of demand greater than 1 are said to have relatively elastic demand they are said to be price elastic Products with a price elasticity of demand equal to 1 are said to have a unit elasticity of demand

DEMAND ELASTICITIES: LESSONS FOR A MANAGER

Elasticity of Demand is a measurement of the extent of

change in demand for a given change in price. This can be measured against many variables other than price like price of other related goods, income etc. Lets have a quick recap: Price Elasticity of Demand: Measures the responsiveness of quantity demanded of a product to changes in its own price. Cross-price elasticity of Demand: This measures the responsiveness of quantity demanded to changes in the prices of other goods (both complements and substitutes) Income elasticity of Demand: Measures the responsiveness of demand to a change in the real income of consumers

DEMAND ELASTICITIES: LESSONS FOR A MANAGER

Firms which want to expand output to concentrate on selling products

with high income elasticities when living standards are rising. With greater purchsing power, people will tend to buy disproportionately more luxury type goods Firms producing goods with low income elasticities will tend to face a more stable market for their products and will be less affected in times of economic downturn. Advertisement expenditure promotes sales, because it creates new demand. This responsiveness of sales to advertisement is referred as promotional elasticity.

DEMAND ELASTICITIES: LESSONS FOR A MANAGER

There is a direct relationship between price elasticity and sales revenue. With a price inelastic demand:
An increase in price causes a reduction in quantity demanded, but total

revenue increases A fall in price causes an increase in quantity demanded, but total revenue earned declines

With a price elastic demand:

An increase in price causes such a large fall in sales that total revenue falls; A reduction in price causes such a large increase in the quantity demanded

that the total revenue rises

Management might raise the price of a product to raise revenues, but

the resulting collapse of demand may actually cause total revenue to contract. Precise responsiveness of demand to a price change determines the effect of a price change on revenue received

Demand Estimation &Forecasting

Strategic sales management seriously considers demand

estimation, forecasting and interpretation Demand forecasting deals with the following two issues:
Estimating demand relationship: Deriving the best specification

of the demand function which establishes relationship between the quantity of the product demanded by consumers and the factors that influence this demand. Eg. Advertisement exp vs. increase in sales. Forecasting demand: This can be both for short-term and longterm decision. Extrapolation or projection of future behaviour on the basis of past behaviour.

Demand Estimation &Forecasting

Demand Estimation involves:
Collection Information: Consumer Surveys and Market

Experiments are considered under this. Historical records of sales is most commonly used. Discovers the future buying patterns of consumers with relative changes to variables like- price, advertising spend, product quality and design etc. Consumer interviews and market research are part of this exercise Market Experiments: Instead of posing hypothetical questions to potential customers, the firm may opt instead to carry out a direct market experiment in order to test buyers reactions to actual changes introduced. Giving money to buyers and asking them to shop in a particular supermarket. Different methods employed for market experimentation are

Sales-wave research Simulated Store Techniques Test marketing

Demand Estimation &Forecasting

Sales Wave Research: This involves the selection of a group of

consumers, supplying them initially with the product at no cost. Some time later the same product is then re-offered to them for sale along with competitors products at prices which can then be varied a number of times (Eg.soaps, shampoos etc). Simulated store techniques: These techniques involve the establishment of a sample group of shoppers who are shown a number of advertising commericals for a range of products including the new products launched. Purchases of new products and of competitors products by the sample group can then be monitored. Test marketing: Involves actually selling the product in a limited number of locations with different packaging and advertising campaigns in order to test market reaction.

Demand Estimation &Forecasting

Forecasting Demand: Planning (getting ready to produce) to meet the future demand necessitates

demand forecasting Forecasting Techniques: Various demand forecasting techniques can be put in two categories:
Barometric Methods Econometric Methods

Demand Estimation &Forecasting

Econometric Methods: Econometric is a science of economic measurement. It is a combination of economics, statistics and methematics The simplest econometric model consists of

One dependent and one independent variable A random disturbance factor

Eg: Let Y = sale of book Y is function of student population (X) Random variable (u), then the econometric model will be Y = f(X) + u

Demand Forecasting Methods

Barometric Methods Include
Historical Analogy Method Survey Method Trend Method or Time Series

(Extrapolation Method) End-use Method Regression Method

Demand Forecasting Methods: Historical Analogy Method

Under this method, forecasting is done on the basis of country

comparisons. There are two stages (i) selection of a country A which sometimes in the past (period 1), particularly with respect to the industry I, the demand of whose product is under forecasting, was in the same stage of development as the country B for which forecasts are being made at present period T, (ii) forecasting of the demand for industry Is product in country B in periods T+1, T+2, T+n on the basis of actual demand of that industrys product in country A in period T+1. T+2T+.n respectively Advantages: It requires neither any time series data nor the use of any statistical technique Limitations:
It is difficult to find two similar countries for comparison Also the trend pattern exhibited in one country in one time period need

not repeat itself in another country in another time

Demand Forecasting Methods: Opinion Poll & Survey Method

Complete Enumeration Survey Method: Aggregate

demand forecasts are obtained by aggregating the probable demands of all individual consumers in the prediction period. By adding the individual demand market demand is obtained. Sample Survey Method:
Select a representative sample of the total universe Obtain the probable demands by the selected sample units Translate the demand of the sample units into the demand of the

whole population

Delphi Methods: Attempt is made arrive at a consensus in

an uncertain area by questioning a group of experts repeatedly until the responses appear to cover along a single line.

Demand Forecasting Methods: Trend Method

Historical data extrapolated Assumed

that the variable under forecasting will move along the established path It is necessary to determine the appropriate trend curve and the values of its parameters to forecast with the help of the estimated trend line or curve

Demand Forecasting Methods: End-use Method

Identify all the possible uses eg : as input to other

industries, direct consumption demand, of the product whose demand is being forecated Obtain the input-output coefficients with respect to the product whose demand forecasting is being attempted and the industries using this product as on item Obtain the desired or target levels of output of all consuming industries and its probable demand for final consumption and exports net of imports in the prediction period; and Derive its inter-industry demand and add the same to its probable demands for final consumption and exports net of imports in the prediction period to yield the forecats of aggregate demand for the product.

Demand Forecasting Methods: Regression Method

Forecast on the basis of an estimated relationship

between the forecast (dependent) variable and variable on whose value it depends i.e. independent variable. Assumed that functional relationship exists between the dependent and independent variable in the past and will continue as before the prediction period Yield of crop in x hectares and the demand for use of tractors. As the yield increases to more hectares, the demand for buying tractors also increases As the literacy population increases, the buyers of books/stationery increases

Consumer Behaviour: Conventional Explanation

Law of demand is not the last word on consumer behaviour Sales executives view law of demand as irrelevant . Consumer Behaviour theory:
The more confidence a person has in price information

as a predictor of quality, the more likely he will be to choose a high-priced, rather than low-priced them A person who perceives himself as experienced in purchasing a product will generally choose a low-priced item, but an inexperienced person will select a highpriced one. A person who purchases a high-priced item will

Believe it is more difficult to judge product quality and Feel he has less ability to make accurate quality judgements than one who chooses a low-priced item

Consumer Behaviour: Conventional Explanation.

A person who purchases a high-priced product would perceive

large quality differentials. He would also feel that it is risky and uncertain to go in for a low priced product. The customer who purchases high-priced product is also cautions. Then social significance or prestige may be attached with the purchase of a high priced product. Business executives also disbelieve that the consumer is rational. Selling a lock at low price resulted in low sales. After increasing its price, the sales picked up. Price got associated with the quality of lock! Purchasing behaviour of the consumer is mostly repetitive in nature Consumer behaviour is complex and is not always as per the law of demand of economics. At each price rise, consumer may reduce his demand/keep demand constant/may even increase it

Consumer Buyer Influences

Cultural factors.

Culture, subculture, social class. Reference groups, family, roles, status. Age, lifecycle, occupation, income. Motivation, perception, learning, beliefs, attitudes.

Social factors.

Personal factors.

Psychological factors.

Culture
Cultural is the most basic cause of a person's wants

and behaviour. Culture is learned from family, church, school, peers, colleagues. Culture includes basic values, perceptions, wants and behaviours.

Social Class
Relatively permanent, ordered divisions. Members share similar values, interests and

behaviours. Determined by a combination of:

Occupation. Income. Education. Wealth.

Other variables.

Social Factors
Groups.
Reference groups, aspirational groups. Importance of opinion leader.

Family.
Most important consumer buying organization.

Roles and status.

Expect activities and esteem given by society to those

roles.

Personal Factors
Occupation.

What we do affects what we need and how much we have to spend. Trend towards more part-time employment and multiple jobs. Affects real spending and consumer confidence in borrowing.
Consumer needs change over time. Difference between chronological and perceived age. A persons pattern of living as expressed in his or her activities, interests and opinions. Also known as psychographics, can capture more detail than personality or social class.

Economic situation.

Age and family life-cycle stage.

Lifestyle.

Personality and Self-Concept

Personality refers to the unique psychological

characteristics that lead to relatively consistent and lasting responses to ones own environment.
Generally defined in terms of traits.
Self-concept suggests that peoples possessions

contribute to and reflect their identities.

Psychological Factors
Motivation.
Perception. Learning.

Beliefs.
Attitudes.

Ultimate Goal

Maslows Hierarchy of Needs (Motivation)

SELFACTUALIZATION

SELF ESTEEM

LOVE & BELONGING

SAFETY & SECURITY

PHYSIOLOGICAL

Highest Priority

Perception
Information inputs.

The sensations received through the sense organs. The process of selecting, organizing and interpreting information inputs to produce meaning. Selecting some inputs to attend to while ignoring others. Changing or twisting of information when it is inconsistent with personal feelings or beliefs. Remembering information that supports personal feelings and beliefs and forgetting inputs that do not.

Perception.

Selective attention.

Selective distortion.

Selective retention.

Learning
A relatively permanent change in behaviour due to experience. Interplay of drives, stimuli, cues, responses and

reinforcement.
Strongly influenced by the consequences of an

individuals behaviour.
Behaviours with satisfying results tend to be repeated. Behaviours with unsatisfying results tend not to be repeated.

Beliefs and Attitudes

Belief
Descriptive thought that a person holds about something.

Attitude
Describes a persons consistently favourable or unfavourable

evaluations, feelings and tendencies toward an object or idea.