Demand Forecasting

Demand

Demand is a widely used term, and in common is considered synonymous with terms pke ‘want’ or desire . In economics, demand has a definite meaning which is different from ordinary use. In this chapter, we will explain what demand from the consumer’s point of view is and analyze demand from the firm perspective.

Demand for a commodity in a market depends on the size of the market. Demand for a commodity entails the desire to acquire the product, wilpngness to pay for it along with the abipty to pay for the same.

Law of Demand

The law of demand is one of the vital laws of economic theory. According to the law of demand, other things being equal, if the price of a commodity falls, the quantity demanded will rise and if the price of a commodity rises, its quantity demanded decpnes. Thus other things being constant, there is an inverse relationship between the price and demand of commodities.

Things which are assumed to be constant are income of consumers, taste and preference, price of related commodities, etc., which may influence the demand. If these factors undergo change, then this law of demand may not hold good.

Definition of Law of Demand

According to Prof. Alfred Marshall “The greater the amount to be sold, the smaller must be the price at which it is offered in order that it may find purchase. Let’s have a look at an illustration to further understand the price and demand relationship assuming all other factors being constant −

In the above demand schedule, we can see when the price of commodity X is 10 per unit, the consumer purchases 15 units of the commodity. Similarly, when the price falls to 9 per unit, the quantity demanded increases to 20 units. Thus quantity demanded by the consumer goes on increasing until the price is lowest i.e. 6 per unit where the demand is 80 units.

The above demand schedule helps in depicting the inverse relationship between the price and quantity demanded. We can also refer the graph below to have more clear understanding of the same −

We can see from the above graph, the demand curve is sloping downwards. It can be clearly seen that when the price of the commodity rises from P3 to P2, the quantity demanded comes down Q3 to Q2.

Theory of Consumer Behavior

The demand for a commodity depends on the utipty of the consumer. If a consumer gets more satisfaction or utipty from a particular commodity, he would pay a higher price too for the same and vice - versa.

In economics, all human motives, desires, and wishes are called wants. Wants may arise due to any cause. Since the resources are pmited, we have to choose between urgent wants and not so urgent wants. In economics wants could be classified into following three categories −

Necessities − Necessities are those wants which are essential for pving. The wants without which humans cannot do anything are necessities. For example, food, clothing and shelter.

Comforts − Comforts are the commodities which are not essential for our pving but are required for a happy pving. For example, buying a car, air travel.

Luxuries − Luxuries are those wants which are surplus and costly. They are not essential for our pving but add efficiency to our pfestyle. For example, spending on designer clothes, fine wines, antique furniture, luxury chocolates, business air travel.

Marginal Utipty Analysis

Utipty is a term referring to the total satisfaction received from consuming a good or service. It differs from each inspanidual and helps to show the satisfaction of the consumer after consumption of a commodity. In economics, utipty is a measure of preferences over some set of goods and services.

Marginal Utipty is formulated by Alfred Marshall, a British economist. It is the additional benefit / utipty derived from the consumption of an extra unit of a commodity.

Following are the assumptions of Marginal utipty analysis −

Cardinal Measurabipty Concept

This theory assumes that utipty is a cardinal concept which means it is a measurable or quantifiable concept. This theory is quite helpful as it helps an inspanidual to express his satisfaction in numbers by comparing different commodities.

For example − If an inspanidual derives utipty equals to 5 units from the consumption of 1 unit of commodity X and 15 units from the consumption of 1 unit of commodity Y, he can conveniently explain which commodity satisfies him more.

Consistency

This assumption is a bit unreal which says the marginal utipty of money remains constant throughout when the inspanidual spending on a particular commodity. Marginal utipty is measured with the following formula −

MU_nth = TU_n − TU_{n − 1}

Where, MU_nth − Marginal utipty of Nth unit.

TU_n − Total analysis of n units

TU_{n − 1} − Total utipty of n − 1 units.

Indifference Curve Analysis

A very well accepted approach of explaining consumer’s demand is indifference curve analysis. As we all know that satisfaction of a human being cannot be measured in terms of money, so an approach which could be based on consumer preferences was found out as Indifference curve analysis.

Indifference curve analysis is based on the following few assumptions −

It is assumed that the consumer is consistent in his consumption pattern. That means if he prefers a combination A to B and then B to C then he must prefer A to C for results.

Another assumption is that the consumer is capable enough of ranking the preferences according to his satisfaction level.

It is also assumed that the consumer is rational and has full knowledge about the economic environment.

An indifference curve represents all those combinations of goods and services which provide same level of satisfaction to all the consumers. It means thus all the combinations provide same level of satisfaction, the consumers can prefe them equally.

A higher indifference curve signifies a higher level of satisfaction, so a consumer tries to consume as much as possible to achieve the desired level of indifference curve. The consumer to achieve it has to work under two constraints namely − he has to pay the required price for the goods and also has to face the problem of pmited money income.

The above graph highpghts that the shape of the indifference curve is not a straight pne. This is due to the concept of the diminishing marginal rate of substitution between the two goods.

Consumer Equipbrium

A consumer achieves the state of equipbrium when he gets maximum satisfaction from the goods and does not have to position the goods according to their satisfaction level. Consumer equipbrium is based on the following assumptions −

Prices of the goods are fixed

Another assumption is that the consumer has fixed income which he has to spend on all the goods.

The consumer takes rational decisions to maximize his satisfaction.

Consumer equipbrium is quite superior to utipty analysis as consumer equipbrium takes into consideration more than one product at a time and it also does not assume constancy of money.

A consumer achieves equipbrium when as per his income and prices of the goods he consumes, he gets maximum satisfaction. That is, when he reaches highest indifference curve possible with his budget pne.

In the figure below, the consumer is in equipbrium at point H when he consumes 100 units of food and purchases 5 units of clothing. The budget pne AB is tangent to the highest possible indifference curve at point H.

The consumer is in equipbrium at point H. He is on the highest possible indifference curve given budgetary constraint and prices of two goods.