Managerial Economics Basics - Gud
Managerial Economics Basics - Gud
Managerial Economics Basics - Gud
Unit I
Definition, Nature and Scope of Managerial Economics, Managerial Economics, Micro Economics and Macro Economics,
Managerial Economics and decision making, Definitions of Basic Concepts: Positive and Normative Approach, Optimization,
Marginal Analysis, Opportunity Cost, Economic Model: Static & Dynamics, Meaning and Determinant of Demand, Demand
Function, Law of Demand, Market Demand, Elasticity of Demand, Types of Elasticity, Measurement of Elasticity, Significance and
uses of Elasticity, Method of Demand Estimation, Demand Forecasting, Forecasting of an established product, Forecasting of a
new product
ECONOMICS: INTRODUCTION
The word Economics is derived from the Greek words “OKIOS NEMEIN” meaning household management .Father of Economics
Adam Smith in his book “ Wealth of Nations 1776” defined economics is the study of wealth (Wealth Definition). Alfred
Marshall in his book “Principles of Economic Science-1890” defined Economics is the study of mankind in the ordinary business
of life (Welfare Definition). Lionel Robbins gave us the most accepted scarcity-oriented definition of Economics. He says
Economics is a social science which studies human behavior as a relationship between unlimited wants and scarce means which
have alternative uses (Scarcity Definition). Economics Noble prize winner (1970) Paul Samuelson proposes a dynamic definition
in his book Economics (1948). Economics is the study of how people and society end up choosing with or without money to
employ scarce productive resources that could have alternative uses to produce various commodities and distribute them for
consumption, now or in the future among various persons and groups in society. Economic analysis is the cost and benefits of
improving patterns of resources use (Growth Definition).
An Example of a microeconomic issue could be the effects of raising wages within a business. If a large business raises its
wages by 10 percent across the board, what is the effect of this policy on the pricing of its products going to be?
Since the cost of producing products has increased, the price of these products for consumers is likely to follow suit.
Likewise, what will happen if a company raises wages for its most productive employees but fires its least productive
workers? Likewise, what will happen if a company raises wages for its most productive employees but fires its least
productive workers?
An Example of Macroeconomic issue would be to observe the effects that low interest rates have on the national housing
market or the unemployment rate. Another common focus of macroeconomics is the way taxes affect the economics of a
nation. A macroeconomist would look at the effects of a decrease in income taxes using measures like GDP and national
income, rather than individual factors.
DEFINITION OF MANAGERIAL ECONOMICS
FEW DEFINITONS
Prof. Evan J Douglas - “Managerial economics
is concerned with the application of economic
principles and methodologies to the decision-
making process within the firm or
organization.”
From the above definitions Nature of Managerial economics can be traced easily.
By Pashupati Nath Verma
MGT 105: MANAGERIAL ECONOMICS: UNIT-I
NATURE OF MANAGERIAL ECONOMICS
1. Managerial Economics is application oriented and uses the body of economic concepts and principles. Thus, we can say
managerial economics is Pragmatic (i.e. practical) in approach.
2. Managerial Economics is mainly used for managerial decision making and forward planning.
3. Managerial economics is deep rooted with micro-economics but it also uses macroeconomics concept also as both are
equally important for decision making and business analysis. Further, Managerial economics heavily depends on
mathematical and optimization techniques. Thus, we can say managerial economics is Eclectic (i.e. diverse).
4. Managerial Economics is more ‘Normative’ (i.e. focuses on prescriptive statement and help establishing rule aimed at
attaining the specified goal of business) than ‘Positive’ (i.e. describing the phenomenon). It is positive when it is confined to
statements about causes and effects and to functional relationships of economic variables. It is normative when it involves
norms and standards, mixing them with cause and effect analysis.
5. Managerial Economics is a Management Oriented Tool.
Demand Analysis and Forecasting: A business firm is an economic organisation which transforms productive resources into
goods to be sold in the market. A major part of business decision making depends on accurate estimates of demand. Demand
analysis and forecasting provided the essential basis for business planning and occupies a strategic place in managerial
economic. The Demand Analysis and Forecasting mainly covers: Demand Determinants, Demand Distinctions and Demand
Forecast.
Cost and Production Analysis: A study of economic costs, combined with the data drawn from the firm’s accounting records, can
yield significant cost estimates which are useful for management decisions. Production analysis frequently proceeds in physical
terms while cost analysis proceeds in monetary terms. The Cost and Production Analysis mainly covers : Cost concepts and
classification, Cost-output Relationships, Economics and Dis-economics of scale, Production function and Cost control.
Pricing Decisions, Policies and Practices: The success of a firm largely depends on how correctly the pricing decisions are taken.
The important aspects dealt with under pricing includes: Price Determination in Various Market Forms, Pricing Method,
Differential Pricing, Product-line Pricing and Price Forecasting.
Profit Management: In a world of uncertainty, expectations are not always realized so the profit planning and measurement
constitute a difficult area of managerial economic. The important aspects covered under this area are: Nature and Measurement
of profit, Profit policies and Technique of Profit Planning like Break-Even Analysis.
Capital Management: Among the various types business problems, the most complex and troublesome for the business
manager are those relating to a firm’s capital investments. Capital management implies planning and control of capital
expenditure. The important aspects covered under this area are: Cost of capital Rate of Return and Selection of Projects.
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Managerial economics applies microeconomic theories and techniques to management decisions. It is more limited in scope as
compared to microeconomics.
Macroeconomists study aggregate indicators such as GDP, unemployment rates to understand the functions of the whole
economy. Macroeconomics models and their estimates are used by the government to assist in the development of economic
policy.
Microeconomics and managerial economics both encourage the use of quantitative methods to analyze economic data.
Managerial economic principles can aid management decisions in allocating these resources efficiently.
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The steps for decision making like problem description, objective determination, discovering alternatives, forecasting
consequences are described below:
Make a Choice
Once all the analysis and scrutinizing is completed, the preferred course of action is selected. This step of the process is said to
occupy the lion’s share in analysis. In this step, the objectives and outcomes are directly quantifiable. It all depends on how the
decision maker puts the problem, how he formalizes the objectives, considers the appropriate alternatives, and finds out the
most preferable course of action.
Normative Science studies things as they ought to be. Ethics, for example, is a normative science. The focus of study is ‘What
should be’. In other words, it involves value judgment or good and bad aspects of an event. Therefore, normative science is
perspective rather than descriptive.
Managerial economics also has a normative approach as it suggests the best course of an action after comparing pros and cons
of various alternatives available to a firm. It also helps in formulating business policies after considering all positives and
negatives, all good and bad and all favors and disfavors. For instance, if a firm wants to raise 10% price of its product, it will
examine the consequences of it before raising its price. The hike in price will be made only after ascertaining that 10% rise in
price will not have any adverse impact on the sale of the firm.
On the basis of the above arguments and facts, it can be said that managerial economics is a blending of positive approach
with normative approach. It is positive when it is confined to statements about causes and effects and to functional
relationships of economic variables. It is normative when it involves norms and standards, mixing them with cause and effect
analysis. Managerial economics is not only a tool making, but also a tool using science. It not only studies facts of an economic
problem, but also suggests its optimum solution.
OPTIMIZATIONS:
Optimization is the process of finding an alternative with the most cost effective or highest achievable performance under the
given constraints, by maximizing desired factors and minimizing undesired ones. Optimization is very crucial activity in
managerial decision making process. According to the objective of the firm, the manager tries to make the most effective
decision out of all the alternatives available.
The optimal decisions differ from company to company ( Why???), and Practice of optimization is restricted by the lack of
full information, and the lack of time to evaluate what information is available.
The first step in optimization is to examine the methods to express economic relationship. Expression may be in the form of
Table, Graph, or by some Algebraic Expression. This Expression (Model) is then analyzed for optimization. We usually depend
upon mathematical concepts and operation research for optimization. In computer simulation (modeling) of business problems,
optimization is achieved usually by using linear programming techniques of operations research.
ECONOMIC MODEL
An economic model is a simplified description of reality, designed to yield hypotheses about economic behavior that can be
tested. Theoretical economic models seek to derive verifiable implications about economic behavior.
Types of Models
1-Visual Models, 2-Mathematical models 3-Empirical models 4-Simulation models
Visual Models
Visual models are simply pictures of an abstract economy; graphs with lines and curves that tell an economic story. These
models are relatively easy to understand, but are somewhat limited in their scope.
Mathematical Models
These are systems of mathematical equations relating number of economic variables. Some of these models can be quite large.
Even the smallest will have five or six equations and as many unknown variables. The manipulation and use of these models
require a good knowledge of algebra or calculus and operation research.
Few examples of mathematical model relating to demand and supply may be as follows:
S=a+bP or D=a+bP2, Here S denotes Supply, D denotes Demand and P price.
Empirical Models
Empirical models are mathematical models designed by use of empirical data. Empirical models aim to verify the qualitative
predictions of theoretical models and convert these predictions to precise, numerical outcomes.
For example, suppose in an economic study the following question is asked: "What will happen to investment if income rises
one percent?" The purely mathematical model might only allow the analyst to say, "Logically, it should rise. “ The user of the
empirical model, on the other hand, using actual historical data for investment, income, and the other variables in the model,
might be able to say, "By my best estimate, investment should rise by about two percent.
Simulation Models
A simulation model is a mathematical model that calculates the impact of uncertain inputs and decisions we make on outcomes
that we care about, such as profit and loss, investment returns, and environmental consequences in an experimental condition.
The computerized simulation model can show the interaction of numerous variables all at once, including hidden feedback and
secondary effects that are not so apparent in purely mathematical or visual models. Such a model can be created by writing
code in a programming language, statements in a simulation modeling language, or formulas in a Microsoft Excel spreadsheet.
STATIC VS. DYNAMIC MODEL
Economic analysis can be conducted either by using a static framework (static model) or a dynamic setting (dynamic model).
Static and dynamic modes of analysis can be differentiated in more than one ways.
In a static model (theory) the variables (cause-effect) are not dated i.e. they does not change with time. The demand-supply
model of market behavior is a static model. The model that demand depends on own price, supply depends on own price, with
an equilibrium condition that demand must equal supply, time does not enter into the picture at all and the variables are all
undated.
A dynamic model would be one where the relevant variables are dated i.e. they change with time. According to this criterion the
following would be a dynamic model.
Dt = f( Pt )
St = g( Pt-1 )
Dt = St
There is no lag in the demand relationship. Demand in period‘t’ depends on own price of the same period.
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However, in the supply relationship a gestation lag exists. Supply in period‘t’ depends on price prevailing in the previous period
(t-1). The price level in previous period (t-1) would have induced the producers to increase or decrease the supply, full impact of
such decisions are visible in time period ‘t’ only. For market to attain equilibrium, demand in period‘t’ must equal supply in
period ‘t’.
It must be noted that if one is concerned with the equilibrium configurations of a market for a good, one has to take recourse to
a static methodology. Equilibrium is a static concept. It describes the position of a market at rest. In contrast, disequilibrium
analysis must pertain to dynamics. In a static framework, we implicitly assume that market adjustment is instantaneous, and
without any loss of time, equilibrium is or is not restored. How the economic agent behaves in the disequilibrium situation is not
the concern of static analysis. This is where dynamic analysis sets in.
Types of Demand:
Individual’s Demand and Market Demand
Firm and Industry Demand
Demand by Market Segments and by Total Market
Autonomous and Derived Demand
Domestic and industrial demand:
New and replacement demand
A firm would be interested in the market demand for its products while each consumer would be concerned basically with only
his own individual demand.
product. For instance, the price of water, electricity, coal etc. is deliberately kept low for domestic use as compared to their
price for industrial use.
DEMAND CURVE: A demand curve is a locus of points showing various alternative price quantity combinations. The demand
schedule can be converted into a demand curve by plotting curve between Price & Demand in which prices are kept on vertical
axis and quantity on horizontal axis. Demand curve slopes downwards (negatively).
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DX = f ( Px, Ps, Pc, Yd, T, A, W, C, E, P, G, U) A simplest demand function may be linear, otherwise it may
Here be non linear. Some specific demand functions are
Dx = Demand for x commodity (say, tea)
Px = Price of x commodity (of tea) a p
Ps = Price of substitute of x commodity (coffee) q
b
Pc = Price of complementary goods of x commodity
a
(sugar, milk) q b
Yd = Disposable income of the consumer pc
T = Taste and Preference of the consumer
A = Advertisement of x commodity a p
q
W = Wealth of purchaser b
C = Climate bp
E = Price expectation of the consumer q ae
P = Population
G = Govt. policies pertaining to taxes and subsidies
U = Other factors (unspecified/unidentified) Here a, b and c are constant, p denotes price and q demand.
Example of a Linear Demand Function for a commodity X Example of a Non-Linear Demand Function for a commodity
Dx =200-7Px D =1280(0.75)P
Corresponding Demand Schedule Corresponding Demand Schedule
In case of the changes in quantity demanded it can be shown on original demand curve by moving upward or downward on the
curve itself. But, in case of change or shift in demand, whole demand curve shift to the left or right from its previous location.
D
Contraction
of Demand
Price
3
Expansion of
(A) Demand
Px
2
D1
D D1 Increase in dd
1 D2 decrease in dd.
D2
10 D
20 30
X
O QD O Q.D. X
Price
holds only in the short run. Law of demand is an empirical law, i.e., this law
is based on observed facts and can be verified with new empirical data. 4
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IMPORTANCE TO GOVERNMENT: If elasticity of demand of a product is low then government will impose heavy taxes on the
production of that commodity and vice – versa. The concept of elasticity of demand also helps the government in fixing an
appropriate foreign rate of exchange for its domestic currency in relation to the currencies of other countries. Before deciding to
devalue or revalue domestic currency in relation to foreign currencies the government has to study carefully the elasticites of
demand for its imports and exports.
IMPORTANCE IN FOREIGN MARKET: If elasticity of demand of a produce is low in the international market then exporter can
charge higher price and earn more profit. It is possible to calculate the terms of trade between two countries only by taking into
account the mutual elasticities of demand for each other’s products.
The rate of foreign exchange is also considered on the elasticity of imports and exports of a country.
IMPORTANCE TO BUSINESSMEN: The concept of elasticity is of great importance to businessmen. When the demand of a good
is elastic, they increases sale by towering its price. In case the demand' is inelastic, they are then in a position to charge higher
price for a commodity.
IMPORTANCE TO TRADE UNION: The trade unions can raise the wages of the labor in an industry where the demand of the
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product is relatively inelastic. On the other hand, if the demand, for product is relatively elastic, the trade unions cannot press
for higher wages.
Illustration1: Yesterday, the price of envelopes was $3 a box, Illustration2 : If Neil's elasticity of demand for hot dogs is
and Julie was willing to buy 10 boxes. Today, the price has constantly 0.9, and he buys 4 hot dogs when the price is $1.50
gone up to $3.75 a box, and Julie is now willing to buy 8 boxes. per hot dog, how many will he buy when the price is $1.00 per
Is Julie's demand for envelopes elastic or inelastic? What is hot dog?
Julie's elasticity of demand? Solution:
Solution: In the case of John let the new demand is X, %Change in
% Change in Quantity Quantity = (X – 4)/4.
(%∆Q) = (8-10)/(10)=-0.20=-20% or 20% (omit negative sign ) % Change in Price = (1.00 - 1.50)/(1.50) = -33%
% Change in Price Therefore:
(%∆P) = (3.75-3.00)/(3.00) = 0.25 = 25% . Elasticity = 0.9 =%∆Q/(%∆P=(X – 4)/4/(33%)
0.9 =(X – 4)/4)/(0.33)
Elasticity (eP) =%∆Q/%∆P= (-20%)/(25%) = 0.8 ((X - 4)/4) = 0.33/.9
Julie's elasticity of demand is inelastic, since it is less than 1. (X - 4)/4=0.37
X-4=1.47
X=5.47
PM
Price elasticity of demand
PR
MATHEMATICAL METHOD
If we have given Demand function in the form of Q=f(P) then price elasticity will
be given by dQ P
ep
dP Q
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Illustration4: If the equation for an item is Q 18 10 p - 3p , determine the price elasticity of demand at p=1.
2
Price Per Pen ($) Quantity Demanded Total Expenditure /Total Outlay
5 60 300
2 100 200
In the fig at a price of $5 per pen the quantity demanded is 50 pens. The total expenditure
is OABC ($300). At a lower price of $2, the quantity demanded is 100 pens.
The total expenditure is OEFG ($200). Since OEFG is smaller than OABC, this implies that
the change in quantity demanded is proportionately less than the change in price. Hence
price elasticity of demand is less than one or inelastic.
ARC METHOD
When we measure elasticity between any two particular points of the demand curve, it is
known as ARC elasticity of demand. When there is a major change in price or in a demand then
ARC elasticity of demand method is appropriate for the economist.
Original Quantity - New Qunatity/O riginal Quantity New Qunatity
Price elasticity of demand
OriginalPrice - New Price/Original Price New Price
Q P1 P2
Symbolical ly, e p X
P Q1 Q2
Where P1 & Q1 are price and quantity at first point (say, original price and quantity) and
P2 & Q2 are price and quantity at second point (say, new price and quantity)
Illustration6: Given the following Demand Schedule, price elasticity of demand between prices
9 to 11 will be calculated as follows:
Demand schedule
PRICE QUANTITY
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9 164
10 160
11 156
Example 2: Consider the markets for widgets and cogs. You study survey data and observe that if widgets cost $5, then 100
widgets are demanded. You also observe that if widgets cost $3, then 150 cogs are demanded and if widgets cost $4 then 100
cogs are demanded. If cogs cost $2, then 125 cogs are demanded. • Can the Price-Elasticity of Demand be calculated for either
good? • If so, calculate the PED.
Example 3: Consider the market for widgets and cogs . You study survey data and observe that if widgets cost $5, then 100
widgets are demanded and 60 cogs are demanded. You also observe that if widgets cost $3, then 200 widgets are demanded
and 100 cogs are demanded. If cogs cost $2, then 125 cogs are demanded. • Can the Price-Elasticity of Demand be calculated for
either good? • If so, calculate the PED.
Example4: Calculate the elasticity coefficient from the data above for the interval where price changes from 8 to 7. Where is the
range of unit price elasticity of demand for the following demand curve?
Price 8 7 6 5 4 3
Quantity 3 4 5 6 7 8
Example5: If the price of good X decreases by 2.1% and the price elasticity of demand is 0.4, find the percentage change in
quantity demanded and the percentage change in revenue. If you want to increase revenue should you increase or decrease the
price in this case?
Ratan Sethi opened a petrol-pump cum retail store on Delhi – Agra Highway about two-hour drive from Delhi. His store sells
typical items needed by highway travelers like fast foods, cold drink, chocolates, hot coffee, children’s toys etc. He charges
higher price compared to the sellers in Delhi, yet he is able to maintain brisk sales – particularly of “Yours’ Special Pack” (YSP)
consisting of soft drink in a disposable plastic bottle and a packer of light snacks. The Highway travellers prefer to stop at his
store because, while their cars wait for with some other item in the store). Each year he could substantially enhance his sales by
providing Special Summer Price on YSP which is almost half of its regular price.
Last year while returning from Delhi, Ratan found that a new, big and modern grocery shop has come up 15 kms from Delhi on
the National Highway. It has affected his sales but only marginally. But last month another large convenience store has opened
just 5 km away from his store. He knows that the challenge has come to his doorsteps and he expects to be adversely affected
by the existence of these two stores. He needs to meet this challenge and decides to use the pricing strategy which he has been
using quite effectively till recently. He now permanently reduces the price of YSP to half of its existing price. But at the end of
the year Ratan finds that his sales in general and of YSP in particular had declined by 20 percent.
Q2. If he was a managerial economist, how do you think he would have handled the situation?
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In general, an estimation technique can be used to forecast demand but a forecasting technique cannot be used to estimate
demand. A manager who wishes to know how high demand is likely to be in two years’ time might use a forecasting technique.
A manager who wishes to know how the firm’s pricing policy could be used to generate a given increase in demand would use
an estimation technique
STAGES IN DEMAND ESTIMATION
Demand estimation involves a number of stages. Some of these stages may be omitted in the simpler methods of estimation,
like the first two steps (for simpler estimates). However, with a statistical study, or econometric analysis there are essentially
seven stages:
1. Statement of a theory or hypothesis: Identification of relationship between economic variables(Usually based on some
empirical experience or based on some well established theory)
An example of such a theory might be that the quantity people buy of a particular product might depend more on the past
price than on the current price
2. Model specification: Developing mathematical equation satisfying relationship between economic variables
Various alternative models may be specified at this stage, since economic theory is often not robust enough to be definitive
regarding the details of the form of model.
3. Collection of Data: Collecting data related to economic variables considered in Model developed earlier from relevant
sources.
4. Estimation of parameters of the Model: On the basis of collected data, parameters values are estimated (these values
parameter defines that how and how much the different variables are related)
5. Checking goodness of fit. Once a model, or maybe several alternative models, have been estimated, it is necessary to
examine how well the models fit the data and to determine which model fits best.
6. Hypothesis testing. Having determined the best model, we want to test the hypothesis stated in the first step; in the
example quoted we want to test whether current price or past price has a greater effect on sales.
7. Development of estimates based best model.
CONSUMER SURVEYS: (Questioning the consumer to determining his behavior). These are based questioning the consumer to
determining his consumption behavior using questionnaire, interviews etc.
Advantages:
• They give up to date information about the current market scenario.
• Much useful information can be obtained that would be difficult to uncover in other ways; for example, if consumers
are ignorant of the relative prices of different brands, it may be concluded that they are not sensitive to price changes.
This can be exploited by the firms for their best possible interest.
Disadvantages: Validity, Reliability, Sample Bias.
MARKET EXPERIMENTS: (Direct market experiments to understand the changes in demand due to changes in it s depended
variables) Here consumers are studied in an artificial environment. Laboratory experiments or consumer clinics are used to test
consumer reactions to changes in variables in the demand function in a controlled environment. Experimenter need to be
careful in such experiments as the knowledge of being in the artificial environment can affect the consumer behavior.
Advantages:
Direct observation of the consumers takes place rather than something of a hypothetical theoretical model.
Disadvantages:
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There is less control in this case, and greater cost; furthermore, some customers who are lost at this stage may be difficult to
recover.
Experiments need to be long lasting in order to reveal proper result.
STATISTICAL TECHNIQUES: These are various quantitative methods to find the exact relationship between the dependent
variable and the independent variable(s).
• The most common method is regression Analysis :
• Simple (bivariate) Regression: Y = a + bX
• Multiple Regression: Y = a +bX1 + c X2 +dX3 +..
1. LONG TERM DEMAND (forecast are related to the need for capacity expansion or reduction depending upon the demand in
the long run ie more than 5 years)
2. MEDIUM TERM FORECAST (deals with business cycles that usually last for periods from two to five years.)
3. SHORT TERM DEMAND (forecast is done for production schedules of less than one year; It is done to deal with annual
variations in sales).
APPROACHES TO FORECASTING
1. JUDGMENTAL APPROACHES: the forecast is based upon the judgment and expertise of experts.
2. EXPERIMENTAL APPROACHES: A demand experiment is conducted among a small group of consumers who are adequately
representative of characteristics of general population. This type of approach is adopted when the product being introduced
is new, and there is no pre-existing data available.
3. RELATIONAL CAUSAL APPROACHES: Interviews and other methods are used to determine the reasons why consumers
purchase a particular product. Once these reasons are clear, the forecast can be done.
4. TIME SERIES APPROACHES: Sales and other data for different markets, for different periods of time is analyzed to get a
general trend or pattern in sales.
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The methods used may be divided broadly into two categories, qualitative and quantitative. Demand forecasting is full of
uncertainties due to changing conditions. Consumer behavior is unpredictable as it is motivated and influenced by a multiplicity
of forces. Every method developed for forecasting has its advantages and disadvantages and selection of the right method is
crucial to make as accurate as possible forecast. A right combination of quantitative and qualitative methods is to be used.
QUALITATIVE TECHNIQUES
Qualitative techniques are generally used when there is insufficient data available for quantitative analysis. They are also known
as subjective methods as they are dependent upon intuition based on experience, intelligence, and judgment. They are also
preferred for giving a quick estimate and cost savings.
Some of these techniques are as follows
OPINION POLE METHODS: As the name suggest, forecast in this method is subjected to opinion of respondent. Respondents
may be either of the Consumers or Sales-force or Experts. On the basis of respondent we can further classify this category as
follows:
1. Consumer’s Survey or Survey of Buyer’s Intention
2. Sales force opinion
3. Experts Opinion
CONSUMER’S SURVEY OR SURVEY OF BUYER’S INTENTION: Under this category consumers are surveyed (in personal or by
phone or by post or using internet) to know the consumer’s buying intention about the product during a specific time period.
While surveying, there are three main methods for the interviews.
Complete Enumeration method: All the Sample Survey Method: A sample of End use Method: Information about the
consumers of the product are consumers is interviewed. end use of the product is collected from
interviewed and their future plans for Advantage: Low Cost the industrial users to calculate the
product is ascertained. Disadvantage: Requires expertise. demand in industries, exports etc.
Advantage: First hand unbiased Advantage: Useful in case of
information intermediate product
Disadvantage: High Cost, Disadvantage: Not useful in case of, ‘too
many’ end uses
SALES FORCE OPINION METHODS: This method is based on gathering opinion of sales personnel who are closer to customers.
Method can be used to forecast competitive technologies that are emerging in the market.
Advantage: Low Cost, Fast, May be used for new product.
Disadvantage: Not useful for long range forecast, Correction and Adjustment factor needed.
EXPERT’S OPINION METHODS: This is a qualitative forecasting technique in which a panel of experts working together in a
meeting arrives at a consensus through discussion & ranking the ideas. Subjective estimates of experts are identified. Method
emphasize on group exercise. It involves key stakeholders: company executives, dealers, distributors, suppliers, marketing
consultants, professional association members.
Advantage: Easy and Quick method of forecasting
Disadvantage: Too much weight to executives opinions truth telling??
TREND PROJECTION: Time series analysis in statistics provides techniques by which all trend components, cyclic component &
Seasonal Component and their effects on demand are isolated and identified. Techniques used for measuring the trend are:
Graphical Method Method of Semi-Averages Method of Moving Averages Method of Least Square
Annual Sales data is Entire set of historical data is In this method an averaging period By the method of least square a
plotted on paper and divided in to two parts. A is selected and forecast for the functional relation between
trend line is drawn trend line is drawn through next period is the arithmetic demand and its determinant is
through the points the averages of the two average of the AP most recent developed by the use of this
for making halves for making forecast. actual demands. functional relation demand is
projection/forecast. This technique is useful only This technique is useful when forecasted.
This method is simple in case of linear trend there is a cyclic variation the Functional relation by this
and less expensive. demand. Sometimes weighted method may be a polynomial or
MAs also used. an exponential relation.
METHOD OF REGRESSION ANALYSIS: Regression analysis establishes a relationship between a dependent variable and one or
more independent variables. In simple linear regression analysis there is only one independent variable. Simple linear regression
can also be used when the independent variable X represents a variable other than time. Multiple regression analysis is used
when there are two or more independent variables.
An example of a multiple regression equation is:
Y = 50.0 + 0.05X1 + 0.10X2 – 0.03X3
where: Y = firm’s annual sales ($millions)
X1 = industry sales ($millions)
X2 = regional per capita income ($thousands)
X3 = regional per capita debt ($thousands)
BOX JENKINS METHOD: Box Jenkins Method also known as ARIMA(‘Auto-Regressive Integrated Moving Average’) models, this is
an empirically driven method of systematically identifying, estimating, analyzing and forecasting time series. This method is used
only for short term predictions since it is suitable only for demand with stationary time series sales data, i.e. the one that does
not reveal the long term trend.
The models are designated by the level of auto regression, integration and moving averages (P,d,q) where P is the order of
regression, d is the order of integration and q is the order of moving average.
There are 3 components of the ARIMA process:
AR(Autoregressive) process.
MA(Moving Average) process.
Integration process.
AR process: Of order ‘p’, generates current observations as a weighted average of the past observations over p periods,
together with a random disturbance in the current period.
Yt=μ+a1Yt-1+a2Yt-2+….+apYt-p+et
MA process: Order q, each observation of Yt is generated by the weighted average of random disturbances over the past q
periods.
Yt= μ +et-c1et-1-c2et-2+….-cqet-q
Integrated Process: Ensures that the time series used in the analysis is stationary. The previous 2 equations are combined to
form:
Yt=a1Yt-1+a2Yt-2+...+apYt-p+μ+et-c1et-1-c2et-2+…-cqet-q
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