elasticity & forecasting 3

8/8/2019 Elasticity & Forecasting 3

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Elasticity and Its

Application


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Elasticity The concept The responsiveness of one variable to

changes in another

When price rises what happens to

demand?

Demand falls

BUT!

How much does demand fall?


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Elasticity The concept If price rises by 10% - what happens to

demand?

We know demand will fall

By more than 10%?

By less than 10%?

Elasticity measures the extent to which

demand will change


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Elasticity . . .

is a measure of how much buyers and

sellers respond to changes in marketconditions

allows us to analyze supply anddemand with greater precision.


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Price Elasticity of Demand

Price elasticity of demand is the

percentage change in quantity demanded

given a percent change in the price.

It is a measure of how much the quantity

demanded of a good responds to a changein the price of that good.


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Determinants of


Necessities versus Luxuries

Availability of Close Substitutes

Time Horizon


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Determinants of


Demand tends to be more elastic :

if the good is a luxury. the longer the time period.

the larger the number of close

substitutes.


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Computing the Price Elasticity

of Demand

The price elasticity of demand is computed

as the percentage change in the quantity

demanded divided by the percentage

change in price.

Price Elasticity of Demand =

Percentage Changein Quantity Demanded

Percentage Changein Price

Price Elasticity of Demand =

Percentage Changein Quantity Demanded

Percentage Changein Price

The Percentage Method


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Computing the Price Elasticity

of Demand

priceicha gePerce tage

dema dedq atityicha gePerce tagedema d ofelasticityPrice !

Example: If the price of an ice cream cone increases

from 2.00 to 2.20 and the amount you buy falls from 10

to 8 cones then your elasticity of demand would be

calculated as:

2percent10

percent20

100

002

002202

10010

810

!!

v

v

.

)..(

)(


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Ranges of Elasticity

Perfectly InelasticQuantity demanded does not respond to

price changes.

Inelastic Demand

Quantity demanded does not respond

strongly to price changes.

Price elasticity of demand is less t an one.


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Ranges of Elasticity

Unit ElasticQuantity demanded changes by the samepercentage as the price.

Elastic DemandQuantity demanded responds strongly tochanges in price.

Price elasticity of demand isgreater t an one.

Perfectly ElasticQuantity demanded changes infinitely with anychange in price.


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A Variety of Demand Curves

Because the price elasticity

of demand measures howmuch quantity demanded

responds to the price, it is

closely related to the slope ofthe demand curve.


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Inelastic Demand

- Elasticity is less than 1

Quantity

Price

4

51. A 25%increasein price...

Demand

100902. ...leads to a 10% decrease in quantity.


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Unit Elastic Demand

- Elasticity equals 1

Quantity

Price

4


Demand



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Elastic Demand

- Elasticity is greate

rthan 1

Quantity

Price

4


Demand



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Perfectly Elastic Demand

- Elasticity equals infinity

Quantity

Price

Demand4

1. At any priceabove 4, quantity

demanded is zero.

2. At exactly 4,

consumers willbuy any quantity.

3. At a price below 4,quantity demanded is infinite.


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ElasticityPrice

Quantity Demanded

D

The importance ofelasticity is theinformation itprovides on theeffect on totalrevenue ofchanges in price.

5

100

Total revenue isprice x quantitysold. In this

example, TR = 5 x100 = 500.

This value isrepresented by theshaded rectangle.

Total Revenue


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ElasticityPrice

Quantity Demanded

D

If the firm decidesto decrease price

to (say) 3, thedegree of priceelasticity of thedemand curvewould determinethe extent of the

increase indemand and thechange thereforein total revenue.

5

100

3

140

Total Revenue


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ElasticityPrice

Quantity Demanded

D

10

5 20

Producer decides to reduce price to increase sales

7

% in Price = - 30%

% in Demand = + 300%

Ped = - 10 (Elastic)Total Revenue rises

Good Move!


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Elasticity

Ifdemand is priceelastic:

Increasing pricewould reduce TR(% Qd > % P)

Reducing price

would increase TR(% Qd > % P)

Ifdemand is priceinelastic:

Increasing pricewould increase TR

(% Qd < % P)

Reducing price

would reduce TR(% Qd < % P)


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Income elasticity of

demand =

incomeinchangePercentage

demandedquatityinchangePercentage


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Types of Income Elasticity

Zero Income Elasticity : Change in income has

no impact on quantity demanded.

Negative Income Elasticity : Increase in incomeleads the quantity demanded to fall.

Positive income Elasticity : Increase in income

leads the quantity demanded to increase. It can

be of three types : Low, Unitary & high.


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Income Elasticity ofDemand:

The responsiveness of demand to changes in

incomes.

Normal Good demand rises as income

rises and vice versa

Inferior Good demand falls as incomerises and vice versa


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Importance of Elasticity

Relationship between changes in price

and total revenue

Importance in determining what goods to

tax (tax revenue)

Importance in analysing time lags in

production

Influences the behaviour of a firm


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Demand Forecasting

A forecast is a prediction or anticipation

of any event which is likely to happen in

future.

Demand forecast is the prediction of the

future demand for a firms product.


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Forecasts are necessary for :

Scheduling of the production process.

Preparations of budgets.

Manpower Planning.

Setting targets of sales executives.

Advertising & promotion decisions.

Decisions about expansion of a firm. Other decisions like long term investment

plans, warehousing and inventory decisions.


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Methods of Demand

forecasting There are two different sets of methods

for demand forecasting :

Interview & survey methods ( for short

term forecasts )

Projection Approach ( for long term

forecasts )


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Interview and Survey approach

To anticipate the demand for a product,

information needs to be collected about

the expected expenditure patterns ofconsumers. Depending on the various

approaches to collect this information,

different sub methods are formulated. We will study them one by one.


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Executive Opinion :

In small companies, usually the owner

takes the responsibility of forecasting. As a result of the experience and

knowledge he is expected to have, he can

predict what would be the course ofactivities in future and plan his ownactivities accordingly.


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Opinion polling method : Information

about the consumers expenditure can be

collected either by the market researchdepartment or through the wholesalers

and retailers.

As a result of technologicaladvancements, it is now possible to collect

this information by the means of internet.


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Collective opinion method :

Jury is a group of individuals, usually the top

bosses or sales, production, marketingmanagers having experience in different fields.

The advantage of this method is that instead of

basing the forecast on the opinion ofone single

individual, a more accurate forecast can be

drawn.


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Users Expectations

Consumer and industrial companies

often poll their actual orpotential

customers.Some Industrial manufacturers ask

about the quantities ofproducts

their customers may purchase infuture and take this as theirforecast.


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Delphi Method

Administering a series ofquestionnaires to

panels ofexperts. This method gathers

information from all experts and the opinion of

all the experts is shared by all other experts.

In case ifan expert finds that his own forecast

is unrealistic, after going through the opinion

ofother experts, there is a chance for

corrections.


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Projection Approach

In this method, the past experience is

projected for the future. This can be done

by tow methods :

Correlation or regression analysis.

Time series analysis.


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Past sales can be used to forecast future demand.Past sales are viewed from the angles of trends,

various cycles ofbusiness, seasonality and then a

forecast is drawn a

fter checking the possibility o

fthe same treads, cycles and seasonality factors.

This method is easy to use, it is based on past

behavior and does not include new company,competitor or macroeconomic developments.

Classical approach to time series analysis:


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Nave Method

Next Years Sales = This Years Sales X This Years SalesLast Years Sales


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Moving Average

Moving averages are used to allow for

marketplace factors changing at different

rates and at different times.


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PERIOD

SALES

VOLUME

SALESFOR

THREE-YEAR

PERIOD

THREE-YEAR

MOVING

AVERAGE

1 200

2 2503 300 750

4 350 900 300

5 450 1100 ( 3) = 366.6

6 ?Period 6 Forecast = 366.6

EXAMPLEOF MOVING-AVERAGEFORECAST


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Trend Projections Least Squares

Eyeballfitting is simply a plot o

fthe data

with a line drawn through them that the

forecasterfeels most accurately fits the

linear trend of the data.


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600

500

400

300

200

100

0

1984

Time

1985 1986 1987 1988 1989 1990

Observed Sales Forecast Sales

Sales

TrendLine

ATREND FORECAST OFSALES


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Use of economic indicators

This method bases demand on certaineconomic indicators e.g,

Construction contracts sanctioned for thedemand for building material, say cement etc

Personal income for the demand for consumergoods

Automobile registration for the demand for

accessories, petrol etc. Agricultural income for the demand of

agricultural inputs, tractors, fertilizers etc.


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Categories of New Products

New-To-The-World

New Product Lines

Product Line Additions

Improvements/Revisions

Repositioned Products

Lower-Priced Products

SixCategories

ofNew

Products


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Forecasting of New Products

Evolutionary method : Whenever a new

product has been evolved from an existing

product ( eg. Colour TV from Black & WhiteTV), the information of the existing product

may be used for prediction of future for the

new product.

Substitution method : Many new goods arepurchased by customers for replacing the old

ones. ( Eg. LCD TVs in place of Colour TVs).


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Growth pattern methods : To predict the

demand for a new product, the growth pattern

of an established related goods can beunderstood.

Opinion polling method : This method

advocates the direct questioning to the

probable buyers or the influencers of sales ofsuch products. (Eg. demand for drugs can be

ascertained by asking the doctors )


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Sample survey method : A product is

first introduced in a test market ( small

city having profiles of customers ofmetros ). Responses from these markets

are taken as a base for forecasts.

Indirect opinion polling : Instead ofasking the probable buyers, here, the

resellers are consulted.

elasticity & forecasting 3

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