Unit 1: Forecasting fundamentals
Business Forecasting notes · PTU syllabus (MBA 964-18)
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Unit summary
Forecasting demand is the starting point for budgets, production, inventory and investment. This unit covers the significance of demand analysis and forecasting, determinants of demand, elasticity, revenue and profit estimation, selection of forecasting techniques, and the purposes of forecasts and types of users.
After this unit you can
- Explain the significance of demand analysis and forecasting
- Analyse determinants and elasticity of demand
- Estimate revenue and profit from demand forecasts
- Select forecasting techniques for different purposes and users
PTU syllabus topics
- Significance of demand analysis and forecasting
- determinants of demand
- elasticity
- revenue and profit estimation
- forecasting technique selection
- purpose of forecast and types of users
Qualitative
Expert opinion, Delphi, surveys
Time series
Moving averages, smoothing, ARIMA
Causal
Regression, econometric models
Barometric
Leading indicators
Topic 1
Significance of demand analysis and forecasting
- Demand forecasting: estimating future demand for a product under given conditions.
- Significance: production and capacity planning, inventory and purchasing, sales targets and budgets, pricing, workforce planning, investment and financing decisions, reducing uncertainty.
- Levels: firm, industry, economy; horizon: short term (operational), medium term (budgets), long term (capacity, strategy).
Topic 2
Determinants of demand
Demand is the quantity of a commodity that consumers are willing and able to buy at a given price during a period. Demand function: Qd = f(P, Pr, Y, T, A, E, N) — own price, prices of related goods, income, tastes, advertisement, expectations, population.
- Law of demand: other things being equal, quantity demanded rises when price falls and falls when price rises.
- Reasons: income effect, substitution effect, law of diminishing marginal utility, new buyers, multiple uses.
- Exceptions: Giffen goods, Veblen (prestige) goods, expectation of further price rise, ignorance, necessities.
Cause
Change in own price
Change in other determinants
Terms
Extension and contraction
Increase and decrease
Graph
Same curve
New curve to the right or left
Topic 3
Elasticity of demand
Elasticity of demand measures the responsiveness of quantity demanded to a change in a determinant.
Price elasticity (Ep)
% change in quantity demanded ÷ % change in price
Arc elasticity
(ΔQ ÷ ΔP) × ((P1 + P2) ÷ (Q1 + Q2))
Income elasticity (Ey)
% change in quantity ÷ % change in income
Cross elasticity (Exy)
% change in quantity of X ÷ % change in price of Y
Total outlay method
Ep > 1 if total spending rises when price falls
| Degree of price elasticity | Value | Example |
|---|---|---|
| Perfectly elastic | ∞ | Theoretical; perfect competition firm's demand |
| Relatively elastic | > 1 | Luxuries, cars, air travel |
| Unitary elastic | = 1 | Rectangular hyperbola |
| Relatively inelastic | < 1 | Necessities — salt, medicines |
| Perfectly inelastic | 0 | Life-saving drugs (approx.) |
Example
Price falls from ₹10 to ₹8 and quantity rises from 100 to 130 units. Ep = (30/100) ÷ (2/10) = 0.30 ÷ 0.20 = 1.5 — elastic, so cutting price raises total revenue (₹1,000 → ₹1,040).
- Income elasticity: positive for normal goods (> 1 luxury, 0–1 necessity), negative for inferior goods.
- Cross elasticity: positive for substitutes (tea and coffee), negative for complements (car and petrol).
- Determinants of price elasticity: availability of substitutes, nature of the good, proportion of income spent, number of uses, time period, habits.
- Managerial uses: pricing, taxation policy, wage fixing, joint products, international trade.
Topic 4
Revenue and profit estimation
Total revenue
Price × forecast quantity
Marginal revenue
Change in TR ÷ change in quantity — MR = P(1 − 1 ÷ abs(e))
Profit
Total revenue − total cost
Break-even quantity
Fixed costs ÷ (price − variable cost per unit)
Example
Forecast sales 50,000 units at ₹200; variable cost ₹120; fixed costs ₹25 lakh. Revenue ₹1 crore; contribution ₹40 lakh; profit ₹15 lakh; break-even 31,250 units.
- Scenario estimation: optimistic, most likely and pessimistic forecasts give a range for revenue and profit.
Topic 5
Selecting a forecasting technique
Purpose and horizon
Short-term operations vs long-term strategy
Data availability
History length, quality, frequency
Pattern in data
Trend, seasonality, cycles, randomness
Accuracy required
Cost and time
Users' understanding
Simplicity and credibility
New product, no history
Little data
Surveys, expert opinion, Delphi, analogy
Stable product, short term
Good history
Moving averages, exponential smoothing
Trend and seasonality
Several years of data
Decomposition, Holt–Winters, ARIMA
Drivers known
Causal data available
Regression and econometric models
Topic 6
Purposes of forecasts and types of users
| User | Forecast needed |
|---|---|
| Production and operations | Short-term demand by product and location |
| Marketing and sales | Sales by segment, promotion response, market share |
| Finance | Revenue, cash flows, capital needs |
| HR | Workforce requirements |
| Top management | Long-term market growth, scenarios for strategy |
| Government and policy makers | GDP, inflation, employment, tax revenue |
Key terms
- Demand forecasting
- Estimating future demand
- Price elasticity
- Responsiveness of quantity to price
- Marginal revenue
- Change in total revenue from one more unit
- Break-even quantity
- Volume where revenue equals total cost
- Forecast horizon
- Period ahead covered by a forecast
Quick revision
- Significance, levels and horizons of forecasting.
- Determinants of demand; price, income, cross and advertising elasticity.
- Revenue, MR, profit and break-even from forecasts.
- Technique selection criteria and situations.
- Users and their forecast needs.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.State three uses of demand forecasts.
- Q2.Name four determinants of demand.
- Q3.What is income elasticity?
- Q4.State the relation between MR and elasticity.
- Q5.Name three criteria for choosing a forecasting technique.
- Q6.Which techniques suit a new product?
Long-answer questions
- Q1.Explain the significance of demand analysis and forecasting.
- Q2.Discuss determinants and elasticity of demand.
- Q3.Explain revenue and profit estimation from demand forecasts.
- Q4.Discuss the selection of forecasting techniques for different purposes and users.
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